Fiscal Cliff Legislation Passed by Congress

The American Taxpayer Relief Act of 2012 (H.R. 8) (the "Act") was passed by Congress late on January 1, 2013 and is expected to be signed into law by President Obama.  In addition to increasing tax rates for high income taxpayers and patching the AMT, the Act contains a number of significant provisions affecting individuals, families and businesses.  The Act does not address "carried interest", and it does not impose any of the new limitations on itemized deductions that have been discussed during the past few months. Of course, this does not rule out the possibility that Congress will revisit these and other possible changes in the year to come. 

The key tax-related elements of the Act are as follows:

• Rate increases for income of high earners.  For individuals with incomes above $400,000 or married couples with incomes above  $450,000, the Act reinstates the maximum 39.6% marginal rate for income other than capital gains and certain dividends.
• Rate increases for investment income of high earners.    For individual taxpayers with income in excess of the thresholds noted above, the maximum statutory rate for long-term capital gains and qualified dividends increases to 20% beginning in 2013.  The highest effective tax rate, however, is about 25% after including the previously enacted 3.8% Medicare tax on investment income and the effect of itemized deductions limitations described below.
• Limitation on itemized deductions and personal exemptions.  For taxpayers with income above $250,000 (individual filers) or $300,000 (married filing jointly), the Act reinstates a reduction in itemized deductions equal to 3% of adjusted gross income above these thresholds (the so-called "Pease limitation") and  reinstates the personal exemption phase-out.
• Permanent Alternative Minimum Tax ("AMT") relief.  The annual drama regarding enactment of the so-called "AMT patch" will be eliminated by provisions that, beginning with 2012 (i) increase the AMT exemption amounts to $50,600 (individuals) and $78,750 (married filing jointly), (ii) index the exemption and phase-out amounts beginning in 2013, and (iii) allow nonrefundable personal credits against the AMT.
• Permanent estate, gift and generation skipping transfer tax relief.  The Act permanently sets the estate, gift tax and GST exemptions at $5 million per person.  This exemption amount is indexed for inflation beginning in 2011, such that the exemption for 2013 is $5.25 million per person.  The Act increases the top tax rate for gifts, GST, and estates of decedents dying after December 31, 2012 to 40% (from 35%).  The Act did not make any other changes to the estate, gift and GST tax rules.
• Extension of certain business incentives through 2013.  The Act reinstates for 2012 and extends until the end of 2013 certain provisions that expired at the end of 2011, including the Production tax credit (an incentive for renewable energy), the Research and Experimentation tax credit, 50% bonus depreciation, the active financing exception under Subpart F of the Code, the look-through treatment of payments between related controlled foreign corporations under the foreign personal holding company rules, and special expensing rules for certain film and television production costs.
• Enhanced Roth Conversion Opportunity for 401(k) etc. Plans.  Starting in 2013, Section 401(k) plans and tax-sheltered annuity plans under Section 403(b) may offer all participants  the opportunity to convert their pre-tax balances - including employer contribution accounts - to a Roth retirement account in the same plan, an opportunity previously available only to participants over age 59-1/2 and to former employees.
• Extended Opportunity to Make Charitable Gifts from IRAs.  The Act reinstates for 2012 and 2013 a provision effectively allowing up to $100,000/year of a taxpayer's charitable gifts, if funded from his IRA and after age 70 ½, to escape the itemized deduction limitations that would apply to direct charitable gifts. Under special rules, charitable gifts made during January 2013 may relate back to 2012.

There are many other provisions in the Act, and many details that are not dealt with in this summary.  Please contact one of our tax partners for further information.

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This memorandum is not intended to provide legal advice, and no legal or business decision should be based on its content. Questions concerning issues addressed in this memorandum should be directed to:

Associate Allison J. Rekkali contributed to this client alert.

IRS Circular 230 disclosure: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this document is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter that is contained in this document.