When President Obama signed the American Taxpayer Relief Act (ATRA) into law in January, the much-feared “fiscal cliff” was avoided, for the most part.
Smart Business spoke with Jim A. Forbes, CPA, a principal with Skoda Minotti’s Tax Planning & Preparation Group, about five key elements of the act affecting both individual taxpayers and businesses.
What item most benefits individuals?
Signage of the act provides permanent relief from the Alternative Minimum Tax (AMT). If the AMT ‘patch’ had not been put in place, as many as 30 million taxpayers could have been affected. Fortunately, a permanent AMT patch has been put in place.
Retroactively, effective for tax years beginning after 2011, the AMT exemption amounts (and indexes for inflation) have been permanently increased to $50,600 for unmarried taxpayers, $78,750 for joint filers and $39,375 for married persons filing separately. This means that, for a single person, the first $50,600 of income is exempt from the AMT calculation.
Do any items have a negative effect on individual taxpayers?
Overall, passage of the act positively impacts most individual taxpayers. The return of the phase-out of itemized deductions and personal exemptions, though, could have a negative impact.
The Personal Exemption Phase-out (PEP) is reinstated with a starting threshold for those making $300,000 for joint filers and a surviving spouse; $275,000 for heads of household; $250,000 for single filers; and $150,000 for married taxpayers filing separately. For 2013, you’ll be able to deduct $3,900 for yourself, your spouse and your dependents. However, if you are over these thresholds, the value of each personal exemption is reduced by 2 percent for each $2,500 above the specified income thresholds. So a married couple making $400,000 would see a $2,000 cut in their personal exemptions.
Also, the ‘Pease’ limitation on itemized deductions was reinstated, with starting thresholds that are the same as for the PEP. For taxpayers subject to the ‘Pease’ limitation, the total amount of their itemized deductions is reduced by 3 percent of the amount by which the taxpayer’s adjusted gross income (AGI) exceeds the threshold amount, with the reduction not to exceed 80 percent of the otherwise allowable itemized deductions. For example, a married couple with income of $400,000 filing their tax return with $50,000 of itemized deductions would see about a $3,000 reduction in their itemized deductions, resulting in about $1,000 more in tax.
How are higher income individuals affected?
The regular tax rate and dividend/capital gains tax rate both increased for higher income individuals. The income tax rates for individuals will stay at 10, 15, 25, 28, 33 and 35 percent, but now a 39.6 percent rate applies for income above $450,000 for joint filers and surviving spouses; $425,000 for heads of household; $400,000 for single filers; and $225,000 for married taxpayers filing separately. The top rate for capital gains and dividends permanently rises to 20 percent for taxpayers with incomes exceeding $400,000 ($450,000 for married taxpayers). When combined with the new 3.8 percent Medicare surtax on investment income, the overall rate for higher income taxpayers will be 23.8 percent.
What are some of the ways that businesses are affected?
Two that are applicable to most businesses are the extension of bonus depreciation and the increase in Section 179 deduction.
The act retroactively extended 50 percent bonus depreciation for property placed in service before Jan. 1, 2014. And some transportation and longer period production property is eligible for 50 percent bonus depreciation through 2014. In other words, businesses can deduct 50 percent of the cost of the property while deducting the remainder of the cost of the property over its useful life. Plus, bonus depreciation can be used to create a loss. The Section 179 deduction can now be taken on new or used property up to $500,000, allowing businesses to fully deduct the cost of the property in the year it acquires it instead of deducting a portion of cost over its useful life. Previously, the deduction could only be applied to new or used property up to $139,000.
Jim A. Forbes, CPA, is a principal at Skoda Minotti. Reach him at (440) 449-6800 or email@example.com.
Contact: Have questions on how the American Taxpayer Relief Act affects you or your business? Contact our Tax Planning & Preparation Group at (440) 449-6800.
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If you surveyed 100 people about the recent tax changes, 95 of them probably will mention the capital gains and income tax rate increases at a certain level, but those are the two changes that may have the least effect, says Bruce Friedman, CPA, director in assurance at SS&G.
“There were a couple of items that the publicity focused on, and therefore the general public focused on, which, based on my experience with taxes, aren’t necessarily going to be as big of an issue as some of the subtle items out there,” he says.
Smart Business spoke with Friedman about some overlooked tax changes that could really have an impact on your 2013 tax bill.
What has been emphasized that won’t necessarily have a large impact?
The higher tax bracket at certain income levels and the new capital gains rate will likely affect people less than they think.
A taxpayer calculates tax in two ways — on normal income tax rules and the alternative minimum tax (AMT) — and then pays whichever is higher. The higher tax bracket and increased capital gains rate both apply on the income tax side to those earning $400,000, or $450,000 if married and filing jointly. However, generally speaking, people whose incomes are between $150,000 and $600,000 likely already pay at the AMT rate, and these two changes, therefore, aren’t likely to raise their income taxes to more than AMT. Those who have closer to $1 million of income will be affected.
What should taxpayers know?
Certain phase-outs have been brought back — the phase-out of itemized deductions and the loss of personal exemptions if your income is more than $300,000 for those married and filing jointly. However, many people who itemize on their returns aren’t aware because it hasn’t been publicized. It’s not dollar for dollar, but you lose some.
Also not renewed was the payroll tax ‘holiday.’ In 2011, all employees had their Social Security tax withholding rate decreased from 6.2 to 4.2 percent, which was renewed through 2012. Nonrenewal means reductions to your regular paycheck.
Is the health care reform surtax a concern?
This year there are new surtaxes on wages and unearned income because of health care reform, where AMT has no impact.
For the wages portion, if you’re married, filing jointly and your adjusted gross income exceeds $250,000 ($200,000 if you’re single) you pay an added 0.9 percent on the excess. For a married couple making $300,000 annually, it’s an added $450 per year.
The bigger impact is the unearned income tax of 3.8 percent, which applies to interest, dividends, capital gains and passive net rental income for the same $250,000 and $200,000 of adjusted gross income. As the owner of a business that generates a Schedule K-1 tax form relative to a passive activity, this could be a concern because that K-1 may have taxable net rental income, which could be included in this calculation. A typical example is where the business pays rent to the business owner who owns the property; many owners set up separate rental activities because it was a method to get cash without paying payroll taxes.
Here’s how the unearned income surtax could work: A married, filing jointly couple has $200,000 of earned income and $100,000 of unearned income. They are only taxed on unearned income that put them over $250,000 — $50,000, but that’s an additional $1,900 in taxes per year.
What can be done to lessen the impact?
There’s not much to be done aside from perhaps adjusting your business’s rental income. Many business owners may have charged on the high side of rent, but now — especially with lower real estate values — it might be worth revisiting the rent the business is paying.
The key point is to know the true dollar amount of your 2013 taxes. For example, the person who has a taxable income of $425,000 might be thinking, ‘No change in rates, I’m good.’ But if that taxpayer has $200,000 of unearned income, it’s another $7,600 in taxes.
What’s the good news?
Some positive business-oriented things were continued, such as accelerated depreciation, which lets you write off up to $500,000 in assets, up to $2 million in expenditures, as well as extending the R&D credit that can offset against AMT.
Bruce Friedman, CPA, is director in assurance at SS&G. Reach him at (330) 668-9696 or BFriedman@SSandG.com.
Website: For detailed 2012-2013 tax planning tips, see our online WebTaxGuide.
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No matter your income, your taxes are likely going to increase in 2013. Although the amount depends on what Congress does about the “fiscal cliff” of budget measures due to expire at the end of 2012, chances are that at least one of many scheduled changes will directly impact your finances.
In addition to automatic spending cuts, the fiscal cliff includes an end to Bush-era tax cuts that will take brackets from current rates of 10 percent, 25 percent, 28 percent, 33 percent and 35 percent back to 15 percent, 28 percent, 31 percent, 36 percent and 39.6 percent, respectively.
Other changes include raising the capital gains rate from 15 percent to 20 percent, reducing the child tax credit from $1,000 to $500, reducing the exemption for estate taxes from $5 million to $1 million and an end to temporary relief for the so-called “marriage penalty.”
“Absent action, we know what’s going to happen — all of these things are going to expire,” says Jim A. Forbes, CPA, a principal with Skoda Minotti. “I read an article calling this the legislative equivalent of a slow-motion train wreck. I’m sure they’ll get something done. It’s a matter of how many things get done before the end of the year.”
Smart Business spoke with Forbes about scheduled tax changes and the impact on families and businesses.
How will these changes impact business owners?
If your business is a closely held corporation, like an S Corp or a partnership, its tax flows through to your personal tax return. So your tax rates are going up if you own a small business that is an S Corp or a limited liability company.
For all businesses, regardless of the type, your ability to write off capital goods or fixed asset purchases will likely be severely limited in the future. Since 2001, we’ve had some form of bonus depreciation — accelerated writeoffs of purchases like computers, machinery, equipment and office furniture. In 2011, you were allowed a 100 percent write off. In 2012, it was 50 percent.
In 2013, absent any action, you’re not going to get an immediate writeoff; you’ll have to depreciate it over five years or whatever the life of the asset is. So incurring capital expenditures before the end of 2012 will give you a much better tax deduction than in 2013.
We’ve been telling clients for a long time to accelerate purchases if it makes good business sense because they’ll get a bigger deduction right now.
How are estate and gift taxes changing?
This year is an ideal time, if you’re wealthy, to gift something to your children. Right now, you can gift up to $5 million per individual, or, if you die today, no estate tax is paid on the first $5 million. Beginning Jan. 1, that reverts back to $1 million. If someone who is 55 or 60 years old wants to get their kid involved in their business that’s worth several million dollars, they can start gifting shares to them now because they can gift up to $5 million.
How will the Alternative Minimum Tax (AMT) change?
Your individual tax is computed under two methods. One is under the regular Form 1040. There is also a separate AMT calculation you have to do. It doesn’t allow you certain deductions, like state and local taxes, and it uses a different tax rate. What happens is that you pay the higher of the two, regular tax or AMT. The AMT captures upper middle class people generally with incomes from about $100,000 to a few hundred thousand — people who are wealthy but not in the top 1 percent of earners.
The AMT exemption is not set to index for inflation, so what’s happening is more people are going to be subject to AMT. That happens every year, but historically, they always put a patch on it. The exemption amount has been around $75,000 and it’s going to drop to $45,000 without action by Congress. About 4 million people paid AMT in tax year 2011. Without a patch, it’s projected that 31 million will pay AMT on their 2012
How will the average family be affected?
The one change that everyone will see in their paychecks is the end of a 2 percent reduction in the Social Security taxes they pay. Since 2011, the rate has been 4.2 percent. That was put into place as part of the stimulus plan. The likelihood of that one getting extended is not very high. That change affects anyone who gets wages. Absent anything else, you’re going to see a 2 percent reduction in take-home pay in January.
Another one that will affect an average family is the reduction of the child tax credit. If you have a child, you’ve been getting up to a $1,000 tax credit per child; that number is going to decrease to a maximum of $500 per child.
Also, the marriage penalty is going to come back. Many years ago, the rule was that the standard deduction and graduated tax rates for a married couple were not two times that of a single person, they were about 167 percent. Congress fixed the marriage penalty and, over the last few years, a married couple’s standard deduction and tax rate were exactly double a single person’s. What’s happening now is that the marriage penalty is returning.
The exemptions and tax brackets that were double the single person amount revert back to around 167 percent. So married couples are going to pay a little bit more tax, absent anything else. That applies whether you file jointly or separately.
JIM A. FORBES, CPA, is a principal with Skoda Minotti. Reach him at (440) 449-6800 or firstname.lastname@example.org.