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Fiscal Cliff Averted

Well we might have fallen off the fiscal cliff at the end of 2012, but luckily Congress pulled out a parachute early on January 1st.  That morning Congress passed the "American Taxpayer Relief Act," which was approved by the House of Representatives just hours later and President Obama signed the act late on January 2nd.  This act prevented many of the tax hikes expected to go into effect this year and retained many favorable tax breaks that were set to expire.  However, the act does increase tax for some high income individuals. Here are the highlights…

Tax Rates

For tax years 2013 and beyond the income tax rates for individuals will stay at 10%, 15%, 25%, 28%, 33%, and 35%. However a rate of 39.6% will apply to taxpayers over a certain income threshold.  This threshold is $400,000 for single filers and $450,000 for joint filers.

Personal Exemption Phaseout

Beginning in 2013, the previously suspended personal exemption phaseout has been reinstated.  The starting threshold for this phaseout is $300,000 AGI for joint filers and $250,000 AGI for single filers.  Under the phaseout, every $2,500 over the threshold will result in a 2% reduction in the total amount of exemptions that can be claimed

Pease Limitations

Beginning in 2013, the previously suspended Pease limitation, which reduces itemized deductions, has been reinstated.  Thus joint filers with an AGI over $300,000 and single filers with an AGI of $250,000 will experience a reduction in itemized deductions of 3% of the amount over the threshold.  The maximum amount that can be reduced is 80% of the otherwise allowable itemized deductions.

Capital Gains and Dividend Rates

Now we start getting a little trickier.

Taxpayers exceeding $400,000 AGI single/$450,000 joint will permanently be subject to a capital gains and dividend rate of 20%.  When you take into account the 3.8% surtax, the overall rate for these taxpayers will be 23.8%.

Taxpayers falling above the 25% tax rate and with an AGI of $200,000 single/$250,000 joint will be subject to a 15% capital gains and dividend rate as well as the 3.8% surtax. This makes their overall rate on capital gains and dividends 18.8%.

Taxpayers that fall into or above the 25% tax rate but have AGI less than $200,000 single/$250,000 joint will pay a 15% rate on dividends and capital gains.

Taxpayers falling under the 25% tax rate will continue to permanently be subject to a 0% dividend and capital gains rate.

Transfer Taxes

The act increased the top estate and gift rate to 40%, but on the bright side the exemption level will stay at $5,000,000.

AMT

The act provides permanent Alternative Minimum Tax relief. The AMT is the excess of the tentative minimum tax for the year over the regular tax for the year.  To compute tentative minimum tax and individual begins with taxable income, and then modifies it with various adjustments and preferences.  The exemption amount is then subtracted to arrive at alternative minimum taxable income, which is subject to a rate of 26% or 28%.

Retroactively the act permanently increases these exemption amounts to $50,600 for single taxpayers and $78,750 for joint filers beginning with the 2012 tax year.

 

Subsequently, various other deductions and credits that were set to expire in 2011 and 2012 such as the American Opportunity Credit and the deduction of state taxes have been extended past their original expiration date.  However, some of these deductions and credits are set to expire at the end of 2013 so we will have to wait to see exactly how long their shelf life really will be.

If you have questions about how the American Taxpayer Relief Act will affect you, please feel free to contact us with any questions.

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