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Tax Relief Act 2012

The followings are articles regarding tax law changes due to the Tax Relief Act 2012 and are categorized in:

• Individual Income Tax Provisions
• Education
• Trust, Estate and Decedent Income Tax
• Estate, Gift, and Generation-Skipping Transfer Taxes
• Business Provisions

Individual Income Tax Provisions

Individual Income Tax Brackets

For tax years beginning after 2012, the 10%, 15%, 25%, 28%, 33% and 35% tax brackets from the Bush tax cuts will remain in place and are made permanent.  This means that, for most Americans, the tax rates will stay the same.  However, there will be a new 39.6% rate, which will begin at the following thresholds: $400,000 (single), $425,000 (head of household), $450,000 (joint filers and qualifying widow(er)s), and $225,000 (married filing separately).  These dollar amounts will be inflation-adjusted for tax years after 2013.

Projected 2013 rate schedules effective for tax years beginning after December 31, 2012

For Single Individuals (Other than Heads of Households and Surviving Spouses)

If taxable income is:	The tax would be:
Not over $8,925	10% of taxable income
Over $8,925 but not over $36,250	$892.50 plus 15% of the excess over $8,925
Over $36,250 but not over $87,850	$4,991.25 plus 25% of the excess over $36,250
Over $87,850 but not over $183,250	$17,891.25 plus 28% of the excess over $87,850
Over $183,250 but not over $398,350	$44,603.25 plus 33% of the excess over $183,250
Over $398,350 but not over $400,000	$115,586.25 plus 35% of the excess over $398,350
Over $400,000	$116,163.75 plus 39.6% of the excess over $400,000

For Heads of Households

If taxable income is:	The tax would be:
Not over $12,750	10% of taxable income
Over $12,750 but not over $48,600	$1,275.00 plus 15% of the excess over $12,750
Over $48,600 but not over $125,450	$6,652.50 plus 25% of the excess over $48,600
Over $125,450 but not over $203,150	$25,865.00 plus 28% of the excess over $125,450
Over $203,150 but not over $398,350	$47,621.00 plus 33% of the excess over $203,150
Over $398,350 but not over $425,000	$112,037.00 plus 35% of the excess over $398,350
Over $425,000	$121,364.50 plus 39.6% of the excess over $425,000

For Married Individuals Filing Joint Returns and Surviving Spouses

If taxable income is:	The tax would be:
Not over $17,850	10% of taxable income
Over $17,850 but not over $72,500	$1,785.00 plus 15% of the excess over $17,850
Over $72,500 but not over $146,400	$9,982.50 plus 25% of the excess over $72,500
Over $146,400 but not over $223,050	$28,457.50 plus 28% of the excess over $146,400
Over $223,050 but not over $398,350	$49,919.50 plus 33% of the excess over $223,050
Over $398,350 but not over $450,000	$107,768.50 plus 35% of the excess over $398,350
Over $450,000	$125,846.00 plus 39.6% of the excess over $450,000

For Marrieds Filing Separate Returns

If taxable income is:	The tax would be:
Not over $8,925	10% of taxable income
Over $8,925 but not over $36,250	$892.50 plus 15% of the excess over $8,925
Over $36,250 but not over $73,200	$4,991.25 plus 25% of the excess over $36,250
Over $73,200 but not over $111,525	$14,228.75 plus 28% of the excess over $73,200
Over $111,525 but not over $199,175	$24,959.75 plus 33% of the excess over $111,525
Over $199,175 but not over $225,000	$53,884.25 plus 35% of the excess over $199,175
Over $225,000	$62,923.00 plus 39.6% of the excess over $225,000

Expansion of Marrieds-Filing-Jointly 15% Rate Bracket to Provide Marriage Penalty Relief is Extended Permanently

Effective for tax years beginning after December 31, 2012

A “marriage penalty” exists whenever the tax on a couple’s joint return is more than the combined taxes each spouse would pay if they were not married and if each filed a single or head of household return.  The tax is more on a joint return if the couple’s taxable income is pushed into a higher marginal tax bracket than would apply if the couple were not married (so they pay at a higher tax rate on the same total income than they would pay if each were single).  And that usually happens where both spouses work and have relatively equal incomes. The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) phased-in an increase in the size of the 15% regular income tax rate bracket for a married couple filing a joint return to equal twice the size (200%) of the corresponding rate bracket for an unmarried (single) individual. EGTRRA also provided special inflation adjustment rules relating to this change. The effect of the 2012 Taxpayer Relief Act’s repeal of the EGTRRA sunset provision is to make permanent the above-described expanded 15% bracket for married joint filers, and the related special inflation adjustment rules. Because the lowest tax rate bracket (the 10% bracket) for married joint filers is twice the size of the 10% bracket for single filers, the tax on a couple’s income reported on a joint return, up to the maximum income level under their 15% bracket, equals the tax two single filers – each reporting half that joint income – would pay. Because all of the tax brackets for joint filers are not made equal to twice the corresponding single filer tax brackets, however, the marriage penalty effect under the income tax rate schedules is not completely eliminated by the above-described changes.

0% and 15% Capital Gain Rates are Made Permanent; 20% Rate is Added for High-Income Taxpayers After 2012

Under pre-2012 Taxpayer Relief Act law, a non-corporate taxpayer’s adjusted net capital gain was taxed at maximum rates of:

• 0%, to the extent it would have been taxed at a rate below 25% (i.e., a 10% or 15% rate) if it had been ordinary income, or
• 15% on adjusted net capital gain in excess of the amount taxed at 0%.

“Adjusted net capital gain” is net capital gain plus qualified dividend income, minus specified types of long-term capital gain that are taxed at a maximum rate of 28% (gain on the sale of most collectibles and on the unexcluded part of Code Section 1202 small business stock) or 25% (unrecaptured section 1250 gain, i.e., gain attributable to real estate depreciation). “Net capital gain” is the excess of net long-term capital gains over net short-term capital losses for a tax year.

New Law

The 2012 Taxpayer Relief Act removes the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA) sunset provision.  Thus, the JGTRRA capital gain rate changes are made permanent. The 2012 Taxpayer Relief Act also adds a new 20% capital gain tax rate for high-income taxpayers.  The 20% rate applies to the adjusted net capital gain (or, if less, taxable income) that exceeds the amount that is taxed at the 0% or 15% rates. For tax years beginning after 2012, the 2012 Taxpayer Relief Act raises the top rate for capital gains and dividends to 20% (up from 15%) for taxpayers with incomes exceeding $400,000 ($450,000 for married taxpayers).  After accounting for Code Sec. 1411’s 3.8% surtax on investment-type income and gains for tax years beginning after 2012, the overall rate for higher-income taxpayers will be 23.8%.  (Under the EGTRRA/JGTRRA sunset provisions, long-term capital gain was to be taxed at a maximum rate of 20%, with an 18% rate for assets held more than five years, and dividends paid to individuals were to be taxed at the same rates that apply to ordinary income.) For taxpayers whose ordinary income is generally taxed at a rate below 25%, capital gains and dividends will permanently be subject to a 0% rate.  (Under the EGTRRA/JGTRRA sunset provisions, long-term capital gain of lower-income taxpayers was to be taxed at a maximum rate of 10%, with an 8% rate for assets held more than five years, and dividends were to be subject to ordinary income rates.)  Taxpayers who are subject to a 25%-or-greater rate on ordinary income, but whose income levels fall below the $400,000/$450,000 thresholds, will continue to be subject to a 15% rate on capital gains and dividends.  The rate will be 18.8% for those subject to the 3.8% surtax (i.e. those with modified adjusted gross income (MAGI) over $250,000 for joint filers or surviving spouses, $125,000 for a married individual filing a separate return, and $200,000 in any other case). Under the 2012 Taxpayer Relief Act, the 15% rate applies to the lesser of:

• the portion of the adjusted net capital gain (or, if less, taxable income) that exceeds the amount that is taxed at a 0% rate, or
• the excess of:  (i) the amount of taxable income that would otherwise be taxed at a rate below 39.6%, over (ii) the sum of the amounts that are taxed at ordinary income rates or the 0% capital gain rate.

The 39.6% income tax rate applies to taxable 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, adjusted for inflation after 2013.  Thus, the 20% capital gain rate applies to taxpayers whose income exceeds these thresholds. Because the 3.8% net investment income tax (NIIT) applies to most capital gains starting in 2013 the overall capital gain rate for some high-income taxpayers will be 23.8% (20% + 3.8%).  The NIIT applies to taxpayers whose modified adjusted gross income (MAGI) exceeds $250,000 for joint returns and surviving spouses, $125,000 for separate returns, and $200,000 in all other cases. Taxpayers who are subject to a 25%-or-greater rate on ordinary income, but whose income is below the 39.6% rate threshold, will continue to be subject to a 15% capital gain rate.  For taxpayers whose ordinary income is taxed at a rate below 25%, capital gains will permanently be subject to a 0% rate.

Qualified Dividends are Taxed at 0%, 15%, and 20% Rates after 2012

“Qualified dividend income” – generally, dividends received from domestic corporations and “qualified foreign corporations,” subject to holding period requirements and specified exceptions – is effectively treated as, and is taxed at the same rates that apply to, adjusted net capital gain.

Holding period

For dividends on stock to qualify as qualified dividend income, the taxpayer must hold the stock for at least 61 days during the 121-day period beginning 60 days before the ex-dividend date.

Unrecaptured Section 1250 gain

The amount of a taxpayer’s “unrecaptured section 1250 gain” – that portion of a noncorporate taxpayer’s long-term capital gain that is attributable to real estate depreciation – that is eligible to be taxed at a maximum 25% rate is limited to the taxpayer’s net capital gain determined without regard to the taxpayer’s qualified dividend income.

New Law

The effect of the provision is to remove the sunset that would have been effective for tax years beginning after December 31, 2012. The 2012 Taxpayer Relief Act removes the JGTRRA sunset provision.  Thus, the treatment of qualified dividend income as adjusted net capital gain, taxable at the same rates that apply to adjusted net capital gain, is made permanent. Under the 2012 Taxpayer Relief Act, capital gain is taxed at 0%, 15%, and 20% rates after 2012.  The 20% rate applies to taxpayers whose income exceeds $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.  Qualified dividends will be taxed at the same 0%, 15%, and 20% rates that apply to capital gain. Because the 3.8% net investment income tax (NIIT) applies to dividends starting in 2013, the overall tax rate on qualified dividends for some high-income taxpayers will be 23.8% (20% + 3.8%).  The NIIT applies to taxpayers whose modified adjusted gross income (MAGI) exceeds $250,000 for joint returns and surviving spouses, $125,000 for separate returns, and $200,000 in all other cases. Taxpayers who are subjected to a 25%-or-greater rate on ordinary income, but whose income is below the 39.6% rate thresholds, will continue to be subject to a 15% rate on qualified dividends.  For taxpayers whose ordinary income is taxed at a rate below 25%, qualified dividends will permanently be subject to a 0% rate. With the removal of the JGTRRA sunset, the following rules related to qualified dividends, discussed above, have also been made permanent:

• The holding period rule for determining when dividends on stock qualify as qualified dividend income.
• The exclusion of qualified dividend income from net capital gain for purposes of computing the limitation on the amount of unrecaptured section 1250 gain that is eligible to be taxed at a maximum 25% rate.

The effect of the provision is to remove the sunset that would have been effective for tax years beginning after December 31, 2012.

Accumulated Earnings Tax Rate and Personal Holding Company Tax Rate of 20% (Up From 15%)

Under pre-2012 Taxpayer Relief Act law, the tax rate for both the accumulated earnings tax and the undistributed personal holding company tax was 15%.

New law effective for tax year beginning after December 31, 2012

The 2012 Taxpayer Relief Act strikes 15% in Code Sec. 531 and inserts 20% (Code Sec. 531 as amended by 2012 Taxpayer Relief Act and strikes 15% in Code Sec. 541 and inserts 20%.  (Code Sec. 541 as amended by 2012 Taxpayer Relief Act.) Thus, the accumulated earnings tax rate and undistributed personal holding company income tax rate are now 20%.

Passthrough of Qualified Dividend Income by Partnerships is Made Permanent

Qualified dividend income received by noncorporate shareholders is taxed at the same maximum rates applicable to adjusted net capital gain.  For a partnership, each partner’s distributive share of qualified dividend income received by the partnership is treated as qualified dividend income in the partner’s hands. Thus, the qualified character of the dividends passes through to the partners, and the partners’ distributive shares of the partnership’s qualified dividend income was taxed at the 0% or 15% maximum rates that were applicable to adjusted net capital gain. Sunset The above rule was due to expire for tax years beginning after December 31, 2012, and qualified dividend income was then to be taxed at ordinary income rates. New law The 2012 Taxpayer Relief Act removes the sunset provision.  Thus, the above passthrough rule for partnership qualified dividend income is made permanent.

Election to Include Qualified Dividends in Investment Income for Purposes of Investment Interest Deduction is Made Permanent

A noncorporate taxpayer’s deduction for investment interest expense is limited to the amount of the taxpayer’s net investment income, i.e., the excess of investment income over investment expenses for the year.  Any investment interest that is disallowed because it exceeds this limit is carried over to the next tax year and treated as investment interest paid or accrued in that year. Qualified dividend income (dividends taxed at capital gain rates) is included in “investment income” for this purpose only to the extent the taxpayer elects to include it.  Any amount that the taxpayer elects to treat as investment income is not treated as qualified dividend income and is not eligible to be taxed at capital gain rates. A taxpayer whose investment interest deduction is limited because the interest exceeds the amount of his net investment income can increase the deduction by electing to include all or part of qualified dividend income in investment income.  The cost of making the election is that the dividends will be taxed as ordinary income rather than capital gain.

Sunset

Under section 303 of the 2003 Jobs and Growth Act, the above rule was due to expire for tax years beginning after December 31, 2012.

New Law

The 2012 Taxpayer Relief Act removes the JGTRRA sunset provision.  Thus, above rule on the election to treat qualified dividend income as investment income is made permanent.

100% Gain Exclusion for Qualified Small Business Stock (QSBS) is Retroactively Restored and Extended Through December 31, 2013

Subject to a per taxpayer limit, noncorporate taxpayers exclude 100% of the gain realized on the sale of “qualified small business stock” (QSBS) held for more than five years and acquired in a temporary period. Additionally, the excluded portion of the gain from eligible QSBS is excepted from treatment as an alternative minimum tax (AMT) preference item. The effect of the AMT exception is that, subject to the per taxpayer limit and the more-than-five-year holding requirement, no gain from QSBS acquired during the temporary period is taxed for either regular tax or AMT purposes. Under pre-2012 Taxpayer Relief Act law, the temporary period began on September 28, 2010 and ended on December 31, 2011. For periods before and after the temporary period, the exclusion, instead of being a 100% exclusion, is a partial exclusion, allowed in varying amounts.  Thus, for stock acquired before or after the temporary period, the excluded percentage is 50% (60% for certain stock issued by corporations in empowerment zones), but is 75% for any QSBS acquired after February 17, 2009 and before September 28, 2010. For regular income tax purposes, the portion of the gain that is includible in taxable income is taxed at a maximum rate of 28%.  Thus, for regular tax purposes, the gain from QSBS that is subject to the 50% exclusion is taxed at a maximum effective rate of 14%, and the gain from QSBS that is subject to the 75% exclusion is taxed at a maximum effective rate of 7%. Presumably, any gain from the sale or exchange of QSBS included in income could be subject to the 3.8% net investment income tax (NIIT) that applies to most capital gains starting in 2013.

New Law

The 2012 Taxpayer Relief Act retroactively restores and extends the 100% exclusion for QSBS for two years by changing the date before which eligible QSBS must be acquired from January 1, 2012 to January 1, 2014. Thus, subject to the per taxpayer limit and the more-than-five-year holding requirement, no regular tax or AMT is imposed on the sale or exchange of QSBS acquired after September 27, 2010 and before January 1, 2014. On October 1, 2012, T, an individual, acquires at original issuance 100 shares of QSBS at a total cost of $100,000.  T sells all of the shares on October 2, 2017 for $1.1 million.  Assuming that none of the possible income exclusion is barred by the per taxpayer limit, T excludes from gross income all of the $1 million of gain for regular tax and AMT purposes.

Qualified Dividend Income Treatment for Ordinary Income on Disposition of Code Sec. 306 Stock Made Permanent

Gain realized by individuals and other noncorporate taxpayers on the disposition of preferred stock that qualifies as Code Sec. 306 stock may be taxable as ordinary income rather than as capital gain.  Ordinary income treatment applies to that amount that would have been a dividend if the issuing corporation distributed cash equal to the fair market value of the stock sold.  However, to the extent an individual shareholder recognizes ordinary income on the disposition of Code Sec. 306 stock (other than a redemption), that amount may be treated as qualified dividend income, which is taxable at the 0%, 15% or 20% maximum rates that otherwise apply to adjusted net capital gain.

Sunset

Under section 303 of the 2003 Jobs and Growth Act the treatment of gains on the disposition of Code Sec. 306 stock as qualified dividend income was scheduled to expire for payments made in tax years beginning after December 31, 2012.  The provisions treating qualified dividend income as part of adjusted net capital gain were also scheduled to expire on December 31, 2012.

New Law

The 2012 Taxpayer Relief Act makes permanent the treatment of gains on the disposition of Code Sec. 306 stock as qualified dividend income.

Personal Exemption Phaseout (PEP) Applies When AGI Exceeds $300,000 (Joint Returns) and $250,000 (Single Filers) for Tax Years Beginning After December 31, 2012

Taxpayers are allowed two types of personal exemptions: the exemption for the taxpayer and the taxpayer’s spouse, also referred to as the “personal exemptions,” and the exemption for dependents.  An individual is entitled to a deduction of a $3,800 for 2012 (as adjusted for inflation) for a personal exemption. Under the personal exemption phaseout (PEP) rules in effect before the 2001 Economic Growth and Tax Relief Reconciliation Act (EGTRRA), the exemption amount of a taxpayer whose adjusted gross income (AGI) for the tax year exceeded a specified threshold amount was reduced by an applicable percentage.  The applicable percentage was two percentage points for every $2,500 (or fraction of $2,500) by which the taxpayer’s AGI for the tax year exceeded the threshold amount.  The threshold amount varied, depending on the taxpayer’s filing status.  The indexed threshold amounts for tax years beginning in 2009 were, for joint filers: $250,200, with complete phaseout occurring at $372,700; and for singles: $166,800, with complete phaseout occurring at $289,300.

New law effective for tax years beginning after December 31, 2012

Under the 2012 Taxpayer Relief Act (the “Act”) the PEP is restored, but the amounts of AGI at which the PEP applies are higher than under pre-Act law.  Under the Act, a taxpayer’s exemption amount is reduced by the applicable percentage when his AGI for the tax year exceeds the “applicable amount” that is in effect. The “applicable amounts” for purposes of the overall limitation on itemized deductions are:  for joint filers or surviving spouses, $300,000; for heads of household, $275,000; for singles, $250,000; and for married filing separately, half of the joint filer amount.  After 2013, the applicable amounts are adjusted for inflation.

Overall Limitation on Itemized Deductions is Restored. Applies when AGI Exceeds $300,000 (Joint Returns) and $250,000 (Single Filers)

Individuals who do not elect to itemize their deductions are allowed, instead, to deduct from their adjusted gross income (AGI) an inflation-adjusted basic standard deduction to determine their taxable income. Under an overall limitation on itemized deductions in effect before the 2001 Economic Growth and Tax Relief Reconciliation Act (EGTRRA), if an individual’s adjusted gross income (AGI) exceeded the “applicable amount,” the amount of the itemized deductions otherwise allowed for the tax year was reduced by the lesser of:  (i) 3% of the excess of AGI over the applicable amount, or (ii) 80% of the amount of itemized deductions otherwise allowable for the tax year.  The inflation-adjusted applicable amounts for any tax year beginning in a calendar year equaled the statutory applicable amount ($100,000 or $50,000, whichever applied), multiplied by the percentage (if any) by which the consumer price index (CPI) for the calendar year preceding the calendar year in which the tax year began exceeded the CPI for calendar year 1990.  For 2009, an individual’s AGI exceeded the statutory $100,000 “applicable amount,” as adjusted for inflation, if it exceeded $166,800.  For 2009 for marrieds filing separately, an individual’s AGI exceeded the statutory $50,000 “applicable amount,” as adjusted for inflation, if it exceeded $83,400. The above-described reduction in total itemized deductions is referred to as the “overall limitation on itemized deductions,” the “3%/80% rule,” or the “Pease limitation.”

New law effective for tax years beginning after December 31, 2012

Under the 2012 Taxpayer Relief Act (Act) the overall limitation on itemized deductions is restored, but the Act has increased the inflation-adjusted “applicable amounts.”  Under the Act, the “applicable amounts” are:

• $300,000, for a joint return or surviving spouse (as defined in Code Sec. 2(a)); (Code Sec. 68(b)(1)(A) as amended by 2012 Taxpayer Relief Act § 101 (b)(2)(A)(i));
• $275,000, for a head of household (as defined in Code Sec. 2(b)) (Code Sec. 68(b)(1)(B) as amended by 2012 Taxpayer Relief Act § 101 (b)(2)(A)(i));
• $250,000, for an individual who is not married and is not a surviving spouse or head of household (Code Sec. 68(b)(1)(C) as amended by 2012 Taxpayer Relief Act § 101 (b)(2)(A)(i)); and
• One-half the amount in (1) (after adjustment for inflation), for a married individual filing separately (Code Sec. 68(b)(1)(D) as amended by 2012 Taxpayer Relief Act § 101 (b)(2)(A)(i)).

The Act also amends the inflation adjustment rules.  The inflation adjustment, which applies to tax years beginning in calendar years after 2013, is arrived at by multiplying the applicable amounts above by the percentage (if any) by which the consumer price index (CPI) for the calendar year before the calendar year in which the tax year begins exceeds the CPI for calendar year 2012.

Summary of Individual Extenders in the 2012 American Taxpayer Relief Act

The new law extends the following items for the period indicated beyond their prior termination date as shown in the listing:

• The deduction for certain expenses of elementary and secondary school teachers, which expired at the end of 2011 and which is now revived for 2012 and continued through 2013;
• The exclusion for discharge of qualified principal residence indebtedness, which applied for discharges before January 1, 2013 and which is now continued to apply for discharges before January 1, 2014;
• Parity for the exclusions for employer-provided mass transit and parking benefits, which applied before 2012 and which is now revived for 2012 and continued through 2013;
• The treatment of mortgage insurance premiums as qualified residence interest, which expired at the end of 2011 and which is now revived for 2012 and continued through 2013;
• The option to deduct State and local general sales taxes, which expired at the end of 2011 and which is now revived for 2012 and continued through 2013;
• The special rule for contributions of capital gain real property made for conservation purposes, which expired at the end of 2011 and which is now revived for 2012 and continued through 2013;
• The above-the-line deduction for qualified tuition and related expenses, which expired at the end of 2011 and which is now revived for 2012 and continued through 2013; and
• Tax-free distributions from individual retirement plans for charitable purposes, which expired at the end of 2011 and which is now revived for 2012 and continued through 2013.  Because 2012 has already passed, a special rule permits distributions taken in 2012 to be transferred to charities for a limited period in 2013.  Another special rule permits certain distributions made in 2013 as being deemed made on December 31, 2012.

Election to Claim Itemized Deduction for State/Local Sales Taxes is Extended Through 2013

Under pre-2012 Taxpayer Relief Act law, taxpayers could – for tax years beginning after December 31, 2003 and before January 1, 2012 – elect to take an itemized deduction for state and local general sales taxes instead of an itemized deduction for state and local income taxes.

New law effective for tax years beginning after December 31, 2011

The 2012 Taxpayers Relief Act replaces “January 1, 2012” with “January 1, 2014.” In other words, the 2012 Taxpayer Relief Act extends for two years (through December 31, 2013) the provision allowing taxpayers to elect to deduct state and local sales taxes in lieu of state and local income taxes.  This deduction appeals especially to taxpayers in states that impose a sales tax but not an income tax – Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming.  The deduction may also be advantageous to any taxpayer who paid more in sales taxes than income taxes, such as a taxpayer who might have bought a new car, boosting the sales tax total, or claimed tax credits, lowering the state income tax paid.

Standard Deduction Marriage Penalty Relief is Made Permanent

Individuals who do not elect to itemize their deductions are allowed, instead, to deduct from their adjusted gross income (AGI) an inflation-adjusted basic standard deduction to determine their taxable income.  The basic standard deduction in 2012 is $5,950 for unmarrieds, $11,900 for marrieds filing jointly and surviving spouses, $5,950 for marrieds filing separately, and $8,700 for heads of household.

New law effective for tax years beginning after December 31, 2012

The 2012 Taxpayer Relief Act repeals the EGTRRA sunset provision. In other words, by deleting the EGTRRA sunset provision as it applies to the EGTRRA/JGTRRA/WFTRA changes to the standard deduction rules, the Act extends permanently the standard deduction marriage penalty relief that otherwise would have expired at the end of 2012.  The basic standard deduction for a married couple filing a joint return continues to be twice the basic standard deduction for an unmarried individual filing a single return.  And, the basic standard deduction for marrieds filing separately equals the basic standard deduction for single filers.

Interest Deduction for Mortgage Insurance Premiums is Extended to Amounts Paid or Accrued Before 2014

Premiums a taxpayer paid or accrued during the tax year for qualified mortgage insurance in connection with acquisition indebtedness for the taxpayer’s qualified residence are treated as qualified residence interest, and so are deductible, subject to phaseout rules affecting taxpayers with adjusted gross income (AGI) over $100,000 for the tax year. “Qualified mortgage insurance” means:

• mortgage insurance provided by the Department of Veterans Affairs (VA), the Federal Housing Administration (FHA), or the Rural Housing Service (RHS), and
• private mortgage insurance.

To be deductible qualified residence interest, the amounts must be paid or accrued under a mortgage insurance contract issued after December 31, 2006. Under pre-2012 Taxpayer Relief Act law, the rules treating qualified mortgage insurance premiums as deductible qualified residence interest did not apply to:

• amounts paid or accrued after December 31, 2011; or
• amounts properly allocable to any period after December 31, 2011.

New Law Effective for Amounts Paid or Accrued after December 31, 2011 Under the 2012 Taxpayer Relief Act (the “Act”), the rules treating the deduction of qualified mortgage insurance premiums as deductible qualified residence interest do not apply with respect to amounts paid or accrued after December 31, 2013, or properly allocable to any period after that date. That is, the Act extends the itemized deduction for private mortgage insurance for two years (only for contracts entered into after December 31, 2006).  Specifically, the Act extends the deduction to amounts paid or accrued before January 1, 2014 that are not allocable to any period after December 31, 2013.

Exclusion for Debt Discharge Income from Home Mortgage Forgiveness is Extended for One Year Until the End of 2013

The rule that a discharge of indebtedness gives rise to income includible in gross income- “cancellation of debt (COD) income” or “debt discharge income” is subject to certain exceptions, including exceptions for discharges in Title 11 bankruptcy cases or when the taxpayer is insolvent (the “insolvency exclusion”).  For these exceptions, taxpayers generally reduce certain tax attributes, including basis in property, by the amount of the debt discharged. An exception for home mortgages – the “mortgage forgiveness exclusion” – applies to discharges after December 31, 2006.  Any debt discharge income resulting from a discharge (in whole or in part) of “qualified principal residence indebtedness” is excluded from gross income.  “Qualified principal residence indebtedness” is acquisition indebtedness (as defined by Code Sec. 163(h)(3)(B) except that the dollar limitation is $2 million) with respect to the taxpayer’s principal residence; – i.e., the debt must have been used to acquire, construct, or substantially improve the taxpayer’s principal residence, or to refinance the debt (but only up to the amount refinanced), and must have been secured by the residence.  This exclusion applies where taxpayers restructure their acquisition debt on a principal residence or lose their principal residence in a foreclosure. The basis of the residence is reduced by the amount excluded under the above-described mortgage forgiveness exclusion, but not below zero. “Principal residence” has the same meaning for this purpose as under the Code Sec. 121 homesale exclusion rules–i.e., the home where the taxpayer ordinarily lives most of the time.  The exclusion does not apply to debt forgiven on second homes, business property, or rental property. If only part of the discharged loan is qualified principal residence indebtedness, the mortgage forgiveness exclusion applies only to so much of the amount discharged as exceeds the amount of the loan (as determined immediately before the discharge) that is not qualified principal residence indebtedness. The mortgage forgiveness exclusion does not apply if the discharge is on account of services performed for the lender or any other factor not directly related to a decline in the residence’s value or to the taxpayer’s financial condition. The mortgage forgiveness exclusion also does not apply to a taxpayer in a Title 11 bankruptcy case; instead, the general exclusion rules apply. Where an insolvent taxpayer (other than the one in a Title 11 bankruptcy) qualifies for the mortgage forgiveness exclusion, the mortgage forgiveness exclusion applies unless the taxpayer elects to apply the insolvency exclusion. Under pre-2012 Taxpayer Relief Act law, the mortgage forgiveness exclusion applied to indebtedness discharged before January 1, 2013.

New Law

The 2012 Taxpayer Relief Act (Act) extends the mortgage forgiveness exclusion for one year, so that it applies to indebtedness discharged before January 1, 2014. As described above, an insolvent taxpayer (not in a Title 11 bankruptcy case) whose debt is discharged (in whole or in part) uses the mortgage forgiveness exclusion rules, including the basis reduction requirement for the residence, for any portion of the discharged debt that is “qualified real property indebtedness.”  That is, if the taxpayer wants to use the insolvency exclusion rules, including the tax attribute reduction requirements, he must elect “out” of the mortgage forgiveness exclusion.  By extending the mortgage forgiveness exclusion for one year, the Act also extends for one year the period for which an insolvent taxpayer must affirmatively elect to use the insolvency exclusion. Taxpayers usually will not benefit from electing the insolvency exclusion here.  The insolvency exclusion requires the taxpayer to make the same basis and tax attribute reductions as are required in a Title 11 bankruptcy case.  The mortgage forgiveness exclusion requires the taxpayer to reduce his basis in the residence.  In addition, the amount of debt discharge income that is excluded from income under the insolvency exclusion is limited to the amount by which the taxpayer is insolvent.  This limitation does not apply in the case of the mortgage forgiveness exclusion.

Parity Extended Through 2013 for Employer-Provided Mass Transit and Parking Benefits

For months beginning February 17, 2009, and employer could exclude from an employee’s income a statutory amount of up to $100 a month ($120, as adjusted for inflation for 2009) for qualified transportation fringe benefits that the employer provided through transit passes and vanpooling.  The 2009 Recovery Act temporarily raised the excludable amount to provide parity for these benefits with employer-provided parking benefits, which are excluded up to a statutory amount of $175 a month ($230, as adjusted for inflation for 2011), for months beginning before January 1, 2012. Thus, for 2011, an employer could exclude from an employee’s income up to $230 a month for qualified transportation fringe benefits that the employer provided through transit passes and vanpooling, the same amount that an employer could exclude for qualified transportation fringe benefits that the employer provided through employer-provided parking.  Before the 2012 Taxpayer Relief Act, there was no such parity for 2012 and 2013 when the monthly exclusion was only $125 for employer-provided transit and vanpooling benefits, while being $240 (estimated to rise to $245 in 2013) for qualified parking.

New Law

The 2012 Taxpayer Relief Act extends parity for the entire 2012 and 2013 tax years.  Thus, for any month beginning before January 1, 2014 (i.e., in 2012 and 2013), the monthly exclusion limitation for employer-provided transit and vanpooling benefits is the same as for employee-provided parking.

Up-to-$250 Above-The-Line Deduction for Teachers’ Out-of-Pocket Classroom-Related Expenses is Retroactively Extended Through 2013

“Eligible educators” – kindergarten through 12^th grade teachers, instructors, counselors, principals, or aides in any elementary or secondary school – are allowed an above-the-line deduction of up to $250 for out-of-pocket expenses they paid in connection with books, supplies (other than nonathletic supplies for courses of instruction in health or physical education), computer equipment (including related software and services), other equipment, and supplementary materials used in the classroom.  Under pre-2012 Taxpayer Relief Act law, this deduction for eligible educator expenses was available in tax years beginning during 2002, 2003, 2004, 2005, 2006, 2007, 2008, 2009, 2010, and 2011.

New law effective for tax years beginning after December 31, 2011

The 2012 Taxpayer Relief Act (Act) replaces “or 2011” with “2011, 2012, or 2013.” Without the deduction for eligible educator expenses, any unreimbursed expenses that elementary or secondary school teachers might be able to deduct in connection with their teaching activities would be deductible only as unreimbursed employee business expenses – i.e., as miscellaneous itemized deductions subject to the 2%-of-adjusted gross income (AGI) floor on miscellaneous itemized deductions.

The Adoption Assistance Exclusion is Made Permanent

Employees can exclude from gross income the qualified adoption expenses paid or reimbursed by an employer under an employer-provided adoption assistance program.  The exclusion is subject to both (i) a dollar limit (under which the total amount of excludible adoption expenses cannot exceed a maximum amount), and (ii) an income limit (under which the exclusion is ratably phased out over a certain income range, based on modified adjusted gross income (AGI)). The 2001 Economic Growth and Tax Relief Reconciliation Act made modifications to the adoption assistance exclusion, as described below. EGTRRA modified the exclusion by:

• increasing the maximum exclusion from $5,000 ($6,000 for special needs adoptions) to $10,000 (for all adoptions);
• allowing the maximum exclusion amount for special needs adoptions, without regard to the amount of adoption expenses actually incurred;
• increasing the income phase-out range from a range of $75,000 to $115,000, to a range of $150,000 to $190,000;
• providing that the dollar limit and the income limit are to be adjusted for inflation; and
• making the exclusion “permanent” (instead of being set to expire after December 31, 2001, as provided under pre-EGTRRA law), but still subject to EGTRRA’s sunset provision which provided that all changes made by EGTRRA (including the changes to the adoption assistance exclusion described above) were not to apply to tax years beginning after December 31, 2010.

The 2010 Tax Relief Act extended the adoption assistance exclusion as expanded by EGTRRA for one year (through 2012).  The 2010 Act accomplished this by amending the EGTRRA sunset provision by replacing the December 31, 2010 sunset date with a December 31, 2012 sunset date.  Thus, under the 2010 Tax Relief Act, the changes made to the exclusion by EGTRRA (items listed above) were extended through 2012. For tax years beginning in 2012:

• the maximum exclusion was $12,170, as adjusted for inflation; and
• the phase-out range was $182,520 to $222,520, as adjusted for inflation.

For tax years beginning after December 31, 2012, the adoption assistance exclusion was going to revert to pre-EGTRRA law, which provided that the exclusion was to expire for amounts paid, or expenses incurred, after December 31, 2001.  Thus, for tax years beginning after 2012, the exclusion was not going to be available.

New Law

The 2012 Taxpayer Relief Act permanently extends the adoption assistance exclusion. For Tax years beginning in 2013 (and years thereafter), it is anticipated that IRS will issue inflation-adjusted amounts for the maximum exclusion and the phase-out range.

AMT Relief in the 2012 American Taxpayer Relief Act

The AMT is a parallel tax system which does not permit several of the deductions permissible under the regular tax system, such as property taxes.  Taxpayers who may be subject to the AMT must calculate their tax liability under the regular federal tax system and under the AMT system taking into account certain “preferences” and “adjustments.”  If their liability is found to be greater under the AMT system, that is what they owe the federal government.  Originally enacted to make sure that wealthy Americans did not escape paying taxes, the AMT has started to apply to more middle-income taxpayers, due in part to the fact that the AMT parameters are not indexed for inflation. In recent years, Congress has provided a measure of relief from the AMT by raising the AMT “exemption amounts” –allowances that reduce the amount of alternative minimum taxable income (AMTI), reducing or eliminating AMT liability.  (However, these exemption amounts are phased out for taxpayers whose AMTI exceeds specified amounts.)  For 2011, the AMT exemption amounts were $74,450 for married couples filing jointly and surviving spouses; $48,450 for single taxpayers; and $37,225 for married filing separately.  However, for 2012, those amounts were scheduled to fall back to the amounts that applied in 2000: $45,000, $33,750, and $22,500, respectively.  This would have brought millions of additional middle-income Americans under the AMT system, resulting in higher federal tax bills for many of them, along with higher compliance costs associated with filling out and filing the complicated AMT tax form.

New law provides permanent fix

To prevent the unintended result of having millions of middle-income taxpayers fall prey to the AMT, Congress has once again applied a “patch” to the problem by extending the 2011 exemption amounts, increased slightly, but this time the patch is intended as a permanent fix.  Under the new law, for tax years beginning in 2012, the AMT exemption amounts are increased to:  (i) $78,750 in the case of married individuals filing a joint return and surviving spouses; (ii) $50,600 in the case of unmarried individuals other than surviving spouses; and (iii) $39,375 in the case of married individuals filing a separate return.  Most importantly, these amounts will indexed for inflation after 2012, meaning that the annual “patches” will no longer be needed. The following table shows the impact of 2012 Taxpayer Relief Act:

	AMT Exemption Amount – Pre-2012 Tax Relief Act			AMT Exemption Amount – 2012 Tax Relief Act
	Unmarried	Joint	Married Filing Separate	Unmarried	Joint	Married Filing Separate
2010	$47,450	$72,450	$36,225	$47,450	$72,450	$36,225
2011	$48,450	$74,450	$37,225	$48,450	$74,450	$37,225
2012	$33,750	$45,000	$22,500	$50,600	$78,750	$39,375

Personal credits may be used to offset AMT

Another provision in the new law provides AMT relief for taxpayers claiming personal tax credits.  The tax liability limitation rules generally provide that certain nonrefundable personal credits (including the dependent care credit and the elderly and disabled credit) are allowed only to the extent that a taxpayer has regular income tax liability in excess of the tentative minimum tax, which has the effect of disallowing these credits against the AMT.  Temporary provisions had been enacted which permitted these credits to offset the entire regular and AMT liability through the end of 2011.  The new law extends this provision permanently.

$1,000 Per Child Amount and Expanded Refundability of Child Tax Credit are Permanently Extended

An individual may claim a child tax credit (CTC) for each qualifying child under the age of 17.

New law effective for tax years beginning after December 31, 2012

The 2012 Taxpayer Relief Act eliminates the EGTRRA sunset. As a result of the 2012 Taxpayer Relief Act’s repeal of the EGTRRA sunset provision, for tax years after 2012:

• the per-child amount of the child tax credit is $1,000.
• the child tax credit is refundable for all taxpayers with qualifying children, regardless of the number of children, to the extent of 15% of the taxpayer’s earned income in excess of a threshold amount.

Increase in Refundable Portion of Child Tax Credit is Extended Through 2017

An individual can claim a child tax credit (CTC) for each qualifying child under the age of 17. The CTC is partially refundable.  For all taxpayers with qualifying children (regardless of the number or qualifying children), the CTC is refundable to the extent of 15% of the taxpayer’s earned income in excess of a statutory dollar amount threshold ($10,000 as indexed for inflation).  The 2009 Recovery Act reduced the threshold to $3,000 (with no indexing for inflation) for tax years beginning in 2009 and 2010.  The 2010 Tax Relief Act extended the $3,000 threshold for the earned income formula for two years (through 2012).  The lower threshold increased the refundable portion of the credit for those years. Under pre-2012 Taxpayer Relief Act law, the lower $3,000 threshold did not apply in tax years beginning after 2012.

New Law

The 2012 Taxpayer Relief Act extends the $3,000 threshold for the earned income formula for five years (through 2017) by providing that the $3,000 dollar amount will be in effect for any tax year beginning after 2008 and before 2018. In other words, for tax years beginning in 2013, 2014, 2015, 2016 and 2017, a taxpayer’s CTC is refundable to the extent of 15% of the taxpayer’s earned income in excess of $3,000.  Under pre-2012 Taxpayer Relief Act law, the refundable portion would have been determined using $10,000 as the earnings threshold, resulting in a smaller refundable amount.

EGTRRA – Expanded Dependent Care Credit Permanently Extended

Taxpayers who have one or more qualifying individuals (a dependent qualifying child under age 13, or a dependent or spouse who is incapable of self-care and has the same principal place of abode as the taxpayer for more than half the tax year) are allowed a dependent care credit equal to a percentage of the expenses paid for the care of the qualifying individual(s) that enable the taxpayer to be gainfully employed (“eligible expenses”).

EGTRRA changes

Sec. 204 of the 2001 Economic Growth and Tax Relief Reconciliation Act increased the dependent care credit’s credit percentage, credit base, and maximum credit.  The maximum credit is $1,050 (35% of up to $3,000 of eligible expenses) if there is one qualifying individual, and $2,100 (35% of up to $6,000 of eligible expenses) if there are two or more qualifying individuals.  The 35% credit rate if reduced, but not below 20%, by one percentage point for each $2,000 (or fraction thereof) of adjusted gross income (AGI) above $15,000.

Sunset

The EGTRRA enhancements to the dependent care credit were subject to the EGTRRA sunset provision.  After the EGTRRA sunset date (December 31, 2010), the credit percentage, credit base, and maximum credit all were scheduled to revert to the lower pre-EGTRRA levels for 2011 and later years.  That is, the credit percentage would drop to 30% and begin to phase out at AGI of $10,000.  The maximum credit would drop to $720 (30% of up to $2,400 of eligible expenses) for one qualifying individual, and to $1,440 (30% of up to $4,800 of eligible expenses) for two or more. However, the 2010 Tax Relief Act provided that the EGTRRA sunset would not take effect until after December 31, 2012 (instead of December 31, 2010), thus extending the dependent care credit enhancements (above) for two years.

New law effective for tax years beginning after December 31, 2012

The 2012 Taxpayer Relief Act makes the dependent care credit enhancements “permanent” by eliminating the EGTRRA sunset provision in its entirety. Thus, the dependent care credit enhancements discussed above are permanently extended, and continue in force without being subject to sunset provisions.

Expanded Adoption Credit Rules (But Not Refundability) Made Permanent

Individuals are allowed a credit against income tax and alternative minimum tax (AMT) for qualified adoption expenses paid or incurred for the adoption of an eligible child.  The credit is nonrefundable subject to a limitation based on tax liability.  The maximum credit is $12,650 per eligible child for 2012.  The credit begins to phase out for taxpayers with modified adjustment gross income (AGI) over $189,710 for 2012 and is fully eliminated at modified AGI of $229,710 for 2012.  All these dollar amounts are adjusted annually for inflation.

EGTRRA changes

The following EGTRRA changes, made in EGTRRA, were scheduled to become inapplicable after the December 31, 2012 sunset date:

• increased the maximum per-child credit from $5,000 ($6,000 for special needs adoptions) to $10,000 for all adoptions;
• increased the modified AGI starting point for the credit phase-out from $75,000 to $150,000;
• for special needs adoptions, allowed the $10,000 maximum credit regardless of actual expenses, and liberalized certain timing rules;
• provided for inflation adjustments to the $10,000/$150,000 statutory dollar amounts;
• for non-special needs adoptions, made the credit permanent (as was the case for special needs adoptions) by eliminating the scheduled December 31, 2001 termination date; and
• allowed the credit against AMT by making it subject to a separate tax liability limitation instead of Code Sec. 26(a)(1) (which generally prevents the offset of AMT by nonrefundable personal credits).

The December 31, 2012 sunset date for the EGTRRA changes meant that the changes listed in the items listed above, would not have applied for tax years beginning after December 31, 2012.  Thus, the adoption credit rules would have reverted to pre-EGTRRA law.  This would have meant that, starting in 2013:

• the credit would have been available only for special needs adoptions;
• the maximum per-child credit would have dropped to $6,000, and would have depended on actual expenses;
• the modified AGI starting point for the credit phase-out would have been reduced to $75,000 – i.e., the credit would have been eliminated at modified AGI of $115,000;
• absent a further extension, the credit would not have been allowed against AMT because it would have been subject to the general Code Sec. 26(a)(1) tax liability limitation.

New law effective for tax years beginning after December 31, 2012

The 2012 Taxpayer Relief Act permanently extends the EGTRRA changes made to the adoption expense credit by deleting the EGTRRA sunset provision. The adoption expense credit, as expanded by EGTRRA, is no longer subject to a sunset provision.  Thus, for example, the credit will continue to apply for non-special needs adoptions as well as special needs adoptions, and will continue to be allowed against the AMT.  Thus, the credit remains refundable, and continues to be provided in Code Sec. 23.

EIC Simplification Made Permanent

Certain low-and moderate-income workers are allowed a refundable credit, the “earned income credit” (EIC).  Eligibility for the EIC is based, in part, on earned income, adjusted gross income, filing status, and number of qualifying children.  The amount of the EIC is based on the presence and number of qualifying children in the taxpayer’s family, as well as on adjusted gross income (AGI) and earned income.  The EIC is computed (subject to a phaseout, discussed below) by multiplying a credit percentage by the taxpayer’s earned income. The EIC generally equals a specified percentage of earned income up to a maximum dollar amount.  The maximum amount applies over a certain income range and then diminishes to zero over a specified phaseout range.  For taxpayers with earned income (or AGI, if greater) in excess of the beginning of the phaseout range, the maximum EIC amount is reduced by the phaseout rate multiplied by the amount of earned income (or AGI, if greater) in excess of the beginning of the phaseout range, the maximum EIC amount is reduced by the phaseout rate multiplied by the amount of earned income (or AGI, if greater) in excess of the beginning of the phaseout range.  For taxpayers with earned income (or AGI, if greater) in excess of the end of the phaseout range, no credit is allowed. Under the Economic Growth and Tax Relief Reconciliation Act of 2001, the EIC rules were simplified as follows:

• the definition of earned income was modified to include only amounts that are includible in gross income for the tax year.  So, the definition includes wages, salaries, tips and other employee compensation, if includible in gross income for the tax year, plus net earnings from self-employment;
• reduction of the EIC for taxpayers subject to the alternative minimum tax (AMT) was eliminated;
• adjusted gross income (AGI) replaced modified adjusted gross income (MAGI) in the phaseout computation rule, i.e., phaseout was made to apply if the taxpayer’s AGI, or earned income, if greater, exceeded the phaseout amount;
• the relationship test was changed to provide that a qualifying child (including a foster child) must reside with the taxpayer for more than six months; descendants of stepchildren were added to the eligible child category; and a brother, sister, stepbrother or stepsister of the taxpayer were reclassified under the general eligible child category, if the taxpayer cared for them as his own;
• the tie-breaking rule were simplified for cases where an individual would be a qualifying child with respect to more than one taxpayer, and more than one taxpayer claimed the EIC with respect to that child.

Sunset

Under Sec. 901 of EGTRRA provisions were made subject, all of the changes described above were scheduled to expire for tax years beginning after December 31, 2010, and the pre-EGTRRA EIC rules were scheduled to come back into effect. However, the 2010 Tax Relief Act provided that the EGTRRA sunset would not take effect until after December 31, 2012 (instead of December 31, 2010), thus extending the EIC simplification rules (above) for two years.

New law effective for tax years beginning after December 31, 2012

The 2012 Taxpayer Relief Act makes the EIC simplification rules “permanent” by eliminating the EGTRRA sunset provision in its entirety. Thus, the EIC simplification rules discussed above are permanently extended, and continue in force without being subject to sunset provisions.

Increased EIC for Families with Three or More Qualifying Children is Extended for Five Years

Certain low-income workers are allowed a refundable earned income credit (EIC), computed (subject to certain limitations) by multiplying a credit percentage by the individual’s earned income.  The credit percentage depends on the number of “qualifying children” the taxpayer has.  Before 2009, the credit percentages were:

• 7.65% for taxpayers with no qualifying children;
• 34% for taxpayers with one child; and
• 40% for taxpayers with two or more qualifying children.

A temporary provision had increased the credit percentage for families with three or more qualifying children (from 40%) to 45% for tax years 2009 and 2010 only.  For tax years after 2010, the pre-2009 40% credit percentage for families with two or more qualifying children was scheduled to again apply for families with three or more qualifying children. The 2010 Tax Relief Act extended the EIC at a rate of 45% for three or more qualifying children for two years (2011 and 2012).

New Law

The 2012 Taxpayer Relief Act provides that the increased credit percentage of 45% for taxpayers with three or more qualifying children applies to any tax year beginning after 2008 and before 2018. Thus, the 2012 Taxpayer Relief Act extends the EIC at a rate of 45% for three or more qualifying children for five years (2013 through 2017).

Rule Allowing Tax-Free IRA Distributions of up to $100,000 if Donated to Charity, is Retroactively Extended Through 2013

The IRA distribution rules allow for the tax-free treatment of distributions from IRAs where the distributions are donated to charity.  Specifically, a taxpayer may exclude from gross income so much of the aggregate amount of his “qualified charitable distributions” not exceeding $100,000 in a tax year. A “qualified charitable distribution” is any otherwise taxable distribution from a traditional IRA or a Roth IRA that is:

• made directly by the IRA trustee to a Code Sec. 170(b)(1)(A) charitable organization (other than a Code Sec. 509(a)(3) private foundation or a Code Sec. 4966(d)(2) donor advised fund); and
• made on or after the date on which the individual for whose benefit the IRA is maintained (i.e., the IRA owner) has attained age 70 ½.

For purposes of the required minimum distribution (RMD) rules as they apply to individual retirement accounts and individual retirement annuities, qualified charitable distributions may be taken into account to the same extent that the distribution would have been taken into account under the RMD rules had the distribution not been directly distributed under the IRA qualified charitable distribution rules.  Thus, an IRA owner who makes an IRA qualified charitable distribution in an amount equal to his RMD for the tax year is considered to have satisfied his minimum distribution requirement for that year, even though a charitable entity (and not the IRA owner) is the recipient of the distribution. Under pre-2012 Taxpayer Relief Act law, the tax-free qualified charitable distribution rules, above, only applied to distributions made in tax years beginning no later than December 31, 2011 (the “termination date”).

New Law

Under the 2012 Taxpayer Relief Act, the termination date of the tax-free qualified charitable distribution rule is amended by substituting December 31, 2013, for December 31, 2011. The Act extends the tax-free qualified charitable distribution rules for two years (through 2013), and thus the rules may be applied to IRA distributions made in tax years beginning after December 31, 2011 and before January 1, 2014. Thus, under the 2012 Act, taxpayers age 70 ½ or older may exclude from gross income up to $100,000 of their qualified charitable distributions for each tax year beginning in 2012 and 2013 (in addition to any qualified charitable distributions they may have made through 2011).

Special elections for December 2012 distributions

Under a special rule, for purposes of both (i) the tax-free qualified charitable distribution rules, and (ii) the RMD rules as they apply to IRAs, any portion of an IRA distribution made to the taxpayer after November 30, 2012, and before January 1, 2013 (i.e., during December 2012), may be treated as a qualified charitable distribution, if the IRA owner so elects at such time and in such manner as IRS will prescribe, to the extent that the portion is:

• transferred in cash after the distribution to an eligible charity before February 1, 2013; and
• part of a distribution that would otherwise satisfy the tax-free qualified charitable distribution rules, but for the fact that the distribution was not transferred directly to an eligible charity.

Thus, the special election for December 2012 distributions provides a limited exception to the general rule that charitable transfers must be made by the IRA trustee directly to an eligible charity. Peter is an individual who is over age 70 ½, and the owner of a traditional IRA.  On December 12, 2012, Peter received a $75,000 distribution from the IRA in satisfaction of his RMD for 2012. Under the special rule for December 2012 distributions, Peter can elect to transfer to an eligible charity any amount of cash up to $75,000 (the amount of his 2012 RMD), and the amount transferred will be treated as a tax-free qualified charitable distribution, as long as Peter makes the charitable transfer no later than January 31, 2013.  Peter will still be considered to have satisfied his 2012 RMD regardless of the amount of the charitable transfer.

Special election for January 2013 distributions effective for IRA distributions made in tax years beginning after December 31, 2011, but not after December 31, 2013

Under another special rule, for purposes of both (i) the tax-free qualified charitable distribution rules, and (ii) the RMD rules as they apply to IRAs, any qualified charitable distribution made after December 31, 2012, and before February 1, 2013 (i.e., during January 2013), will be deemed to have been made on December 31, 2012, if the IRA owner so elects at such time and in such manner as IRS will prescribe. Thus, at the taxpayer’s election, a qualified charitable distribution made in January 2013 is permitted to be treated as made in 2012, and thus permitted to (i) count against the 2012 $100,000 limitation on the exclusion, and (ii) be used to satisfy the taxpayer’s RMD for 2012. For purposes of the special election for January 2013 distributions, the IRA distribution must be made by the IRA trustee directly to the eligible charity, unlike the exception to the direct transfer rule provided under the special election for December 2012 distributions, above. John is an individual who is over age 70 ½, and the owner of a traditional IRA.  During 2012, he did not take any distributions from the IRA, even though he was required to take a $100,000 minimum distribution for 2012.  On January 18, 2013, John directs the IRA trustee to make a $100,000 charitable transfer. Under the special rule for January 2013 distributions, John can elect to treat the $100,000 charitable transfer as having been made on December 31, 2012.  If John makes the election (pursuant to rules that IRS is to prescribe), he will be (i) considered to have satisfied his minimum distribution requirement for 2012, and (ii) entitled to make another tax-free charitable transfer of up to $100,000 in 2013.

Roth Conversions for Retirement Plans in the 2012 American Taxpayer Relief Act

The new provision permits individuals to convert any portion of their balance in an employer-sponsored tax-deferred retirement plan account into a Roth account under that plan. Roths are a popular retirement plan option because they offer several advantages, namely:

• Earnings within the account are tax-sheltered (as they are with a regular qualified employer plan or IRA).
• Unlike a regular qualified employer plan or IRA, withdrawals from a Roth IRA are not taxed if some relatively liberal conditions are satisfied.
• A Roth IRA owner does not have to commence lifetime required minimum distributions (RMDs) after he or she reaches age 70 ½, as is generally the case with regular qualified employer plans or IRAs.
• Beneficiaries of Roth IRAs also enjoy tax-sheltered earnings (as with a regular qualified employer plan or IRA) and tax-free withdrawals (unlike with a regular qualified employer plan or IRA). They do, however, have to commence regular withdrawals from a Roth IRA after the account owner dies.

The catch under the new law conversion provision, and it is a big one, is that the conversion will be fully taxed, assuming the conversion is being made with pre-tax dollars (money that was not taxed to an employee when contributed to the qualified employer-sponsored retirement plan) and the earnings on those pre-tax dollars.  For example, a taxpayer in the 28% federal tax bracket who converted $100,000 from an employer-sponsored plan funded entirely with deductible dollars to a Roth IRA would owe $28,000 of tax.  So, in deciding whether to pursue a Roth conversion, one would need to weigh the price of paying tax now against the advantages afforded by future tax-free withdrawals and freedom from the RMD rules. The conversion option for retirement plans would only be available if employer plan sponsors include this feature in the plan.  The provision is effective for post-2012 transfers, in taxable years ending after December 31, 2012.

Education

Extension of the American Opportunity Credit in the 2012 American Taxpayer Relief Act

The recently enacted 2012 Taxpayer Relief Act includes a five-year extension (through 2017) of the American Opportunity tax credit for college costs.  Added to the tax code in 2009 as a temporary replacement of the previous Hope tax credit, the American Opportunity credit both increased the tax relief available for students from middle-income families and also extended relief for the first time to students from lower-income families.  Now that the American Opportunity tax credit has been extended for five years, it might be a good time to review the tax benefits available under that credit, with an eye to how it compares with the Hope credit, which would have been in effect over the next two years had the American Opportunity credit not been extended.

• Families with a family member in college can benefit from a tax credit for tuition and fees.  From a taxpayer’s point of view, a credit is almost always preferable to a deduction, because a credit reduces taxes owed, while a deduction only reduces taxable income.  The maximum amount of the American Opportunity tax credit is $2,500 (up from a maximum credit of $1,800 under the Hope credit).  The credit is 100% of the first $2,000 of qualifying expenses and 25% of the next $2,000, so the maximum credit of $2,500 is reached when a student has qualifying expenses of $4,000 or more.
• While the Hope credit was only available for the first two years of undergraduate education, the American Opportunity tax credit is available for up to four years.
• Under the Hope credit, qualifying expenses were narrowly defined to include just tuition and fees required for the student’s enrollment.  Textbooks were excluded, despite their escalating cost in recent years.  The American Opportunity tax credit expands the list of qualifying expenses to include textbooks.
• The Hope credit was nonrefundable, i.e., it could reduce your regular tax bill to zero but could not result in a refund.  This meant that if a family did not owe any taxes it could not benefit from the credit, which prompted critics to argue that the credit was thus denied to the very families most in need of help affording college.  The American Opportunity tax credit addresses this criticism to a degree by providing that 40% of the credit is refundable.  This means that someone who has at least $4,000 in qualified expenses and who would thus qualify for the maximum credit of $2,500, but who has no tax liability to offset that credit against, would qualify for a $1,000 (40% of $2,500) refund from the government.
• The Hope credit was not available to someone with higher than moderate income.  Under the credit’s “phaseout” provision, taxpayers with adjusted gross income (AGI) over $50,000 (for 2009) saw their credits reduced, and the credit was completely eliminated for AGIs over $60,000 (twice those amounts for joint filers).  Under the American Opportunity tax credit, taxpayers with somewhat higher incomes can qualify, as the phaseout of the credit begins at AGI in excess of $80,000 ($160,000 for joint filers).

Qualified Tuition Deduction is Retroactively Extended Through 2013

An individual is allowed an above-the-line deduction for “qualified tuition and related (QT&R) expenses” for higher education paid by the individual during the tax year.  These expenses include tuition and fees for the enrollment or attendance of the taxpayer, the taxpayer’s spouse, or any dependent for whom the taxpayer can claim a personal exemption, at an eligible institution of higher education for courses of instruction at the institution.  These expenses must be in connection with enrollment at an institution of higher education during the tax year, or with an academic term beginning during the tax year or during the first three months of the next tax year.  The amount of these expenses must be reduced by tax-free educational assistance and certain exclusions from income under the rules for savings bond interest, Coverdell education savings accounts (ESAs), and qualified tuition programs (QTPs or 529 plans). The maximum deduction is:

• $4,000 for an individual whose adjusted gross income (AGI), with certain modifications, does not exceed $65,000 ($130,000 for a joint return),
• $2,000 for an individual whose modified AGI exceeds $65,000 ($130,000 for a joint return), but does not exceed $80,000 ($160,000 for a joint return), or
• zero for other taxpayers.

Under pre-2012 Taxpayer Relief Act law, the higher-education expense deduction was not available for tax years beginning after December 31, 2011.

New law effective for tax years beginning after December 31, 2011

The 2012 Taxpayer Relief Act (Act) replaces “December 31, 2011” with “December 31, 2013.”  Thus, the Act extends the qualified tuition deduction for two years so that it is generally available for tax years beginning before January 1, 2014. Most individuals are on a calendar year.  For these individuals, the qualified tuition expenses must be paid before 2014.  But, as noted above, the deduction is for expenses in connection with enrollment at an institution of higher education during the tax year, or with an academic term beginning during the tax year or during the first three months of the next tax year,  Thus, expenses for an academic term beginning as late as March 31, 2014 may qualify for the deduction, if the taxpayer pays these expenses before 2014. A taxpayer who plans to go to college or graduate school for an academic term beginning in January, February, or March of 2014 (or whose spouse or dependent plans to do so) should consider paying some tuition for that term at the end of 2013 –namely, the dollar amount equal to the maximum allowable deduction ($4,000 or $2,000, depending on the taxpayer’s modified AGI).

EGTRRA Changes to Student Loan Deduction Rules are Made Permanent

Individuals can deduct a maximum of $2,500 annually for interest paid on qualified higher education loans.  The deduction is claimed as an adjustment to gross income to arrive at adjusted gross income (AGI).  For tax years beginning in 2012, the deduction phases out ratably for taxpayers with modified AGI between $60,000 and $75,000 ($120,000 and $150,000 for joint returns).  The phaseout amounts and ranges are indexed for inflation. The Economic Growth and Tax Relief Reconciliation Act amended the rules for deducting interest on student loans, effective generally for tax years beginning after 2001, by:

• eliminating the 60-month limit on the deduction for interest paid on a qualified education loan and
• increasing the pre-2001 EGTRRA AGI phaseout ranges ($40,000 to $55,000 for taxpayers other than joint filers; $60,000 to $75,000 for a married couple filing jointly) applicable to the student loan interest deduction.  The phaseout ranges, as amended by 2001 EGTRRA, were indexed for inflation.

Sunset after 2012

Under pre-2012 Taxpayer Relief Act law, a sunset provision in 2001 EGTRRA provided that all changes made by 2001 EGTRRA did not apply to tax years beginning after December 31, 2012.

New law effective for tax years beginning after December 31, 2012

The 2012 Taxpayer Relief Act removes the sunset provision. In other words, the 2012 Taxpayer Relief Act removes the 2001 EGTRRA sunset as it applies to the student loan interest deduction and makes permanent the provisions of the student loan deduction that were added by 2001 EGTRRA.  Thus, for tax years beginning after 2012, the sixty-month limitation on the student loan interest deduction will not apply.  Also, for tax years beginning after 2012, the AGI phaseout ranges will not revert to the AGI phaseout ranges that applied before 2001 EGTRRA.

Increased $2,000 Contribution Limit and Other EGTRRA Enhancements to Coverdell ESAs are Made Permanent

An individual can make a nondeductible cash contribution to a Coverdell education savings account (“Coverdell ESA”, or “CESA”, formerly called an “education IRA”) for qualified education expenses of a beneficiary under the age of 18.  A specified aggregate amount can be contributed each year by all contributors for one beneficiary.  The amount an individual contributor can contribute is phased out as the contributor’s modified adjusted gross income (MAGI) exceeds specified levels.  A 6% excise tax applies to excess contributions. Earnings on the contributions made to a CESA are subject to tax when withdrawn.  But distributions from a CESA are excludible from the distributee’s (i.e., the student’s) gross income to the extent the distributions do not exceed the qualified education expenses incurred by the beneficiary during the tax year the distributions are made.  The earnings portion of a CESA distribution not used to pay qualified education expense is includible in a distributee’s income, and that amount is subject to a 10% tax that applies in addition to the regular tax. Tax-free (including free of the 10% tax described above) transfers or rollovers of CESA account balances from a CESA benefiting one beneficiary to a CESA benefitting another beneficiary (and redesignations of named beneficiaries) are permitted if the new beneficiary is a family member of the previous beneficiary and is under age 30.  Generally, a balance remaining in a CESA is deemed to be distributed within 30 days after the beneficiary turns 30. Under the Economic Growth and Tax Relief Reconciliation Act of 2001, the CESA rules were modified to:

• increase the limit on CESA aggregate annual contributions (from $500) to $2,000 per beneficiary;
• permit corporations and other entities (in addition to individuals) to make contributions to a CESA, regardless of the corporation’s or entity’s income;
• increase the MAGI phaseout range for joint filers (from $150,000 – $160,000) to $190,000 – $220,000 to equal twice the range for single filers (i.e., $95,000 – $110,000), and so eliminate any “marriage penalty;”
• permit contributions to a CESA for a tax year to be made until April 15^th of the following year;
• modify the definition of excess contribution to a CESA for purposes of the 6% excise tax on excess contributions to reflect various other EGTRRA changes;
• extend the time (to before June 1^st of the following tax year) for taxpayers to withdraw excess contributions (and the earnings on them) to avoid imposition of the 6% excise tax;
• expand the definition of education expenses that can be paid by CESAs to include elementary and secondary school expenses (in addition to qualified higher education expenses);
• provide for coordination of the Hope and Lifetime Learning credits with the CESA rules to permit a Hope or Lifetime Learning credit to be taken in the same year as a tax-free distribution is taken from a CESA for a designated beneficiary (but for different expenses);
• provide rules coordinating distributions from both a qualified tuition program (QTP, or “529 plan”) and a CESA for the same beneficiary for the same tax year (but for different expenses);
• eliminate the age limitations described above for acceptance of CESA contributions, deemed balance distributions, tax-free rollovers to other family-member-beneficiaries, and tax-free change of beneficiaries, for “special needs beneficiaries;”
• provide that the 10% additional tax on taxable distributions from a CESA does not apply to distributions of contributions to a CESA made by June 1^st of the tax year following the tax year in which the contribution was made.

Sunset

Under EGTRRA all of the changes described above were scheduled to expire for tax years beginning after December 31, 2010.  The 2010 Tax Relief Act extended the rules by providing that the EGTRRA sunset would not take effect until after December 31, 2012.

New law effective for tax years beginning after December 31, 2012

The 2012 Tax Relief Act permanently extends the EGTRRA rules, by deleting the EGTRRA sunset provision. Specifically, as a result of the above extension, the following rules apply on a permanent basis:

• the limit on CESA aggregate annual contributions is $2,000 per beneficiary (and is not decreased to $500 per beneficiary);
• corporations and other entities (not just individuals) can make contributions to a CESA, and the corporations and other entities can do so regardless of their income;
• the MAGI phaseout range for joint filers is $190,000 – $220,000 (and does not decrease to $150,000 – $160,000);
• CESA contributions for a tax year can be made until April 15^th of the following year;
• the definition of CESA excess contribution reflects the various other EGTRRA changes to the CESA rules;
• taxpayers have until June 1^st of the following tax year to withdraw excess contributions (and the earnings on them) to avoid imposition of the 6% excise tax;
• education expenses that can be paid by CESAs include elementary and secondary school expenses and qualified higher education expenses (rather than only qualified higher education expenses);
• a Hope or Lifetime Learning credit can be taken in the same year as a tax-free distribution is taken from a CESA for a designated beneficiary (but for different expenses);
• the rule coordinating distributions being made from both a QTP and a CESA for the same beneficiary for the same tax year (but for different expenses) applies;
• special needs beneficiaries are exempted from the age limitations for a CESA’s acceptance of contributions, deemed balance distributions, tax-free rollovers to other family-member-beneficiaries, and tax-free change of beneficiaries; and
• the 10% additional tax on taxable distributions from a CESA is inapplicable to distributions of contributions to a CESA  made by June 1st of the tax year following the tax year in which the contribution was made.

Exclusion for Employer-Provided Educational Assistance, and Restoration of the Exclusion for Graduate-Level Courses, Made Permanent

Under Code Sec. 127, an employee’s gross income does not include amounts paid or expenses incurred (up to $5,250 annually) by the employer in providing educational assistance to employees under an educational assistance program.  An educational assistance program is a separate written plan of the employer for the exclusive benefit of its employees, having the purpose of providing the employees with educational assistance.  The courses taken need not be related to the employee’s job for the exclusion to apply.  To be qualified, the program must not discriminate in favor of highly compensated employees, nor may more than 5% of the amounts paid or incurred by the employer for educational assistance during the year be provided for individuals (and their spouses and dependents) owning more than 5% of the employer.  Further, the program cannot provide employees with a choice between educational assistance and other remuneration that would be includible in their gross income.  Finally, reasonable notification of the program’s availability and terms must be provided to employees. Before the 2001 Economic Growth and Tax Relief Reconciliation Act (EGTRRA), Congress had periodically waited until the educational assistance exclusion was set to expire before renewing it, and had sometimes allowed it to expire, and then extended it retroactively.  The exclusion was set to expire for courses beginning after December 31, 2001.  Under EGTRRA, the exclusion was extended “permanently” subject to the EGTRRA sunset. Also, EGTRRA restored the exclusion for graduate level courses, which had earlier been eliminated.  This was also subject to the EGTRRA sunset.

Sunset after 2012

With certain exceptions, all provisions of, and amendments made by, EGTRRA did not apply to tax, plan, or limitation years beginning after December 31, 2010.  Under this sunset rule, the Code was to have been applied and administered to tax, plan, or limitation years beginning after December 31, 2010, as if the provisions of, and amendments made by, EGTRRA had never been enacted.  Thus, for tax years beginning after December 31, 2010, the specific exclusion for employer-provided educational assistance would have expired along with the restoration of the exclusion to graduate courses. The 2010 Tax Relief Act extended the EGTRRA sunset date from December 31, 2010 to December 31, 2012.  Thus, the Code Sec. 127 exclusion, including the assistance for graduate courses, would have expired after 2012.

New law effective for tax years beginning after December 31, 2012

Under the 2012 Taxpayer Relief Act, the EGTRRA sunset as extended by the 2012 Tax Relief Act to December 31, 2012, is repealed. Thus, the Code Sec. 127 exclusion, including the assistance for graduate courses, is made permanent.

Income Exclusion for Awards Under the National Health Service Corps and Armed Forces Health Professions Programs Made Permanent

Gross income does not include (i) any amount received as a “qualified scholarship” by an individual who is a candidate for a degree at a primary, secondary, or post-secondary educational institution, or (ii) qualified tuition reductions for certain education provided to employees (and their spouses and dependents) of those educational institutions.  But these exclusions do not apply to any amount that a student receives that represents payment for teaching, research, or other services provided by the student, required as a condition for receiving the scholarship or tuition reduction. Thus, before enactment of the Economic Growth and Tax Relief Reconciliation Act of 2001, there was no exclusion from gross income for health profession scholarship programs which required scholarship recipients to provide medical services as a condition for their awards. EGTRRA provided that education awards received under specified health scholarship programs may be tax-free qualified scholarships, without regard to any service obligation on the part of the recipient.  Specifically, the rule that the exclusions for qualified  scholarships and qualified tuition do not apply to amounts received which represent compensation does not apply to any amount received by an individual under the following programs:

• the National Health Service Corps Scholarship Program (the “NHSC Scholarship Program,” under Sec. 338A(g)(1)(A) of the Public Health Services Act), and
• the F. Edward Hebert Armed Forces Health Professions Scholarship and Financial Assistance program (the “Armed Forces Scholarship Program,” under Subchapter 1 of Chapter 105 of Title 10 of the United States Code).

A sunset provision in EGTRRA provided that the changes made by 2001 EGTRRA will not apply to tax years beginning after December 31, 2012.  Thus, under pre-2012 Taxpayer Relief Act law, the exception from the payment-for-services rule for NHSC Scholarship Program and the Armed Forces Scholarship Program would not have applied for amounts received in tax years beginning after December 31, 2012.

New law effective for taxable years beginning after December 31, 2012

The 2012 Taxpayer Relief Act repeals the EGTRRA sunset provision.  Thus, the exclusion from gross income for awards received under the NHSC and Armed Forces Scholarship Programs is made permanent. This means that after 2012 recipients of scholarships under the NHSC Scholarship Program and the Armed Forces Scholarship Program, whose awards are conditioned on providing medical services, will not have to include the amount of their scholarships in gross income.

Trust, Estate and Descendent Income Tax

25%, 28%, and 33% Trust and Estate Income Tax Rates are Permanently Extended, Top Rate Increases to 39.6% Beginning in 2013

The 2012 Taxpayer Relief Act provides the following tax brackets beginning after 2012, for trusts’ and estates’ income tax at 15%, 25%, 28%, 33%, and 39.6% marginal tax rates.

Projected 2013 Rate Schedule for Trusts and Estates Effective tax years beginning after December 31, 2012:

If taxable income is:	The tax would be:
Not over $2,450	15% of taxable income
Over $2,450 but not over $5,700	$367.50 plus 25% of the excess over $2,450
Over $5,700 but not over $8,750	$1,180.50 plus 28% of the excess over $5,700
Over $8,750 but not over $11,950	$2,034.00 plus 33% of the excess over $8,750
Over $11,950	$3,090.00 plus 39.6% of the excess over $11,950

Estate, Gift, and Generation-Skipping Transfer Taxes

Current Estate Tax Rules Made Permanent, but Top Rate Increases from 35% to 40%

Under the 2001 Economic Growth and Tax Relief Reconciliation Act (EGTRRA), the estate tax was scheduled to be repealed in 2010, and then to return in 2011 with an exemption of $1 million and graduated rates reaching a top rate of 55% on transfers over $3 million.  The 2010 Tax Relief Act reinstated the estate tax retroactively to the beginning of 2010, except where the executor of the estate of a decedent dying in 2010 made an election to opt out of the estate tax and be subject to the modified carryover basis rules instead. For estates of decedents dying after 2009, the 2010 Tax Relief Act provided an estate tax exemption of $5 million (indexed for inflation after 2011).  The exemption amount was $5,120,000 for 2012, and based on inflation data, RIA has calculated the exemption amount to be $5,250,000 for 2013.  Also, under the 2010 Tax Relief Act, the tax was imposed at a top rate of 35% on all transfers exceeding the exemption amount. For estates of decedents dying after 2010, the 2010 Tax Relief Act made the estate tax exclusion (but not the GST exemption) portable between spouses, by allowing the estate of a surviving spouse to use any unused portion of the deceased spouse’s exclusion, in addition to the surviving spouse’s own exclusion. Under pre-2010 Tax Relief Act law, the generation-skipping transfer (GST) tax was scheduled to be repealed in 2010.  The 2010 Tax Relief Act reinstates the GST tax retroactively to the beginning of 2010.  For transfers in 2010 only, the tax rate for GST tax purposes was zero.  The amount of the GST exemption is the same as the estate tax exemption ($5 million in 2010 and 2011, indexed for inflation after 2011, see above).  The GST exemption may have been allocated to a trust created or funded in 2010. The gift tax was never scheduled to be repealed.  For gifts made after 2010, the 2010 Tax Relief Act reunified the gift tax exemption with the estate tax exemption ($5 million, as indexed for inflation, see above).  For gifts made after 2010, the 2010 Tax Relief Act reunified the gift and estate tax rate schedule, which imposed tax at a top rate of 35% on all transfers exceeding the exemption amount.

Sunset after 2012

The 2010 Tax Relief Act provided that several estate and gift tax changes that were made by EGTRRA, which had been scheduled to sunset on December 31, 2010, would have expired on December 31, 2012 instead.  The 2010 Tax Relief Act also provided that the EGTRRA sunset date (as extended to December 31, 2012) applied to the estate, gift, and GST tax changes made by the 2010 Tax Relief Act.  This meant that, after 2012, in the absence of further legislation:

• the estate, gift, and GST exemption would have been $1 million;
• the maximum estate and gift tax rate would have been 55% on transfers in excess of $3 million; and
• the rules allowing for the portability of the estate tax exclusion between spouses would not have applied.

New law effective for estates of decedents dying, generation-skipping transfers, and gifts made after December 31, 2012

Under the 2012 Taxpayer Relief Act, the EGTRRA sunset as extended by the 2010 Tax Relief Act to December 31, 2012, is repealed. Thus, except for the changes to the estate and gift tax rates (see below), all of the estate, gift and GST tax rules applicable during the years 2010 to 2012 are made permanent starting in 2013.  This includes the increased and indexed estate, gift and GST tax exemption of $5 million ($5,250,000 in 2013, as indexed for inflation), and the portability rules.

Top tax rate increased to 40%

The Act also provides that the estate and gift tax rates for amounts over $500,000 are as follows:

• For amounts over $500,000 but not over $750,000, the tax is $155,800, plus 37% of the excess over $500,000;
• For amounts over $750,000 but not over $1 million, the tax is $248,300, plus 39% of the excess over $750,000; and
• For amounts over $1 million, the tax is $345,800, plus 40% of the excess over $1 million.

Thus, under the Act, the top estate and gift tax rate is increased from 35% to 40%.

Business Provisions

Increased 2010 and 2011 Code 179 Dollar Limitation and Phase-Out Threshold, and 2010 and 2011 Treatment of Qualified Real Property as Section 179 Property, are Extended to 2012 and 2013

Subject to certain limitations, taxpayers can elect to treat the cost of any section 179 property placed in service during the tax year as an expense which is not chargeable to capital account, and, thus, allowed as a deduction for the tax year in which the section 179 property is placed in service. Under pre-2012 Taxpayer Relief Act law, the deductible Code Sec. 179 expense could not exceed $125,000, adjusted for inflation, in the case of a tax year beginning in 2012, and $500,000 not adjusted for inflation (dollar limitation) in the case of a tax year beginning in 2010 or 2011.  The maximum deductible expense had to be reduced (i.e., phased out, but not below zero) by the amount by which the cost of section 179 property placed in service during a tax year beginning in 2012 exceeded $800,000, adjusted for inflation, and during a tax year beginning in 2010 or 2011, exceeded $2,000,000 not adjusted for inflation (beginning-of-phaseout amount). Under pre-2012 Taxpayer Relief Act law, for a tax year beginning in 2010 or 2011, subject to a dollar limitation and a carryover limitation, “Section 179 property” included up to $250,000 of the cost of “qualified real property.” Under pre-2012 Taxpayer Relief Act law, for tax years beginning after 2012, the dollar limitation (discussed above) was to be $25,000 and the paseout amount (discussed above) was to be $200,000. The $25,000 and $200,000 amounts were not to be adjusted for inflation.

New law effective for tax years beginning after December 31, 2011 and before January 1, 2014

The 2012 Taxpayer Relief Act extends the $500,000 limitation and $2,000,000 beginning of phase-out amount, that each apply to tax years beginning in 2010 and 2011, to tax years beginning in 2012 and 2013. The 2012 Taxpayer Relief Act also extends the treatment of up to $250,000 of the cost of “qualified real property” as section 179 property, that applies to tax years beginning in 2010 and 2011, to tax years beginning in 2012 and 2013.

Increase in First-Year Depreciation Cap for Cars that are “Qualified Property” is Extended Through December 31, 2013

Code Sec. 280F(a) imposes dollar limits on the depreciation deductions (including deductions under the Code Sec. 179 expensing election) that can be claimed with respect to “passenger automobiles.”  The dollar limits are adjusted annually from a base amount to reflect changes in the automobile component of the Consumer Price Index (CPI).  Generally, for passenger automobiles placed in service in 2012, the adjusted first-year limit was $3,160.  For passenger automobiles built on a truck chassis (“qualifying trucks and vans”) a different CPI component is used, and for 2012 the adjusted first-year limit was $3,360. For any passenger automobile that is “qualified property” and which is not subject to a taxpayer election to decline the bonus depreciation and AMT depreciation relief otherwise available for “qualified property” under Code Sec. 168(k), the above rules apply, except that the applicable first-year depreciation limit is increased by $8,000 (not indexed for inflation). Under pre-2012 Taxpayer Relief Act law, qualified property did not include property placed in service after December 31, 2012.

New law effective for property placed in service after December 31, 2012 in tax years ending after December 31, 2012

The 2012 Taxpayer Relief Act provides that the placed-in-service deadline for “qualified property” is December 31, 2013. Thus, for a passenger automobile that satisfies the other requirements (see below) for qualified property (and is not subject to the election to decline bonus depreciation and AMT depreciation relief), the 2012 Taxpayer Relief Act extends the placed-in-service deadline for the $8,000 increase in the first-year depreciation limit from December 31, 2012 to December 31, 2013. On October 15, 2013, T, a calendar year taxpayer, places a new passenger automobile into service in his business.  Assume that the vehicle is “qualified property” (and an election to decline bonus depreciation and AMT depreciation relief does not apply to the vehicle).  T is allowed first-year depreciation for 2013 of no more than $11,160 (the $3,160 amount discussed above –assuming, for illustration purposes, that it remains the same for 2013 –plus $8,000).

Bonus Depreciation and AMT Depreciation Relief are Extended for Most Qualified Property Placed in Service Through December 31, 2013

Under code Sec. 168(k), a taxpayer that owns “qualified property” (see below) is, generally, allowed 50% depreciation (bonus depreciation) in the year that the property is placed in service (with corresponding reductions in basis and, thus, reductions of the regular depreciation deductions otherwise allowed in the placed-in-service year and in later years).  However, 100% bonus depreciation, (resulting in temporary 100% expensing) was available, instead of 50% bonus depreciation, for qualifying property that, generally, was placed in service and acquired after September 8, 2010 and before January 1, 2012. Additionally, qualified property is exempt from the alternative minimum tax (AMT) depreciation adjustment, which is the adjustment that requires that certain property depreciated on the 200% declining balance method for regular income tax purposes must be depreciated on the 150% declining balance method for AMT purposes. Also, qualified property is allowed an $8,000 increase in the otherwise-applicable dollar limit on first-year depreciation for passenger cars. The rules discussed above for qualified property do not apply to classes of property for which, under Code Sec. 168(k)(2)(D)(iii), the taxpayer elects to not apply Code Sec. 168(k) (an “election-out”). The following are the requirements for qualified property under Code Sec. 168(k)(2):

• the property must be of a qualifying type; i.e., generally, most machinery, equipment or other tangible personal property; most computer software; and certain leasehold improvements;
• the property must not be property that must be depreciated under the alternative depreciation system;
• the property must not be the subject of certain disqualifying transactions involving users other than the taxpayer or persons related to the taxpayer or the other users;
• the property’s original use generally must begin with the taxpayer after December 31, 2007;
• the property must meet a timely-placed-in-service requirement (see below); and
• the property must meet a timely acquisition requirement (see below).

Under pre-2012Taxpayer Relief Act law, the timely-placed-in-service requirement was that the property had to be placed in service by the taxpayer before January 1, 2013. Under pre-2012 Taxpayer Relief Act law, the timely acquisition requirement was satisfied if the property was acquired by the taxpayer either (i) after December 31, 2007 and before January 1, 2013, but only if no written binding contract for the acquisition was in effect before January 1, 2008, or (ii) under a written binding contract entered into after December 31, 2007 and before January 1, 2013.  For a taxpayer manufacturing, constructing or producing property for its own use, the timely acquisition requirement was treated as met if the taxpayer began the manufacture, construction or production after December 31, 2007 and before January 1, 2013.

New law effective for property placed in service after December 31, 2012 in tax years ending after December 31, 2012 and before January 1, 2014

The 2012 Taxpayer Relief Act extends the availability of 50% bonus depreciation, but not the availability of 100% bonus depreciation. The 2012 Taxpayer Relief Act changes the timely-placed-in-service requirement (above) to provide that qualified property has to be placed in service by the taxpayer before January 1, 2014, except that the aircraft and long-production-period property discussed above have to be placed in service before January 1, 2015. In addition to extending the eligibility period for bonus depreciation, the extension of the placed-in-service deadline for qualified property also extends the eligibility period for obtaining the exemption, discussed above, from the AMT depreciation adjustment.

Changes to the Timely-Acquisition Rules

Under the 2012 Taxpayer Relief Act, the timely acquisition requirement is satisfied if the property is acquired by the taxpayer either (i) after December 31, 2007 and before January 1, 2014, but only if no written binding contract for the acquisition was in effect before January 1, 2008, or (ii) under a written binding contract entered into after December 31, 2007 and before January 1, 2014.

Disregard of Certain Bonus Depreciation in Applying the Percentage of Completion Method is Extended for an Additional Time Period

Under the percentage of completion method of accounting (PCM) for a long term contract, the taxpayer includes in income the percentage of the total estimated revenue from the contract that corresponds to the “completion percentage.”  The completion percentage is determined by comparing costs allocated to the contract and incurred before the close of the tax year with the estimated total contract costs.  The completion percentage is then multiplied by the total estimated revenue to obtain the cumulative gross receipts.  The gross receipts for the current year are then determined by subtracting the cumulative gross receipts for the immediately preceding tax year.  Thus, as the taxpayer incurs allocable contract costs, it includes the contract price in gross income. Costs are allocated to a contract under a regular PCM method or under an alternative simplified method.  Under both methods, depreciation, amortization and cost recovery allowances on equipment and facilities used to perform the contract are taken into account as costs under the contract. Thus, an increased depreciation deduction for a tax year will increase the percentage of completion for that year and the amount of gross receipts for the year. Under Code Sec. 168(k), a taxpayer that owns “qualified property,” is, generally, allowed a 50% depreciation deduction (bonus depreciation) in the year that the property is placed in service (with corresponding reductions in basis and, thus, reductions of the regular depreciation deductions otherwise allowed in the placed-in-service year and in later years). For purposes of determining the completion percentage (see above), bonus depreciation, with respect to certain qualified property, is not taken into account.  The qualified property to which the exclusion applies is property that (i) has an MACRS recovery period of seven years or less (the recovery period requirement) and (ii) is placed in service during a required period (the timing requirement).  Under pre-2012 Taxpayer Relief Act law, the required placed-in-service period was after December 31, 2009 and before January 1, 2011.

New law effective for property placed in service after December 31, 2012 in tax years ending after December 31, 2012 and before January 1, 2014

The 2012 Taxpayer Relief Act adds an additional period of time (i.e., during the calendar year 2013, and during 2013 and 2014 for long-production period property) during which qualified property satisfies the timing requirement discussed above.  The additional period is the period after December 31, 2012 and before January 1, 2014.

15-Year MACRS Depreciation for Certain Building Improvements and Restaurants is Extended to Apply to Property Placed in Service Before January 1, 2014

The rules that in most situations assign a recovery period (i.e., depreciation period) to the various types of MACRS property are known as the General Depreciation System (GDS). Assets that are nonresidential real property-generally, nonresidential buildings and their structural components – are depreciated on the straight-line method, over a thirty-nine-year GDS recovery period. However, under pre-2012 Taxpayer Relief Act law, a building improvement that was “qualified leasehold improvement property” placed in service before January 1, 2012 was depreciated on the straight-line method, over a fifteen-year GDS recovery period. Similarly, a building improvement that was “qualified retail improvement property” placed in service before January 1, 2012 was depreciated on the straight-line method, over a fifteen-year GDS recovery period. Also, a building or a building improvement that was “qualified restaurant property” placed in service before January 1, 2012 was depreciated on the straight-line method, over a fifteen-year GDS recovery period. However, under pre-2012 Taxpayer Relief Act law, qualified leasehold improvement property, qualified retail improvement property and qualified restaurant property placed in service before January 1, 2012 were depreciated over a 39-year recovery period for ADS purposes.

New law effective for property placed in service after December 31, 2011 and before January 1, 2014

The 2012 Taxpayer Relief Act extends the rules discussed above for qualified leasehold improvement property, qualified retail improvement property, and qualified restaurant property for two years by providing that the three types of property must be placed in service by January 1, 2014. Thus, the 2012 Taxpayer Relief Act retroactively restores and extends for two years the period in which qualifying property can be placed in service to be eligible for the accelerated depreciation rules discussed above. The fifteen-year GDS recovery period continue in effect for qualified leasehold improvement property, qualified retail improvement property and qualified restaurant property placed in service before January 1, 2014, but a thirty-nine-year GDS recovery period will apply to qualified leasehold improvement property, qualified retail improvement property and qualified restaurant property placed in service after December 31, 2013.

Business Extenders in the 2012 American Taxpayer Relief Act

Business tax breaks extended

The following business credits and special rules are extended:

• The research credit is modified and retroactively extended for two years through 2013.
• The temporary minimum low-income tax credit rate for nonfederally subsidized new building is extended to apply to housing credit dollar amount allocations made before January 1, 2014.
• The housing allowance exclusion for determining area median gross income for qualified residential rental project exempt facility bonds is extended two years.
• The Indian employment tax credit is retroactively extended for two years through 2013.
• The new markets tax credit is retroactively extended for two years through 2013.
• The railroad track maintenance credit is retroactively extended for two years through 2013.
• The mine rescue team training credit is retroactively extended for two years through 2013.
• The employer wage credit for employees who are active duty members of the uniformed services is retroactively extended for two years through 2013.
• The work opportunity tax credit is retroactively extended for two years through 2013.
• Qualified zone academy bonds are retroactively extended for two years through 2013.
• The enhanced charitable deduction for contributions of food inventory is retroactively extended for two years through 2013.
• Allowance of the domestic production activities deduction for activities in Puerto Rico applies for the first eight tax years of the taxpayer beginning after December 31, 2005, and before January 1, 2014.
• Exclusion from a tax-exempt organization’s unrelated business taxable income (UBTI) of interest, rent, royalties, and annuities paid to it from a controlled entity is extended through December 31, 2013.
• Treatment of certain dividends of regulated investment companies (RICs) as “interest-related dividends” is extended through December 31, 2013.
• Inclusion of RICs in the definition of a “qualified investment entity” is extended through December 31, 2013.
• The exception under subpart F for active financing income (i.e., certain income from the active conduct of a banking, financing, insurance or similar business) for tax years of a foreign corporation beginning after December 31, 1998 and before January 1, 2014, for tax years of foreign corporations beginning after December 31, 2005, and before January 1, 2014.
• Look-through treatment for payments between related controlled foreign corporations (CFCs) under the foreign personal holding company rules is extended through January 1, 2014.
• Exclusion of 100% of gain on certain small business stock acquired before January 1, 2014.
• Basis adjustment to stock of S corporations making charitable contributions of property in tax years beginning before December 31, 2013.
• The reduction in S corporation recognition period for built-in gains tax is extended through 2013, with a five-year period instead of a ten-year period.
• Various empowerment zone tax incentive, including the designation of an empowerment zone and of additional empowerment zones (extended through December 31, 2013) and the period for which the percentage exclusion for qualified small business stock (of a corporation which is a qualified business entity) is 60% (extended through December 31, 2018).
• Tax-exempt financing for New York Liberty Zone is extended for bonds issued before January 1, 2014.
• Temporary increase in limit on cover over rum excise taxes to Puerto Rico and the Virgin Islands is extended for spirits brought into the United States before January 1, 2014.
• American Samoa economic development credit, as modified, is extended through January 1, 2014.

Energy-Related Tax Breaks Extended in the 2012 American Taxpayer Relief Act

The recently enacted 2012 American Taxpayer Relief Act extends a host of important energy-related tax breaks for individuals and businesses. The various energy credits extended include:

• The nonbusiness energy property credit for energy-efficient existing homes is retroactively extended for two years through 2013.  A taxpayer can claim a 10% credit on the cost of: (i) qualified energy efficiency improvements, and (ii) residential energy property expenditures, with a lifetime credit limit of $500 ($200 for windows and skylights).
• The alternative fuel vehicle refueling property credit is retroactively extended for two years through 2013 so that taxpayers can claim a 30% credit for qualified alternative fuel vehicle refueling property placed in service through December 31, 2013, subject to the $30,000 and $1,000 thresholds.
• The credit for 2-or 3-wheeled plug-in electric vehicles is modified and retroactively extended for two years through 2013.
• The cellulosic biofuel producer credit is modified and extended one year through 2013.
• The credit for biodiesel and renewable diesel is retroactively extended for two years through 2013.
• The production credit for Indian coal facilities placed in service before 2009 is extended one year.  The credit applied to coal produced by the taxpayer at an Indian coal production facility during the eight-year period beginning on January 1, 2006, and sold by the taxpayer to an unrelated person during such eight-year period and the tax year.
• The credits with respect to facilities producing energy from certain renewable resources is modified and extended one year.  A facility using wind to produce electricity will be a qualified facility if it is placed in service before 2014.
• The credit for energy-efficient new homes is retroactively extended for two years through 2013.
• The credit for energy-efficient appliances is retroactively extended for two years through 2013.
• The additional depreciation deduction allowance for cellulosic biofuel plant property is modified and extended one year.
• The special rule for sale or disposition to implement federal energy regulatory commission (FERC) or State electric restructuring policy for qualified electric utilities is retroactively extended for two years through 2013.
• The alternative fuels excise tax credits for sale or use of alternative fuels or alternative fuel mixtures is retroactively extended for two years through 2013.

Rule that S Corporation’s Charitable Contribution of Property Reduces Shareholder’s Basis Only by Contributed Property’s Basis is Extended for Tax Years Beginning in 2012 and 2013

The 2006 Pension Protection Act amended the S corporation rules so that the decrease in a shareholder’s basis in his S corporation stock by reason of a charitable contribution made by the S corporation equals the shareholder’s pro rata share of the adjusted basis of the contributed property.  Where this rule applies to limit the decrease in the basis resulting from the charitable contribution, the rule that limits the aggregate amount of losses and deductions that may be taken by the S corporation shareholder to his basis in the S corporation’s stock and debt does not apply to the extent of the excess of the shareholder’s pro rata share of the charitable contribution over the shareholder’s pro rata share of the adjusted basis of such property.  These rules were originally effective for contributions made in tax years beginning after December 31, 2005 and before January 1, 2008, but were later extended for tax years beginning in 2008 through 2011.

New Law

The 2012 Taxpayer Relief Act extends the rule that the decrease in a shareholder’s basis in his S corporation stock by reason of a charitable contribution made by the S corporation equals the shareholder’s pro rata share of the adjusted basis of the contributed property for contributions in tax years beginning before January 1, 2014. This means that the extension applies to contributions made in tax years beginning in 2012 and 2013.

Shortened S Corp Built-in Gains Holding Period Extended for 2012 and 2013 and Application of Built-in Gains Tax Clarified

An S corporation is generally not subject to tax, but passes through its items to its shareholders, who pay tax on their pro-rata shares of the S corporation’s income.  Where a corporation that was formed as a C corporation elected to become an S corporation (or where an S corporation received property from a C corporation in a nontaxable carryover basis transfer), the S corporation was taxed at the highest corporate rate (currently 35%) on all gains that were built-in at the time of the election if the gains were recognized during the recognition period, i.e., the first ten S corporation years (or during the ten-period after the transfer).  The 2009 Recovery Act provided that, for S corporation tax years beginning in 2009 and 2010, no tax was imposed on the net unrecognized built-in gain of an S corporation if the seventh tax year in the recognition period preceded the 2009 and 2010 tax years.  This rule applied separately for property acquired from C corporations in carryover basis transactions.  The 2010 Small Business Act added that for S corporation tax years beginning in 2011, no tax was imposed on the net unrecognized built-in gain of an S corporation if the fifth year in the recognition period preceded the 2011 tax year. Where the net recognized built-in gains (i.e., the amount by which recognized built-in gains exceeded the recognized built-in losses) for any tax year exceeded the taxable income of the S corporation (as determined for purposes of the built-in gains tax), the built-in gains tax was not imposed.  However, the excess net recognized built-in gain was carried forward to the next year to be treated as a recognized built-in gain in that next tax year.

New law effective for tax years beginning after December 31, 2011

The 2012 Taxpayer Relief Act provides that for S corporation tax years beginning in 2012 and 2013, the recognition period is limited to five years. Thus, a five year period applies for the 2011, 2012 and 2013 tax years.  Since the ten-year period will apply after the 2013 tax year (unless extended by Congress), sellers should complete the sales in the 2013 tax year. The 2012 Taxpayer Relief Act also provides that when an asset is sold in an installment sale under Code Sec. 453, the treatment of the payments is determined by the tax year in which the sale is made. Thus, if an asset is sold within the recognition period, the gain will be subject to the built-in gains tax, even if the gain is recognized after the recognition period under the installment sale rules. The 2012 Taxpayer Relief Act amends the rules regarding carryovers of net recognized built-in gain so that net recognized built-in gain is only carried over to years that are within the recognition period. Thus, if built-in gain is not taxed during the recognition period because of the taxable income limitation, the built-in gain will not be taxed in a later year.