United States: Congress Avoids The Fiscal ‘Cliff’—Now What?

The new federal tax bill establishes permanent income, estate, gift and generation-skipping transfer tax provisions that present additional planning opportunities for 2013 and beyond.

* * * * * * * * * *

At the very edge of the "fiscal cliff," Congress approved the American Taxpayer Relief Act of 2012 (ATRA) on January 1, 2013. ATRA raises income taxes on the top 2 percent of taxpayers. It also permanently extends certain income, estate, gift and generation-skipping transfer (GST) tax provisions introduced in 2001 (by deleting the sunset of those provisions scheduled to take effect after 2012). ATRA raises taxes on some taxpayers compared to their taxes in 2012, but it also provides greater certainty and additional planning opportunities for many individuals. Provisions of ATRA that are relevant to our private clients are discussed in this newsletter. A few thoughts on planning in light of ATRA also are included. This is a summary and as such omits important details. You should consult your tax adviser before taking any steps regarding your tax planning.

Income Taxes

Income Tax Rates

ATRA permanently retains the preexisting marginal income tax rates for most individuals. Absent ATRA, these rates were scheduled to increase to pre-2001 levels after 2012. However, ATRA does increase the top tax rate from 35 percent to 39.6 percent on earned income and certain other ordinary income of high income taxpayers. These are taxpayers with total income exceeding $400,000 for single filers, $450,000 for married couples filing jointly and $11,950 for trusts with taxable income that is not distributed. In addition, the previously enacted Patient Protection and Affordable Care Act adds another 3.8 percent tax on investment income of high income taxpayers over certain threshold amounts, thus raising the top rate on investment income over the thresholds to as much as 43.4 percent.

Capital Gains and Dividends

At the end of 2012, the 15 percent maximum tax rate on long-term capital gains and qualified dividends was scheduled to revert to 20 percent on long-term capital gains and as much as the top tax rate (39.6 percent) on qualifying dividends. ATRA maintains the 15 percent rates on long-term capital gains and qualified dividends for most taxpayers, but sets the rates for high income taxpayers (including trusts) at 20 percent on the amount of this income in excess of the thresholds indicated above. The 3.8 percent tax under the Patient Protection and Affordable Care Act also applies to long-term capital gains and qualifying dividends, making the top rate on such income for high income taxpayers 23.8 percent. Short-term capital gains will continue to be taxed at ordinary income tax rates, which for high income taxpayers means 43.4 percent (39.6 percent plus the additional 3.8 percent).

Limitations on Deductions and Exemptions

Under ATRA, starting in 2013 individual high income taxpayers will again be subject to the "3 percent limitation" on itemized deductions and the personal exemption phaseout (PEP) that applied before 2010.

The 3 percent limitation reduces the benefit of itemized deductions, including those for charitable contributions, mortgage interest and state and local taxes. Under this provision, the amount of itemized deductions that a taxpayer may deduct is reduced by 3 percent of the amount by which the taxpayer's adjusted gross income exceeds a threshold ($250,000 for single filers and $300,000 for married couples filing jointly), up to a maximum reduction of 80 percent of the taxpayer's itemized deductions. These threshold amounts will be indexed for inflation for all years after 2013.

ATRA reinstates the PEP limitations that reduce a taxpayer's total personal and dependent exemptions by 2 percent for each $2,500 (or fraction thereof) by which such taxpayer's adjusted gross income exceeds a threshold ($250,000 for single filers and $300,000 for married couples filing jointly). These threshold amounts also will be indexed for inflation for all years after 2013.

Other Significant Income Tax Provisions

IRA Distributions to Charity

ATRA retroactively reinstates for 2012 and extends for 2013 a law that permits individuals age 70½ or older to make tax-free distributions to charity from an individual retirement account (IRA). This provision permits an individual to have his or her IRA distribute up to $100,000 to charity in 2012 and then again in 2013 without any income tax cost. In addition, this provision permits an IRA distribution of up to $100,000 to charity made before February 1, 2013, to count as having been made in the 2012 taxable year. Also, individuals who took a minimum required or larger IRA distribution in December 2012 can contribute the amount of the distribution in cash (up to $100,000) to charity before February 1, 2013, and have it count as a 2012 charitable distribution from the IRA. Individuals who are required to take distributions from their IRAs can use this provision to make charitable contributions and to reduce their tax liability on their required IRA distributions.

Alternative Minimum Tax

ATRA increases the alternative minimum tax (AMT) exemption amounts retroactively for 2012 to $50,600 (single filers) and $78,750 (married couples filing jointly), and indexes these amounts for 2013 and beyond. While this provision will reduce the number of taxpayers subject to the AMT, it will have little or no effect on high income taxpayers.

Conversion of 401(k) Plans to Roth Accounts

In the past, only money that could be taken out of a 401(k) as a result of a plan participant reaching age 59½ or separating from service could be converted to a Roth account. ATRA removes these restrictions and allows plan participants to convert vested, otherwise undistributable amounts (e.g., 401(k) deferrals, employer matching or non-elective contributions, or earnings) from their 401(k) plans into designated Roth accounts that are in the same plan, if the plan permits this. The individual who makes the conversion is taxed on the total value of the amount converted at the time of the conversion but avoids any penalty tax for an early distribution (which would have previously applied). After the conversion, the new Roth account grows tax-free and no tax will be due on distributions made from that account. For 401(k) in-plan conversions there are two important differences compared to the rules that apply to the conversion of an IRA to a Roth IRA. First, the income tax due on the 401(k) amount converted must be paid from other assets, where this is optional for a conversion from IRA to a Roth IRA. Second, there is no election to undo the conversion of a 401(k), unlike the conversion of an IRA to a Roth IRA where an individual can decide to undo the conversion by the due date for the income tax return (as late as October 15 if extended properly) of the following year.

Transfer Taxes

Transfer Tax Exemptions and Rates

Under the previous tax law, the $5 million estate and gift tax exemptions were scheduled to decrease to $1 million in 2013. The top marginal transfer tax rate in 2012 was 35 percent, but was scheduled to increase to 55 percent in 2013. The $5 million GST exemption also was scheduled to be reduced to about $1.4 million, but was indexed for inflation.

ATRA permanently maintains the estate, gift and GST exemptions at $5 million (indexed for inflation with 2011 as the base year), but increases the top tax rate on transfers in excess of the relevant exemptions from the 2012 rate of 35 percent to 40 percent for 2013 and forward. For 2013, the inflation adjustment raises all three of these exemptions to $5.25 million. Cumulative taxable gifts during life or at death that exceed the $5.25 million exemption will be taxed at the top tax rate of 40 percent.

Individuals who did not use all of their exemptions in 2012 or earlier can take advantage of any remaining amount of their $5.25 million ($10.5 million for married couples) exemption amounts in 2013 and beyond. Even those individuals who did use all of their exemptions can transfer an additional $130,000 ($260,000 for married couples) without any transfer tax liability in 2013. In either case, the inflation adjustment may provide additional estate, gift and GST tax exemptions in future years.

An individual's separate GST exemption applies to the GST tax that is imposed (in addition to any gift or estate tax) on transfers made to grandchildren or others who are two generations or more younger than the donor. You should consult your tax adviser about how you can use your GST exemption.

Portability

Starting in 2011, the estate and gift (but not GST) exemptions were made "portable," meaning a surviving spouse could use a deceased spouse's unused exemption. Portability was set to expire at the beginning of 2013. ATRA, however, permanently extends portability for the estate and gift exemptions. Now, spouses can take full advantage of their combined estate and gift exemptions without transferring assets between them or using trusts. However, portability will not allow spouses to maximize use of their GST exemptions.

Unification of the Transfer Tax Exemptions

From 2004 through 2010, the estate and gift taxes were decoupled in that each tax had a different exemption amount. While the previous tax legislation used the same amounts for these exemptions for 2011 and 2012 only, ATRA makes the estate and gift tax exemptions the same indefinitely. This unification provides increased flexibility in many estate plans by allowing an individual to use a single $5 million (indexed for inflation) exemption for gifts during life and at death.

Annual Exclusion

While not part of ATRA, the gift tax annual exclusion amount for individuals was increased by the inflation adjustment from $13,000 for 2012 to $14,000 for 2013 ($28,000 for married couples).

Planning Implications

  • Individuals who did not use their full gift or GST exemptions in 2012 continue to have the opportunity for significant gift and GST planning in 2013 and beyond. Lifetime gifts shift any post-gift income from and appreciation on the transferred assets out of the donor's estate, so that using one's gift and GST exemptions during life can result in reducing the amount subject to the new 40 percent estate tax rate.
  • Making a gift in 2013 can allow an individual to take advantage of the existing grantor trust income tax rules and current low interest rates.
  • Individuals over age 70½ who received an IRA distribution in December 2012 can elect to treat that distribution as a 2012 distribution to charity from an IRA if they transfer the amount of the distribution in cash (up to $100,000) to one or more eligible charities before February 1, 2013.
  • Individuals over age 70½ can direct distributions from their IRAs directly to eligible charities before February 1, 2013, and elect to have such distributions treated as qualified charitable distributions in 2012. They can also direct IRA distributions to eligible charities later in 2013.
  • The 3 percent limitation on deductions will provide additional planning challenges for individuals with itemized deductions. One planning technique that can minimize the effect of the 3 percent limitation for the charitably inclined is the charitable lead trust (CLT). Because a CLT's income is not part of the settlor's adjusted gross income, the charitable payments made by the CLT are not affected by the 3 percent limitation. The tax effect to the settlor is the same as a complete charitable deduction for the CLT's income (but there is no charitable deduction for the amount transferred to the CLT).
  • The new 3.8 percent tax on investment income applies to trusts (that are not grantor trusts) with retained investment income over $11,950 (for 2013, indexed annually). Trustees should add this to their list of considerations when deciding whether to distribute current trust income to trust beneficiaries that have higher thresholds against the 3.8 percent tax.

What's Next?

ATRA has provided permanence in the sense that its tax changes do not come with automatic "sunset" provisions that terminate the new rules in favor of prior law. Whether ATRA represents all of the tax changes we will see in the near term is anybody's guess as Congress and President Obama take on the problems of the impending debt ceiling and long-term spending cuts.

Caitlin T. Gunther, an associate based in the Firm's New York office, also contributed to this newsletter.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
Hughes Hubbard & Reed LLP
Ostrow Reisin Berk & Abrams
Shearman & Sterling LLP
Reinhart Boerner Van Deuren s.c.
Duane Morris LLP
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Hughes Hubbard & Reed LLP
Ostrow Reisin Berk & Abrams
Shearman & Sterling LLP
Reinhart Boerner Van Deuren s.c.
Duane Morris LLP
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions