American Taxpayer Relief Act of 2012 & Prospects for Tax Reform

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1 American Taxpayer Relief Act of 2012 & Prospects for Tax Reform Wayne M. Zell, Esq. FPA of the National Capital Area February 1, 2013 Overview A Little Bit of History and 2013 Outlook ATRA 2012 in Detail Prospects for Tax Reform Tax Quote Time! The income tax has made more liars out of the American people than golf has. Even when you make a tax form out on the level, you don't know when it's through if you are a crook or a martyr. ~Will Rogers 1

2 History of ATRA A Little Bit of History Reactions to ATRA 2013 Legislative Outlook History of ATRA Tax provisions were to expire in year extension for with changes to Estate Planning Negotiations started in 2011 Boehner failed to get Republican consensus Biden and McConnell s show History of ATRA (cont d.) Senate passed H.R. 8 by vote of 89-8 (2am, 1/1/13) House passed ATRA by vote of (11pm, 1/1/13) President signed into law 1/3 American Taxpayer Relief Act of 2012 (even though enacted in 2013) = ATRA 2

3 Reactions to ATRA Unhappy Congress Unhappy Public (with Congress) More complexity E.g., 7 brackets; 35% bracket applies to $1500 in income PEP/Pease limitations SFC extenders passed On to Tax Reform! Breadth of ATRA Permanently extends Bush tax cuts for all but wealthy Cost = $3.9T!! Covers: Income tax Dividends and capital gains Alternative minimum tax (AMT) Estate, gift and GST tax Business, energy and foreign tax 2013 Legislative Outlook Economic and Fiscal Backdrop Continued slow recovery Mounting deficits Sequestration under BCA 2011 delayed 2 months Debt ceiling needs to rise 113 th Congress Spending cuts Tax reform 3

4 Sequestration = auto cuts Due to the 2011 failure of the Joint Select Committee on Deficit Reduction to agree on a deficit reduction plan, the BCA mandated $1.2 trillion of scheduled savings through an automatic spending cut process (sequestration). Tax Quote Time! The hardest thing in the world to understand is the income tax. ~ Albert Einstein, physicist ATRA-Individual rates Individual tax rates of 10%, 15%, 25%, 28%, 33%, and 35% were permanently extended on income at or below $450,000 for joint filers and $400,000 for single filers. The 39.6% rate applies above the income threshold amounts. The threshold amounts are indexed for inflation after

5 ATRA Capital gain and dividend rates 15% maximum retained for lower brackets 20% capital gain rate applies above wealthy income threshold amounts. NOTE: 3.8% Medicare Surtax still applies AMT Patch Permanently extended $78,750 for joint, $50,600 for single Indexed for inflation $1.8T cost!! Non-refundable personal credits allowed to offset AMT PEP and Pease Phase-out Itemized deduction phase out (the Pease limitation) and personal exemption phase out (PEP) levels are repealed permanently on incomes at or below $300,000 for joint filers and $250,000 for single filers. Phase outs apply above these income threshold amounts. 5

6 Deduction Phase-out Example Angie and Brad, who are married and file jointly, have AGI of $320,000 and itemized deductions of $28,000 in Their itemized deductions will be decreased by $600 in 2013: ($320,000 - $300,000) * 3% Allowable deductions = $27,400 Personal Exemption Phase-out $3900 exemption phased out as income exceeds $300K joint/$250k single. For every $2500 ($1250 for MFS) over limit, exemption is reduced by 2%. Exemption Phase-out Example Same example, except Angie and Brad also have two kids: Rosemary and Sage. So, they are claiming 4 exemptions. Their personal exemptions will be decreased by $2,496 in 2013: ($320,000 - $300,000)/$2500 * 2% = 16% Allowable exemption= $13,104 = ($3900*4*(100%-16%)) 6

7 Payroll Tax Changes Payroll tax reduction to 4.2% expired on 12/31/2012 Everyone earning that amount (or more) must pay an additional $2,268 (2%*$113,400). New 0.9% Medicare surtax on earned incomes over $250K joint, $200K single Medicare Payroll Tax Example Brangelina (single) has $300,000 salary in 2013 He/she will pay $900 more in Medicare tax in 2013 than would be the case under prior law: ($300,000 - $200,000) * 0.9% Medicare Surtax on Net Investment Income Enacted in Health Care Reform Act in 2010 First effective 1/1/ % of net investment income for AGI over $250K joint/ $200K single 7

8 Medicare Surtax on NII- Example In 2013, Barack, single, has net investment income of $40,000 and AGI of $230,000. Medicare surtax is $1,140 (($230K - $200K) 3.8%). If Barak s AGI is $300,000 with $40,000 of NII, he would owe $1,520 ($40,000 x 3.8%). Ordinary Income Rates Investment Income Rates 8

9 Trust and Estate Rates? Does 39.6% rate apply? Probably, but unclear Per JCT, YES! Still opportunity to use 2012 rates for estates choosing fiscal year end Elect beneficiary taxation of capital gains? ATRA Charitable Changes 50% limitation applies to contributions of CG property 2013 only Tax-free transfers of up to $100K to charities for age 70-1/2 or older 2013 only Not extended corporate contributions of books and computers Roth 401(k) Rollovers Direct taxable conversions are now permitted Previously, could only take distributions of $ they had the right to take out of the plan, usually because they were over 59 ½ or separated from service Applies to 401(k), 403(b) and 457(b) accounts 9

10 Estate, Gift and GST Tax Changes $5.25MM exemption-surprise! No more clawback concerns Permanent 40% rate-split the baby Portability permanent Applies only to estate and gift, not GST Pro s and con s Estate, Gift and GST Tax Changes GST Changes that were set to expire and made permanent: Deemed allocation and retroactive allocation rules Inclusion ratio valuation rules Relief from late allocations Estate, Gift and GST Tax Changes Basic planning for <$5.25MM: Probate avoidance Asset protection Trustee choices Income tax planning Control Leverage exemptions 10

11 Estate, Gift and GST Tax Changes Some things DID NOT CHANGE: GRATs, IDGTs, ILITs remain in tact Valuation discounts remain alive Rolling GRATs permitted Dynasty trusts survive FOR NOW Estate, Gift and GST Tax Changes Advanced Planning for >$5.25MM: High exemption gifts Values remain depressed Interest rates remain low FLPs/LLCs; sales Grantor Trusts for SCINs and private annuities Non-Traditional Strategies State estate and income tax planning moving income to more favorable states or offshore Choice of entity Business succession and exit planning remains important 11

12 Business Cost Recovery Extensions Additional first year 50% bonus depreciation placed in service before 1/1/2014 (1/1/2015 for certain long-lived property) 179 expense $500,000 limit 2012 and 2013 Phase out begins at $2MM of annual purchases Real Estate Cost Recovery Extensions Up to $250,000 of qualified leasehold improvements, qualified restaurant property, and qualified retail improvements included in year straight line (rather than 39 year) extended to qualified leasehold improvements, qualified restaurant property, and qualified retail improvements acquired through 2013 Other Business Tax Extensions 5-year holding period for BIG tax for sales in 2012 and % exclusion for LTCG from sale of qualified small business stock Stock acquired before 1/1/2014 Owned > 5 years No AMT preference! Research, Work Opportunity Credits 12

13 Foreign Tax Provision 20% withholding rate on gains on the disposition of U.S. real property interests by partnerships, trusts, or estates that are passed through to partners or beneficiaries that are foreign persons is made permanent Marriage Penalty Relief Standard deductions and 15% tax bracket = 2x for singles (permanent change) Top rate does not apply until $450K ($50K higher than single) In 2012, the highest rate for single and married was at the same income level Individual Extensions through 2013 State and local sales tax deduction Teacher s classroom expense Residential energy credit Principal mortgage debt relief excluded from income (<$2MM) Mortgage insurance premiums 13

14 Energy Extensions through 2013 Alternative fuel vehicle refueling property Plug-in motorcycles and highway vehicles Cellulosic biofuels producers, including algae-based fuels Credit for biodiesel and renewable diesel Tax Quote Time! A tax loophole is "something that benefits the other guy. If it benefits you, it is tax reform.'' Russell B. Long, U.S. Senator Tax Reform - Background 1986 Tax Act Bush Tax Cuts Different environment today: Deficits need for revenue Complexity abounds Corporate reform is a priority, but probably will lead to other reforms Individual? Estate and gift tax? 14

15 Corporate Tax Reform Common assumptions Lower corporate tax rate Broaden tax base Shift to territorial system Need anti-base erosion provisions Revenue neutrality how to define? Changes within current system (no VAT) Top business tax expenditures 1. Accelerated depreciation for equipment 2. CFC deferral of income 3. Deduction for U.S. MFG 4. Inventory sales source rule exception 5. Low-income housing credit 6. Small business health tax credit 7. Exclude interest on tax-exempt bonds 8. Expense R&D 9. Accelerated depreciation on rental housing 10. LIFO inventory method 11. Charitable contribution deduction 12. R&D tax credit 13. Like-kind exchanges Business tax reform proposals Obama 28% corporate rate, 25% for MFG Minimum tax on foreign profits Retain worldwide system? Camp international discussion draft 25% rate Territorial system of taxing foreign earnings No individual provisions Portman plan Revenue neutral plan with 25% rate Territorial system 15

16 Political trade-offs Corporate vs. pass-through entities Corporate-only base broadeners vs. business base broadeners Multinational interests vs. domestic interests Capital intensive businesses vs. service businesses Industry vs. industry Historic vs. new entities within the same industry Specific tax incentives vs. rate reduction as a better economic growth driver Transition relief vs. permanent benefits Individual reforms? None have been introduced Broaden base, lower rates What do you give up? Employer-provided health care exclusion Mortgage interest Charitable deductions Inside build-up of life insurance Convert deductions to CR s Top individual tax expenditures 1. Health care exclusion ($720B) 2. Retirement plan contribution deferrals ($715B) 3. Mortgage interest deduction ($465B) 4. Reduced rates on dividends and CG s ($460B) 5. State and local income tax deduction ($340B) 6. Exclusion of Medicare benefits ($330B) 7. Earned income credit ($295B) 8. Exclude CG s at death ($220B) 9. Charitable cont. deduction ($220B) 10. Exclusion of interest on tax-exempt bonds ($200B) 11. Cafeteria plan exclusion ($200B) 12. Exclusion of untaxed Social Security ($190B) 13. Child care credit ($175B) 14. Exclude interest on life insurance ($130B) 15. CG exclusion on sale of homes ($120B) 16

17 More on individual reforms Appropriate tax rates? Owners of pass-through entities? AMT? Tax gap? Effects on Pass-Through Entities Higher rates on owners than C corporations pay? Carried interest Obama Tax large passthroughs as C corps Eliminate business deductions w/o changing tax rate on owners of pass-throughs? A Final Word You have to take away some of tax breaks for the wealthy, and you have to cut back on some entitlements. Because, unless we do all of these things, it just doesn't work. And what's good theater and what's good politics isn't necessarily good economic policy. ~ Michael Bloomberg 17

18 Thank you! Wayne M. Zell, Esq. Odin, Feldman & Pittleman, P.C Wiehle Avenue S. 400 Reston, VA