THE UNIVERSITY OF TENNESSEE 2012 SINGLETON B. WOLFE MEMORIAL TAX CONFERENCE OCTOBER 25, FEDERAL INCOME TAX UPDATE.

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1 THE UNIVERSITY OF TENNESSEE 2012 SINGLETON B. WOLFE MEMORIAL TAX CONFERENCE OCTOBER 25, FEDERAL INCOME TAX UPDATE Presented by: JOHN D. HOUSTON, CPA Pointe Centre 1200 Building 1200 Premier Drive, Suite 260 Chattanooga, Tennessee (423) ; (423) Fax Copyright 2012 by John D. Houston, CPA Table of Contents I. Federal Income Taxation of Individuals 2012 Tax Year II. III. IV. Federal Income Taxation of Businesses 2012 Tax Year Selected Federal Court Tax Cases Selected IRS Regulations, Rulings and Developments V. Closing Comments Where Will We Go from Here? This outline and the accompanying presentation are designed to present an overview of significant developments in Federal income taxation effective for the 2012 calendar year. Secondary emphasis is placed on significant changes in Federal income taxation which may become effective for the 2013 calendar year. This outline and the accompanying presentation are based on Federal tax legislation enacted into law as of October 9, Comments by the author concerning future and 2012 retroactive Federal tax legislation to be enacted subsequent to the November 6, 2012 Presidential and Congressional elections represent his professional opinion as of the presentation date. These comments should not be interpreted as the author s prediction of future and/or retroactive legislative changes in Federal income taxation. Page 1 of 18

2 I. Federal Income Taxation of Individuals 2012 Tax Year A Individual Income Tax Rate Schedules Range of Taxable Income The Tax is Of the Amount Over Single Taxpayers $ 0 to $ 8,700 $ % $ 0 8,700 to 35, % 8,700 35,350 to 85,650 4, % 35,350 85,650 to 178,650 17, % 85, ,650 to 388,350 43, % 178, ,350 and up 112, % 388,350 Married Joint Return Taxpayers $ 0 to $ 17,400 $ % $ 0 17,400 to 70,700 1, % 17,400 70,700 to 142,700 9, % 70, ,700 to 217,450 27, % 142, ,450 to 388,350 48, % 217, ,350 and up 105, % 388,350 Comment Maximum 2012 Marriage Tax Rate Penalty = $7, B Individual Income Tax Rate Schedule Trusts and Estates $ 0 to $ 2,400 $ % $ 0 2,400 to 5, % 2,400 5,600 to 8,500 1, % 5,600 8,500 to 11,650 1, % 8,500 11,650 and up 3, % 11,650 Page 2 of 18

3 C. Standard Deductions and Personal Exemptions Standard Deductions CCH 2013 Married Filing Jointly $ 11,600 $ 11,900 $ 12,200 Single Taxpayers 5,800 5,950 6,100 Kiddie Dependents ,000 Single Additional 65+ or Blind 1,450 1,450 1,500 Married Additional 65+ or Blind 1,150 1,150 1,200 Personal Exemptions Amount $ 3,700 $ 3,800 $ 3,900 D. Social Security and Medicare Tax Rates and Wage Limits FICA Taxes - Employee Social Security Tax Rate 6.20% 4.20% 4.20% Medicare Tax Rate 1.45% 1.45% 1.45% Total FICA Tax Rate Employee 7.65% 5.65% 5.65% FICA Taxes Employer Social Security Tax Rate 6.20% 6.20% 6.20% Medicare Tax Rate 1.45% 1.45% 1.45% Total FICA Tax Rate Employer 7.65% 7.65% 7.65% SECA Taxes Self Employed Social Security Tax Rate 12.40% 10.40% 10.40% Medicare Tax Rate 2.90% 2.90% 2.90% Total SECA Tax Self Employed 15.30% 13.30% 13.30% Social Security Wage Base Limit Income Subject to Social Security $106,800 $106,800 $110,100 (+3.09%) Income Subject to Social Security $113,700 (+3.27%) Social Security Taxation Limits Maximum Earnings < Normal Retirement Age $ 14,640 Base Modified AGI Start of 50% SS Taxable Single $ 25,000 Base Modified AGI Start of 85% SS Taxable Single $ 34,000 Base Modified AGI Start of 50% SS Taxable Married $ 32,000 Base Modified AGI Start of 85% SS Taxable Married $ 44,000 Page 3 of 18

4 E. Child Tax Credit The 2012 child tax credit (CTC) is equal to $1,000 per eligible child for children 16 years old and younger. The CTC phases out at a rate of $50 for each $1,000 or fraction thereof that adjusted gross income (AGI) exceeds $110,000 for married taxpayers filing jointly or $75,000 for single taxpayers and heads of household. The credit is refundable to the extent of 15% of a taxpayer s earned income in excess of $3,000. F. Long-term Capital Gains Tax Rates The maximum 2012 individual net long-term capital gains tax rate is 15% for capital assets sold and installment payments received. The net long-term capital gains tax rate is reduced to zero to the extent the income of individual or fiduciary taxpayers are in the 10% or 15% lowest ordinary income tax rate brackets. Many important provisions and rules governing individual and fiduciary taxation of capital gains and losses have not changed for many years and include the following: The over one-year asset holding period for long-term capital gains or losses. The 25% long-term rate to the extent of unrecaptured Section 1250 gain from sales of depreciable real estate. The 28% long-term rate for gains from collectibles (including precious metals) and net gains from sales of small business stock (after the 50% exclusion). The $3,000 annual limitation that net capital losses can be deducted against ordinary income. The alternative maximum tax rates for net long-term capital gains continue are allowed for both regular and AMT tax purposes. G. Special Individual Tax Rate for Qualified Dividend Income Certain dividends received by individuals and fiduciary taxpayers in 2012 are taxed at a special 15% tax rates. Qualified dividends are those received from: A domestic (i.e., C corporation) or A qualified foreign corporation Under accepted tax law, a dividend is defined as a corporate distribution with respect to its stock to the extent it is paid out of current or accumulated earnings and profits. Dividends paid by a real estate investment trust (REIT) are not eligible to the extent they are deductible to the REIT. Page 4 of 18

5 H. Individual Retirement Account (IRA) Contributions The following chart shows the maximum IRA account contribution limits by tax year: Tax Years Beginning In Taxpayers < 50 Taxpayers $3,000 $3, ,000 4, & ,000 5, ,000 6, (CCH Estimate) 5,500 6,500 I. Roth IRA Conversions and Contributions For tax years after 2009, the AGI limitation has been eliminated for conversions from traditional IRA accounts to Roth IRA accounts. However, the modified AGI threshold for eligibility to make direct Roth IRA contributions for the 2012 year begins at $110,000 for single taxpayers and $173,000 for married filing jointly taxpayers. CCH estimates that inflation indexing will increase these amounts for the 2013 year to $112,000 for single taxpayers and $178,000 for married filing jointly taxpayers. J. Elective Deferrals to IRC Section 401(k) and SIMPLE Plans The following chart shows the annual limits on elective deferrals under IRC Sections 401(k), 403(b), and 408(k) and SIMPLE plans for the last five years: Tax Years Beginning In Elective Deferrals SIMPLE Plans 2008 $15,500 $10, ,500 11, ,500 11, ,500 11, ,000 11,500 The additional catch-up contribution dollar limit for elective deferrals for individuals who are at least 50 years of age or older by the end of the plan year (e.g., Catch-up Contributions ) is $5,500 for the 2012 tax year. The additional catch-up contribution for SIMPLE plan contributions is $2,750 for the 2012 tax year. K. Qualified Plan Maximum Compensation Limits The IRC Section 401(a)(17) qualified plans maximum compensation limit is inflation indexed in $5,000 increments. The qualified plan maximum compensation limit was increased by inflation indexing to $250,000 for the 2012 tax year. Page 5 of 18

6 L. IRC Section 415(c) Defined Contribution Maximum Addition The maximum annual addition limit for defined contribution plans is inflation indexed in $1,000 increments. The annual addition limit for defined contribution plans was increased by inflation indexing to $50,000 for the 2012 tax year. M. Alternative Minimum Tax (AMT) for Individuals Since the 2003 tax year there have been a series of one and two year temporary increases in the individual AMT exemption amounts. For the 2011 tax year, the 2010 Tax Relief Act increased the respective 2011 AMT exemption amounts to $74,450 for married taxpayers filing jointly and $48,450 for single taxpayers. Under current law, the AMT exemptions amounts for the 2012 tax year are scheduled to decrease to $45,000 for married taxpayers filing jointly and $ for single taxpayers. Both houses of Congress have recently passed separate pieces of legislation that would retroactively increase the 2012 AMT exemption amounts for individual taxpayers to $78,750 for married taxpayers filing jointly and $50,600 for single taxpayers. The maximum individual tax rates for net long-term capital gains and qualifying dividend income are used to calculate both regular and AMT tax liability. AMT provisions that have not changed for many years include the following: The AMT exemption phase-out ranges which begins at $150,000 of AMTI income for married taxpayers and $112,500 for single taxpayers. The AMT exemption phases out at a rate of 25% for each dollar in excess of the beginning of the respective AMTI exemption phase-out range. The AMT tax rate schedule of 26% of AMT ordinary taxable income up to $175,000 and 28% for AMT ordinary taxable income in excess of $175,000. Page 6 of 18

7 II. Federal Income Taxation of Businesses 2012 Tax Year A. Corporate Income Tax Rates (unchanged for over 15 years) If Taxable Income But Not Of The Is Over Over The Tax Is Amount Over $ 0 $ 50,000 15% $ 0 50, $ 7,500+25% 50,000 75, ,000 13,750+34% 75, , ,000 22,250+39% 100, ,000 10,000, ,900+34% 335,000 10,000,000 15,000,000 3,400,000+35% 10,000,000 15,000,000 18,333,333 5,150,000+38% 15,000,000 18,333, % 0 B. IRC Section 179 Expense Election Since the 2008 tax year there have been a series of temporary increases in the maximum amount of purchased tangible personal property eligible for the IRC Section 179 expense election and the maximum annual capital expenditure amount to claim the IRC Section 179 expense deduction. For tax years beginning in 2010 and 2011, the maximum IRC Section 179 election amount increased from $250,000 to $500,000 while the maximum qualifying investment limit increased from $800,000 to $1,000,000. For tax years beginning after 2011, the maximum IRC Section 179 election amount was reduced to $139,000 and the qualifying investment limit was reduced to $560,000. C. IRC Section 168(k) Bonus Depreciation In the days following the September 11, 2011 terrorist attacks on the United States, IRC Section 168(k) or bonus depreciation was enacted. Under the original 2002 Tax Act, qualified property acquired between September 11, 2001 and September 10, 2004 was eligible for a special bonus depreciation allowance equal to 30% of the adjusted basis of the property. This allowance was available for both regular and Alternative Minimum Tax (AMT) depreciation. The original IRC Section 168(k) bonus depreciation percentage was subsequently increased to 50% for qualified property acquired after May 5, 2003 and placed in service before January 1, The remaining adjusted basis was depreciated consistent with prior law. The original Federal bonus depreciation provisions of IRC Section 168(k) expired on December 31, Page 7 of 18

8 IRC Section 168(k) accompanied by the special 50% bonus depreciation allowance for qualifying property acquired and placed in service was reinstated for the 2008 and 2009 tax years. In 2010, there was a retroactive extension of the special 50% bonus depreciation allowance for qualified property acquired and placed in service after December 31, The 2010 tax legislation further extended and modified the IRC Section 168(k) bonus depreciation allowance as follows: IRC Section 168(k) Special Bonus Depreciation Allowances o Placed in service 1/1/2010 9/8/ % o Placed in service 9/9/ /31/ % w/ 50% option o Placed in service 1/1/ /31/ % o Placed in service 1/1/ /31/ % o Placed in service after 12/31/2012 None 1. Qualified Property Definition In general, qualified property is defined as new tangible personal property with a recovery period of 20 years or less. IRC Section 168(k)(2) specifically also includes additional items of qualifying property including computer software and qualified leasehold improvement property. Qualified leasehold improvements consist of interior build out type expenditures subject to a lease for buildings that are three years old. 2. Option to Elect Out IRC Section 168(k)(2)(C)(iii) allows taxpayers to elect out of the special bonus depreciation allowance. This election applies to all property in the class or classes of property for which the election is made. 3. Lack of State Income Tax Conformity Tennessee, Georgia, and several other southeastern states do not allow IRC Section 168(k) bonus depreciation to be claimed on state income tax returns. D. Standard IRS Mileage Rates The standard mileage rate for business use of an automobile for 2012 is equal to 55.5 cents per mile. The standard mileage rates for medical and moving expense purposes for 2012 is equal to 23.0 cents per mile. The charitable standard mileage rate remains set by statute at 14.0 cents per mile. Page 8 of 18

9 E. Income Attributable to U.S. Production Activities The 2004 Jobs Act created a new deduction of a portion of a taxpayer s qualified production activities income (QPAI). The IRC Section 199 QPAI deduction was phased in according to the following schedule: 2005 & % of QPAI % of QPAI After % of QPAI Qualified domestic production property includes tangible personal property, computer software, sound recordings and motion picture film. Qualified domestic production receipts also include sales of electricity, natural gas, and potable water (i.e., utilities), construction services, and engineering or architectural services. QPAI is generally defined as domestic production receipts reduced by cost of sales, other direct expenses, and allocated indirect expenses. Tax legislation in 2008 capped the QPAI deduction for oil-related qualified production activities at the 2009 rate of 6%. F. Small Employer Health Care Credit The 2010 Health Care Act created a new tax credit for small employers providing employee health insurance effective for tax years beginning after Only an eligible small employer (ESE) may claim the credit. To qualify as an ESE, an employer must have no more than 25 full-time equivalent employees whose average annual full-time equivalent wages average no more than $50,000. However, phase-out rules limit the full amount of the credit to employers with ten or fewer FTE s whose average annual full-time equivalent wages are less than $25,000. The maximum small employer health care credit is generally 35% of the lesser of the cost of the employer s health insurance premiums or the average premium for the small group market in the employer area as determined by the HHS Secretary. Family members and domestic employees are not eligible for the credit. In addition, the employer s deduction for salaries and wages must be reduced by the amount of the credit. Page 9 of 18

10 III. Selected Federal Court Tax Cases A. National Federation of Independent Business v Sebelius (U.S. Supreme Court, June 28, 2012, USTC) In one of the most anticipated (and for some dreaded) Supreme Court decision since the Bush v Gore Supreme Court decision on the 2000 State of Florida vote recount, the U.S. Supreme Court by a 5-4 decision upheld the Patient Protection and Affordable Care Act (the 2010 Obama Health Care Act ). and its companion law, the Health Care and Education Reconciliation Act. As a result, it is almost certain the 0.9% Medicare Earned Income Surtax and its companion 3.8% Medicare Investment Income Surtax for higher income taxpayers will become effective as of January 1, The new Medicare income surtaxes are discussed elsewhere in this presentation. B. Keller v Commissioner (TC Memo ) The Tax Court held in a memorandum decision involving an auto body shop that seven auto repair workers were in fact independent contractors after application of seven common law factors chosen by the court. The Tax Court further held that office workers were in fact employees and not independent contractors. However, none of the employees were provided IRS Forms 1099-MISC. Therefore, the auto body shop was not eligible to relief under Section 530 of the Revenue Act of C. Donald G. Cave PLC v Commissioner (5 th Circuit ) The 5 th Circuit Court of Appeals upheld a 2012 Tax Court case which was discussed in my 2011 presentation. The plaintiff in this case was a corporate Louisiana law firm specializing in personal injury cases which had elected to be taxed as an S corporation. The corporation hired associate attorneys, law clerks, and support staff. All persons working at the law firm had been paid as independent contractors. The employment facts varied among the various persons ranging from exclusive employment for the president and sole shareholder and some support personnel to clearly part-time work with minimal supervisions for some of the associate attorneys. The Tax Court upheld the IRS classification of the president as a statutory employee and all other persons as employees instead of independent contractors. The Tax Court further denied relief under Section 530 of the Revenue Act of 1978 since relief was not available to statutory employees and the Court found no reasonable basis for not treating the remaining persons as employees. Page 10 of 18

11 D. United States v Home Concrete & Supply LLC (U.S. Supreme Court, ) The U.S. Supreme Court resolved a split among the Federal circuit courts of appeal by concluding that an overstatement of basis does not result in an omission of income for statute of limitations purposes. As a result, the Internal Revenue Service will be subject to the regular three year statute of limitations to assess additional tax as a result of a basis overstatement. E. Taproot Administrative Services Inc v Commissioner (9 th Circuit, CA-9, ) The 9 th Circuit Court of Appeals upheld the Tax Court and ruled that a Roth IRA is not a permissible shareholder of an S Corporation. The Tax Court based its finding on Revenue Ruling where the IRS determined that a trust that qualified as an IRA is not a permissible shareholder of an S Corporation. F. Atlantic Coast Masonry Inc v Commissioner (TC Memo ) The Tax Court held in a memorandum decision involving a taxpayer engaged in masonry subcontracting that its masonry workers were not independent contractors but were in fact employees. The Tax Court applied the same seven common law worker classification factors considered by the Tax Court in the Keller case. As in Keller, none of the masonry employees were provided IRS Forms 1099-MISC. Therefore, the masonry subcontractor was not eligible to relief under Section 530 of the Revenue Act of Page 11 of 18

12 IV. Selected IRS Regulations, Rulings, and Developments A. Internal Revenue Service Regulations and Rulings 1. IRS Temporary Repair Regulations (TD 9564) The temporary repair versus capitalization regulations issued by the IRS in late 2011 regarding the treatment of payments to acquire, produce or improve tangible property generated many complex questions regarding their interpretation and application. These comprehensive temporary regulations include provisions dealing with materials and supplies, de minimis expensing, amounts paid to acquire, produce, or improve tangible property, and various sections relating to MACRS property tax accounting. A detail discussion of these regulations is beyond the scope of this presentation. 2. Revenue Ruling The IRS issued a revenue ruling denying use of the recurring items exception to deduct an expense that should be accrued over a 12-month period that spans two years for financial statement reporting purposes. The ruling applies to two specific situations involving the leasing of property and payments for services. 3. IRS Announcement re Medicare Premiums Paid by the Self-Employed In a clarification of previous confusion and practitioner disagreement involving earlier IRS statements regarding instructions to Form 1040 Schedule C, the Internal Revenue Service has advised that all Medicare parts (i.e., B, C and D) are insurance premiums similar to other health insurance premiums which can be taken into account for purposes of the deduction for health insurance costs of self-employed individuals. B. Internal Revenue Service Practitioner Developments 1. Preparer Taxpayer Identification Numbers (PTINs) Preparer taxpayer identification numbers (PTINs) expire on December 31 of each year and must be renewed prior to January 1 of the following year. Both on-line and paper renewals are expected to be available in late October The IRS issued Notice in the fall of 2011 providing additional guidance for individuals with a regular or provisional PTIN or who are seeking to obtain a PTIN. The Treasury Department final regulations state that all individuals preparing income tax returns and refund claims for compensation must have a valid TIN to be used in signing returns as a paid preparer. Page 12 of 18

13 The IRS continues to develop procedures for collecting and processing fingerprints for certain PTIN applicants. Fingerprinting is expected to be used for future suitability checks for PTIN applicants who are not attorneys, CPAs, enrolled agents, or enrolled actuaries. At this point, it appears fingerprinting may be not be implemented for the 2012 tax return filing season. PTIN holders are required to meet the 15 hour CPE education requirements for the 2012 calendar year. The IRS CPE requirements consist of 2 hours of ethics or professional conduct, 3 hours of Federal tax law updates, and 10 hours of Federal tax law topics. PTIN applicants who are not attorneys, CPAs, enrolled agents, or enrolled actuaries are subject to the competency testing requirement and are required to pass the Registered Tax Return Preparer competency examination prior to obtaining or renewing their PTIN as part of their 2013 renewal process. 2. Tax Professionals E filing Return Requirements Tax professionals and tax firms are required to obtain an Electronic Filing Identification Number (EFIN) to comply with Federal income tax return e-filing requirements. The tax year mandatory e-filing requirements reduced the e-filing threshold for 2011 and future tax years to more than 10 combined Form 1040 and Form 1041 series returns. The IRS continues to permit tax professionals to obtain IRS Form 8948 Preparer Explanation for Not Filing Electronically from clients desiring to file a paper Form 1040 or Form IRS Audit Technique Guides Attorneys, Business Consultants, Cash- Intensive Businesses, Architects, and Landscaping The IRS has issued Audit Technique Guides (ATGs) covering IRS examinations of attorneys, business consultants, cash-intensive businesses, architects and landscape architect services. Selected comments regarding these taxpayer classes are as follows: Attorneys Primarily cash basis taxpayers operating in various forms of business entities. Areas of audit emphasis include gross income, trade or business expense substantiation, employee versus independent contractor, and Forms 1099 and 8300 information reporting compliance. Business Consultants These individuals and firms also operate in various forms of business entities. Areas of audit emphasis include income reporting, doctrine of substance over form, trade or business expense substantiation (especially travel and meals and entertainment), and employee versus independent contractor. Cash-Intensive Businesses These businesses are characterized by numerous and intensive cash transactions without documentation to the seller or provider. The IRS believers many cash-intensive businesses have a high degree of unreported income accompanied by a relatively low risk of detection through normal IRS procedures including Form 1099 reporting. The ATG states that the most significant indicator for unreported income in a cash-intensive business is a consistent pattern of losses or profit percentages that seem insufficient to sustain the business or its owners. Page 13 of 18

14 Architects and Landscape Architects Architects share many tax similarities with attorneys. However, audit emphasis for architects will include the IRC Section 199 domestic production activities deduction. Landscape architect services provided to residential customers are noted to potentially involve cash intensive transactions. 4. Expanded EIC Paid Preparer Penalty A little publicized revenue raiser included in the United States South Korea Free Trade Agreement Implementation Act (H.R. 3080) became effective in the fall of This revenue raiser provision increased by 400% (from $100 to $500) the tax return preparer penalty for failing to comply with certain due diligence requirements in determining the eligibility of a taxpayer for the earned income tax credit (EIC) and/or in the calculation of the credit amount. Under proposed IRS regulations, preparers are required to file IRS Form 8867 Paid Preparer s Earned Income Credit Checklist with every tax return filed after January 1, 2012 claiming the EIC tax credit. Both firms and preparers are subject to the expanded EIC penalty. 5. IRS Audit Emphasis Correspondence Examinations IRS Notice CP2000 Issued by IRS Service Centers with a 30-day required response from the notice date. Taxpayers may call an IRS number to request a 30- day extension of time to respond. IRS Publication 3498-A Seven page publication primarily designed to document the taxpayer s appeal and Tax Court petition rights and procedures. Appeal Rights Taxpayers subject to correspondence examinations have three administrative appeal options as follows: o Informal conference (primarily by telephone) with the examiner s manager. o Small Case Appeals Office Request for smaller cases (< $25,000) in proposed total tax, penalties and interest assessment per period. This type of appeal is initiated by filing IRS Form Request for Appeals Review. o Formal Protest A formal Appeals Office written protest conforming to IRS guidelines and containing the required signature under penalties of perjury declaration for larger cases (> $25,000). Current IRS Timeframe Routine documentation support cases (e.g., an itemized deduction verification request ) usually take IRS examiners days to review the case documentation after receipt by the IRS. More complex cases can take as long as 150 days. IRS correspondence examinations often involve multiple examiners at different points in time who process cases that involve multiple issues and follow up document requests. Common Practitioner Complaints Difficulty in examiner contact, lack of timely IRS response acknowledging receipt of faxed documents, delays in recognizing the proper submission of IRS Form 2848 Power of Attorney and Declaration of Representation, and balance due cases being immediately transferred to the IRS collection division when the examiner closes the case. Page 14 of 18

15 6. IRS Eliminates Certain Circular 230 Rules The IRS recently issued anticipated proposed regulations to Circular 230 rules on practice before the IRS. These proposed changes would eliminate complex rules governing covered opinions and expand other requirements for written tax advice. Additional responsibility for oversight of a firm s practice governed by Circular 230 including written compliance procedures would be placed on CPA firm management. The proposed regulations would clarify that the IRS Office of Professional Responsibility (OPR) has exclusive responsibility for practitioner discipline. 7. IRS Expands Fresh Start Initiative by Revising OIC Program In IRS News Release IR , the IRS announced an expansion of its Fresh Start initiative by providing more flexible terms for Offers in Compromise (OIC). The more flexible OIC initiatives include the following provisions: The threshold for using an installment agreement without having to provide the IRS a financial statement is increased to $50,000. The streamlined (or short version OIC) is now available for taxpayers with annual incomes up to $100,000. Participants can have a tax liability up to $50,000 (double the previous $25,000 maximum liability). Certain other requirements have been modified to facilitate the use of installment agreements by more small businesses. Page 15 of 18

16 V. Closing Comments Where Will We Go from Here? A. December 31, 2012 Sunset of the Bush-Era Tax Cuts The phrase Bush-Era tax cuts is a collective term referring to reductions in ordinary, capital gains, and qualified dividend tax rates for individual and fiduciary taxpayers that were enacted primarily in 2001 and 2003 during the first term of former President George W. Bush. Under current law, the 2012 individual and fiduciary Federal income tax rate schedules are scheduled to revert to inflation adjusted tax brackets that were in effect as of December 31, Some of the more significant individual and fiduciary sunset provisions are summarized as follows: Ordinary income tax brackets 10% bracket eliminated, 15% bracket retained, 25%, 28%, and 33% brackets increased to 28%, 31%, and 36%, respectively, with the top bracket increased from 35% to 39.6%. Long-term capital gain and qualified dividend tax rates Long-term capital gain tax rate increased from 15% to 20% with repeal of the 15% qualified dividend tax rate. Alternative Minimum Tax (AMT) exemptions The current AMT dollar exemption amounts decreased by approximately 30% (single) and 40% (married). Child tax credit The child tax credit decreased from $1,000 to $500. American Opportunity tax credit (AOTC) The enhanced AOTC education credits revert to the less generous Hope education credit. Personal exemption phase-out The phase-out of personal exemptions for higherincome taxpayers reinstated. 3% reduction in itemized deductions The 3% reduction in itemized deductions for higher-income taxpayers reinstated. B. December 31, 2012 Other Expired and Expiring Tax Provisions 2.00% temporary reduction in employee Social Security and Self-employment tax rates The 2012 calendar year reduction in the employee portion of social security and self-employment taxes is scheduled to expire December 31, The following individual deductions (referred to as the extenders ) which expired as of December 31, 2011: o The itemized deduction for sales taxes in lieu of income taxes. o Exclusion of IRA income when proceeds transferred directly to charity. o Teacher s $250 classroom expense AGI deduction. o Above-the-line deduction for student loan interest up to $2,500. o AGI deduction for up to $4,000 in qualified tuition and fees at post-secondary education institutes (subject to income phase-out). Page 16 of 18

17 C. Federal Estate, Gift and GST Transfer Taxes For the 2012 calendar year, the 2011 maximum credit equivalent exemption amount of $5,000,000 for Federal estate taxation increased by inflation indexing to $5,120,000 and the maximum Federal estate and gift tax rate continues at 35%. Absent additional legislation, the maximum Federal estate and gift tax rate is scheduled to increase to 55% while the maximum credit equivalent exemption is scheduled to be reduced to $1,000,000 as of January 1, Similar scheduled reductions would also occur in the Generation Skipping Transfer (GST) tax exemption. The 2011 and 2012 concept of estate tax portability for the estate of the surviving spouse would be repealed. D Medicare Surtaxes on Higher Income Taxpayers The 2010 Obama Health Care Act included two major revenue raising provisions directed at higher income individual taxpayers. While both new tax provisions are referred to as Medicare surtaxes, in practice they are additional income taxes to be imposed and collected on higher income individual taxpayers on their Federal individual income tax return (Form 1040). Both new Medicare surtaxes have a scheduled effective date of January 1, New 0.9% Medicare Earned Income Surtax on Higher Income Taxpayers For wages and self-employment earnings for 2013 and future tax years, the 2010 Obama Health Care Act imposes a Medicare surtax of 0.9%. For single taxpayers, the 0.9% Medicare surtax apples to aggregate employee Medicare wages (i.e., Form W-2 wages) and self-employment (SECA) income in excess of $200,000. For married taxpayers filing joint returns, the 0.9% Medicare tax applies to combined earned income. The new 0.9% Medicare earned income surtax is not eligible for the 50% selfemployed SECA income tax deduction. Although the employer portion of FICA Medicare taxes is not impacted, employers will be required to withhold employee 0.9% Medicare earned income surtax to the extent an employee s annual Medicare wages exceeds $200,000. Page 17 of 18

18 2. New 3.8% Medicare Investment Income Surtax on Higher Income Taxpayers For net investment income as defined for 2013 and future tax years, the 2010 Obama Health Care Act imposes a second Medicare surtax of 3.8%. This 3.8% Medicare surtax applies to the lesser of a taxpayer s net investment income or their Modified Adjusted Gross Income (MAGI). Net investment income for this purpose includes interest, dividends, annuities, most net rental income, business income from passive activities, and most short and long-term capital gains. The MAGI threshold amounts will be $200,000 for single taxpayers and $250,000 for married taxpayers filing joint returns. The new 3.8% Medicare surtax on investment income is not eligible for the 50% selfemployed SECA income tax deduction. The definition of net investment income excludes tax-exempt bond interest, the excluded portion of gain from sale of a personal residence, retirement plan distributions, and taxable social security benefits. However, taxable excluded income as well as all earned and/or trade or business income will be included in the MAGI threshold for calculation for the 3.8% Medicare surtax. Page 18 of 18