The American Taxpayer Relief Act of 2012 was enacted into law early in 2013 and, together with the Patient Protection and Affordable Care Act (PPACA) from 2010, impacts nearly all taxpayers, some in better ways than others. Like the old spaghetti western movie, there is good for most taxpayers, bad for almost all, and ugly for many others. The new law offers some good with more certainty for financial and retirement planning, some bad in the form of increased rates, and some ugly in increased complexity that creates traps for the unwary.
The good: Increased certainty
On the positive side, the Taxpayer Relief Act creates greater certainty in terms of income tax rates, the application of the Alternative Minimum Tax (AMT), as well as the estate tax rules. All of these provisions are now made permanent for 2013 and beyond, which is beneficial from the perspective of trying to do financial and retirement planning.
Since 2001, the tax law has provided for temporary income tax, capital gains, dividends and estate tax rates. Depending on what year we were in, the rates could be scheduled to go up or down, and it is hard to do financial, retirement and estate planning when you are not sure what the rates will be in the future.
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The Taxpayer Relief Act eases this planning burden by making these rates permanent, which means that we now know what the rates will be a year from now and 10 years from now. Of course, new legislation, including the much discussed possibility of tax reform, could change these rates. But at least the laws in effect today do not provide for the rates to change over time.
The tax law for the past decade also provided uncertainty in terms of the application of the Alternative Minimum Tax to taxpayers. The AMT was created to catch millionaires using tax planning techniques to zero out income, but since the AMT exemption amount was not indexed for inflation it has come to impact many taxpayers, particularly in states with high income taxes and high property taxes. The so called “AMT fix” has been an almost annual Congressional action to limit the impact of the AMT by providing an increased exemption to shield many from the tax simply because of inflation increases in salary.
The Taxpayer Relief Act fixes the AMT exemption permanently, which means that we will no longer be waiting at yearend to see if Congress acts to provide a temporary fix. By making the AMT fix permanent, individuals need not worry about the AMT exemption reverting to its original amount and increasing the burden of the alternative tax or making one subject to it in the first place. In addition, we will no longer be waiting for Congress to act each year, which has resulted in delays of the tax filing season so the IRS could reprogram its computers.
Since 2001, the estate tax exemption has increased from $1 million to over $5 million, with estate tax rates decreasing from 55 percent to 35 percent. In one year, 2010, the estate tax was entirely repealed. Consequently, during the past decade, it has really mattered in what year a person died, with significant differences in estate tax liability depending on the actual year of death. This uncertainty made estate tax planning very challenging, and was not good policy since death was effectively encouraged in some years more than others. Indeed, 2010 was sometimes referred to, with tongue in cheek, as the “throw Grandma from the train” year. But the Taxpayer Relief Act makes these rates and exemption permanent so that planning can once again occur without factoring in the specific year of death.
The Taxpayer Relief Act also makes permanent the estate exemption portability rule that allows a surviving spouse to utilize the unused portion of a deceased spouse’s estate tax exemption amount. This portability concept was introduced as a temporary provision for 2011 and 201, and making it permanent also aids the estate planning process.
Rounding out the good news from the Taxpayer Relief Act is the extension through 2013 of several provisions, such as the deduction for state and local sales taxes and the exclusion from income of up to $100,000 of required IRA distributions when given to charity. While the extenders included in the bill are temporarily prolonged and do not provide the certainty of the other changes, they do provide tax benefits for many taxpayers.
The bad: Increased taxes
As the Taxpayer Relief Act was being negotiated, the president, senators and representatives proudly pointed out that its passage avoided a tax increase on 98 percent-plus of American taxpayers. This is technically true, if you are looking at that ordinary income tax and capital gains rates scheduled to increase in 2013. But it avoids the point that the Social Security tax was scheduled to increase automatically from 4.2 percent to 6.2 percent. While this had always been viewed as a temporary rate reduction for 2011 and then 2012, the fact that Congress did not extend it means that wage earners will pay 2 percent more in taxes on income up to $113,700. Again, this was not a tax that resulted from the Relief Act, but the reality is that a wage earner making $100,000 will pay $2,000 more in taxes in 2013 than in 2012. This effective tax increase will be borne by all wage earners, which means that even with the lower tax rates being the same the average worker will have a significant tax increase in 2013.