The fiscal cliff compromise extends the majority of tax cuts that were scheduled to expire at the end of 2012, in addition to retroactively reinstating some rules that had expired in 2011. The legislation also introduces a number of changes including a new top tax bracket of 39.6%, and an increase in the top long-term capital gains and qualified dividend rate to 20%. The changes under the act are permanent.
The top tax bracket rises to 39.6%, and applies to income in excess of $400,000 for individuals, and $450,000 for married couples. These thresholds are indexed for inflation (in a similar manner to all the other tax bracket thresholds). This change is effectively the same as just allowing the top tax bracket to lapse back to the old rates, as the top tax bracket was already at $388,350 in 2012. The remaining tax brackets are extended at their current levels.
Phaseout of Itemized Deductions and Personal Exemptions
The phaseout of itemized deductions and personal exemptions returns for 2013. The phaseout for itemized deductions reduces total itemized deductions by 3% of excess income over a threshold. The threshold amounts are now an Adjusted Gross Income of $300,000 for married couples, and $250,000 for individuals. These amounts are indexed for inflation.
The personal exemptions phaseout, reduces personal exemptions by 2% of the total exemptions for each $2,500 of excess income over a threshold.
The new rules make the current estate tax laws permanent, including the $5,120,000 (in 2012) gift and estate tax exemption. The top estate tax rate is increased from the prior 35% to a new maximum rate of 40%.
The portability rules for a deceased spouse’s unused estate tax exemption amount are made permanent.
Capital Gains and Dividends
The act makes permanent the 0% and 15% long-term capital gains tax rates, but increases the tax rate to 20% for any long-term capital gains that fall in the top tax bracket (the new 39.6% bracket with the $400,000 / $450,000 thresholds noted earlier).
Qualified dividend treatment is also made permanent. The top tax rate for qualified dividends has now risen to 20%.
Individuals subject to the new 20% top long-term capital gains and qualified dividends tax rate will actually find their capital gains and dividends taxes at 23.8%, due to the onset of the new 3.8% Medicare tax on net investment income that would also apply at this income levels.
Miscellaneous Extension Provisions
The American Opportunity Tax Credit (the $2,500 tax credit for college expenses that replaced the prior Hope Scholarship Credit in 2009) is extended 5 years and will now run until 2017. The Child Tax Credit and the Earned Income Tax Credit were also extended over the same 5-year time period.
A series of “extender” rules are retroactively patched for 2012 and extended one year through 2013, including the exclusion from income of discharged mortgage debt (necessary to prevent a short sale from triggering income tax consequences for the amount of debt that was discharged).
The ongoing series of AMT exemption patches over the past decade are made permanent, and fixed retroactively. The new AMT exemption amount will be $78,750 for married couples and $50,600 for singles in 2012.
Source: Financial Planning Implications of HR8 – the Taxpayer Relief Act of 2012 – kitces.com | Nerd’s Eye View