During a lame duck session in December 2010, Congress passed the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010. The act extended the Bush tax cuts for an additional two years and “patched” the exemptions to the Alternative Minimum Tax (hereinafter “AMT”) for tax year 2011. This act also authorized a one-year reduction in the Social Security (hereinafter “FICA”) employee payroll tax. This was extended for an additional year by the Middle Class Tax Relief and Job Creation Act of 2012, which also extended federal unemployment benefits and the freeze on Medicare physician payments.
On August 2, 2011, Congress passed the Budget Control Act of 2011 (hereinafter “BCA”) as part of an agreement to resolve the debt-ceiling crisis. The Act provided for a Joint Select Committee on Deficit Reduction (the “super committee”) to produce legislation by late November that would decrease the deficit by $1.2 trillion over ten years. When the super committee failed to act, another part of the BCA went into effect. This directed automatic across-the-board cuts (known as “sequestrations”) split evenly between defense and domestic spending, beginning on January 2, 2013. Also, the Affordable Care Act imposed new taxes on families making more than $250,000 a year ($200,000 for individuals) starting at the same time.
At the end of 2011, the patch to the AMT exemptions expired. Technically, the AMT thresholds immediately reverted to their 2000 tax year levels, a drop of 26% for single people and 40% for married couples. Anyone over these reduced thresholds at the end of 2012 would be subject to the AMT. Therefore, more taxpayers would pay more unless some legislation was passed (as was done in 2007) that affects the exemptions retroactively.
The fiscal cliff was finally eliminated at the very last minute during late night and early morning sessions of congress on New Year’s Eve and New Year’s Day. During a 2 a.m. vote on January 1, 2013, the Senate passed the American Taxpayer Relief Act of 2012 (hereinafter “The ATRA”) by a margin of 89–8. The House passed the bill without amendments by a margin of 257–167 at about 11 p.m. that same day. Eighty-five House Republicans and 172 Democrats voted in favor while 151 Republicans and 16 Democrats were opposed. President Barack Obama, while on vacation with his family in Hawaii, directed the bill be signed into law by autopen on January 2nd.
Timeline of the Tax Laws Leading to the Fiscal Cliff
A myriad of tax laws led to the fiscal cliff, including these notable provisions:
- Expiration of the Bush tax cuts enacted as part of the Economic Growth and Tax Relief Reconciliation Act of 2001 and the Jobs and Growth Tax Relief Reconciliation Act of 2003, as extended by the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010;
- Across-the-board spending cuts (“sequestration”) to most discretionary programs as directed by the Budget Control Act of 2011;
- Reversion of the Alternative Minimum Tax thresholds to their 2000 tax year levels;
- Expiration of measures delaying the Medicare Sustainable Growth Rate from going into effect (i.e., the “doc fix”), as extended by the Middle Class Tax Relief and Job Creation Act of 2012 (hereinafter “MCTRJCA”);
- Expiration of the 2% Social Security payroll tax cut, most recently extended by MCTRJCA;
- Expiration of federal unemployment benefits, as extended by MCTRJCA; and
- New taxes imposed by the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act of 2010.
Without new legislation, these provisions would automatically go into effect on January 1 or 2, 2013, except for the Alternative Minimum Tax growth, which can be changed retroactively until December 31, 2012. Some provisions would increase taxes (i.e., the expiration of the Bush and FICA payroll tax cuts and the new Affordable Care tax and AMT thresholds) while others would reduce spending (i.e., sequestration, expiration of unemployment benefits and implementation of the Medicare SGR).
Key Highlights of The ATRA
The subsequent synopsis serves to highlight a few key provisions within the legislation:
- Taxpayers will continue to be subject to the current 10/15/25/28/33/ and 35% tax rates on all income up to $450,000 for married filing joint taxpayers or $400,000 for single taxpayers. Those with taxable income in excess of these thresholds will pay tax on the excess – and only the excess — at 39.6%;
- The tax-rate on long-term capital gains and qualified dividends will increase from 15% to 20% for only those taxpayers with taxable income in excess of the aforementioned thresholds. The rates will remain 15% for everyone else. As a caveat, however, remember to add on the 3.8% Obamacare tax on net investment income on the lesser of 1) A taxpayer’s net investment income (i.e., generally interest, dividends, royalties, annuities, rents and capital gains), or 2) Modified adjusted gross income (i.e., this will be the same as AGI unless you’ve got foreign earnings) in excess of the applicable threshold: $250,000 for married filing joint taxpayers or $200,000 for single taxpayers;
- The estate tax exemption will remain at $5,000,000 (i.e., adjusted for inflation, so approximately $5,120,000 in 2013) but the rate will increase from 35% to 40%;
- The phase-out of a taxpayer’s itemized deductions and personal exemptions return, but only at increased levels of income. The new threshold kicks in at $300,000 of AGI for married taxpayers and $250,000 for single taxpayers;
- The increased child tax and earned income credits and the expanded education credits have been extended for five years;
- The R&D tax credit has been retroactively reinstated to cover calendar year 2012 and prospectively extended to cover calendar year 2013;
- 50% bonus depreciation is extended through 2013. In addition, some transportation and longer period production property is eligible for 50% bonus depreciation through 2014;
- Energy tax incentives for individuals under I.R.C. § 25C for energy improvements to their personal residences in connection to energy efficient insulated windows, skylights, etc. have been extended through 2013;
- The I.R.C. § 45 production tax credit for facilities that produce energy from wind facilities was extended through 2013; and
Numerous other energy tax incentives have also been extended through 2013 including:
- Credits for alternative fuel vehicle refueling property
- Credits for cellulosic biofuel production
- Credits for biodiesel and renewal diesel
- Production credits for Indian coal facilities
- Credit for energy-efficient new homes
- Credit for energy-efficient appliances
- Allowance for cellulosic biofuel plant property
- Special rules for sales of electric transmission property
- Tax credits for ethanol
The ATRA has laid the groundwork to avert the fiscal cliff and hopefully steer the U.S. economy away from another deep recession by putting more taxpayer dollars back in the hands of U.S. taxpayers to spend on consumer goods and services which is critical as two thirds of the U.S. economy is based upon consumer spending. Please be sure to obtain and analyze a complete copy of the ATRA to ensure you are properly addressing and resolving your client’s tax matters during tax season based upon this legislation and always remember to engage subject matter experts as applicable to ensure sustainable tax return filing positions per Circular 230.
The author of this article is Peter J. Scalise who serves as the National Partner-in-Charge and the Federal Tax Practice Leader for Engineered Tax Services. Peter is also a highly distinguished and long-standing member of both the Board of Directors and Board of Editors for The American Society of Tax Professionals and is the Founding President and Chairman of The Northeastern Region Tax Roundtable, an Operating Division of ASTP. Peter is a frequent keynote speaker for the AICPA, ABA, TEI & AIA on specialty tax incentives and legislative updates from the Hill.