US Tax Law Changes: View from the Cliff
By Ken Meissner
(Second of three parts)
First Published in Business World (4/22/2013)
Last week, we discussed how the actions of US Congress to avert the so-called “Fiscal Cliff” have resulted in a slew of changes to US tax laws. These changes have brought some much needed stability to some previously uncertain tax provisions, and extended the lifespan of some other taxpayer-friendly provisions that were about to expire. We will continue discussing some of the main features of these tax changes.
Personal Exemptions reduced or eliminated for high income taxpayers. For 2013, each personal exemption reduces taxable income by US$3,900. A taxpayer and his/her spouse each get one exemption, plus one for each dependent. So for a family of four, personal exemptions reduce taxable income by US$15,600. But people whose taxable income goes beyond certain thresholds do not get the full value of the exemptions they would otherwise be entitled to. The thresholds vary depending on filing status: US$300,000 for couples filing jointly, US$275,000 for unmarried household heads, US$250,000 for single people, and US$150,000 for married people filing separate returns. The exemptions’ overall value is cut 2% for each US$2,500 (or fraction of US$2,500) of taxable income beyond a taxpayer’s threshold. That means exemptions are worth nothing if a taxpayer exceeds his threshold by US$122,501.
Some Itemized deductions lose value for high earners. Certain categories of itemized deductions (everything other than medical expenses, investment interest expense, casualty or theft losses, or gambling losses) are reduced for high income taxpayers whose taxable income exceeds certain thresholds. The thresholds are the same ones mentioned above that reduce the value of personal exemptions. Itemized deductions are cut by 3% of the portion of taxable income that exceeds a taxpayer’s threshold. However, the affected deductions cannot be reduced below 20% of their original value.
These reductions in exemptions and itemized deductions had been temporary features of the tax law that expired in 2010. Now they are back as permanent features of the Code. The thresholds that trigger these reductions will be subject to inflation adjustments starting in 2014.
Option to deduct state and local sales tax as an alternative to deducting state and local income taxes is extended. For a few years, taxpayers have had the option of deducting either (i) what they had paid for state and local income tax, or (ii) what they had paid for state and local sales tax. Deducting sales taxes is a useful option for someone who lives in a state with no income tax. Sometimes it is helpful for people who pay Alternative Minimum Tax (AMT) at the federal level and who live in states like New York that do not allow a state level deduction for state income tax. This option expired at the end of 2011, but has now been extended for 2012 and 2013.
AMT is restricted to high income taxpayers on a more reliable and permanent basis. The AMT is essentially a flat (or nearly flat) tax on a version of taxable income that has far fewer deductions, exemptions, allowances, credits, etc, than the regular tax. The AMT’s rates are lower than the regular tax, but the tax base (alternative minimum taxable income or AMTI) is much broader. Taxpayers are required to calculate their liability under both systems (the regular tax and the AMT). Anyone whose AMT liability is higher than the regular tax must pay that higher amount.
From the beginning, taxpayers were allowed one fairly generous exemption that reduced AMTI to ensure that very few low- or middle-income taxpayers would have to pay AMT. However, that initial AMT exemption was never adjusted or indexed for inflation. This meant that a tax initially designed to hit a handful of high rollers was increasingly likely to affect average American taxpayers. To keep this from happening, Congress got in the habit of enacting “patches” every year or two that would temporarily raise exemption amounts — which they often did at the last minute, and sometimes, retroactively.
Congress has now set the exemptions at a level that protects most ordinary taxpayers, and has added an inflation adjustment that makes this protection permanent. The new AMT exemption amounts are US$78,750 for couples filing jointly, US$50,600 for unmarried household heads and for single people, and US$39,375 for married people filing separate returns.
Certain credits will now reduce both regular tax and AMT. A number of the credits that reduce regular income tax were set to “sunset” at the end of 2011. The new law changed this by making the following credits permanently allowable against both the regular tax and the AMT:
• Child and dependent care credit
• Credit for the elderly and disabled
• Credit for interest paid or accrued on certain home mortgages of low-income persons
• Credit for energy-efficient improvements to a principal residence
• Credit for a personal-use qualified plug-in electric vehicle
• Credit for a personal-use alternative motor vehicle
• Credit for a personal-use qualified plug-in electric drive motor vehicle
Charitable contributions: Until the end of 2011, taxpayers who had reached age 70-1/2 could withdraw up to US$100,000 from a qualified retirement plan (IRA) and donate it to charity under three special conditions, namely: (1) The IRA withdrawal was not counted as part of the taxpayer’s gross income; (2) the taxpayer did not have to claim a charitable contribution deduction, which might be partially disallowed if it exceeded certain limits; and (3) The distribution could be counted as part of the required minimum withdrawal that people over 70-1/2 years of age must take each year. This could indirectly affect federal income tax liability by softening the impact of provisions that limit deductions keyed to a percentage of the taxpayer’s adjusted gross income (AGI). It might also be helpful for taxpayers in states that tax gross income and that allow limited or no itemized deductions.
The new law extends this tax break retroactively to the beginning of 2012 and continues it through the end of 2013.
Special temporary rules that maximize the benefit of charitable contribution deductions for “S corporation” shareholders whose corporations donate appreciated property are extended back to the beginning of 2012 through the end of 2013. Similar extensions back to 2012 and through the end of 2013 apply to rules affecting businesses’ donations of food inventory, and donations of “qualified conservation easements,” by individuals and by corporate farmers or ranchers.
In next week’s article, we will discuss the other significant changes to US tax laws.
Ken Meissner is a Tax Senior Director of SGV & Co.
To ensure compliance with requirements imposed by the Internal Revenue Service (IRS) of the United States of America (US), we inform you that any US tax advice contained in this communication was not intended or written to be used, and cannot be used, by the recipient, for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions.
This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinion expressed above are those of the author and do not necessarily represent the views of SGV & Co.