The American Taxpayer Relief Act of 2012 – impact on business

The debate that consumed Washington during the holiday season has, thankfully, subsided for now.  In January both houses of Congress passed and President Obama signed the American Taxpayer Relief Act of 2012, which was supposed to be the long-awaited solution to the “fiscal cliff.” However, the legislation was only a stop-gap measure to postpone debate on the larger issue over how to manage and control the debt ceiling and federal spending. We can look forward to returning to that debate during the upcoming weeks and months. In the meantime, it is important that businesses understand how they will be impacted by the new rules.

First, let’s discuss what was not included in the legislation. The provision receiving the most media attention was the payroll tax deduction (the employee’s share of FICA), which had been at the reduced rate of 4.2 percent for 2011 and 2012.  The reduced rate was not extended to 2013.  As a result, human resource departments across the country were sent scrambling to make employees aware that their portion of FICA would be increasing from 4.2 percent to 6.2 percent effective Jan.1, 2013. 

Receiving less attention was the fact that the Act failed to postpone or reduce new surtaxes resulting from the Patient Protection and Affordable Care Act of 2010. These taxes also took effect on Jan. 1, increasing taxes on earned income (0.9 percent on wages or self-employed income of more than $200,000 for a single filer or $250,000 for married joint filers) and net investment income (3.8 percent on interest, dividend, capital gain and passive income from flow-through entities such as S corporations, partnerships, or LLCs). These new taxes are likely to impact small business owners in the short term as they calculate and remit quarterly estimated payments during 2013.

Some of the major and wide-reaching provisions that were included in the 2012 Act related to depreciation.  One such provision provided for increased limits for Section 179 relating to small-business expensing of certain depreciable business assets. Without the Act, the Section 179 limit for 2012 would have been $139,000 ($560,000 investment limit) and for 2013 the limit would have been $25,000 ($200,000 investment limit). The increased limits allow businesses that qualify to expense immediately the cost of certain depreciable assets (new or used) up to $500,000 ($2,000,000 investment limit) through 2013.  Additionally, the ability to claim 50 percent bonus depreciation on qualifying new assets was extended through 2013.  This was seen as a win for businesses as these extensions were not widely discussed before the final legislation.

There were also a variety of tax credit benefits, including the Research Tax Credit, Work Opportunity Tax Credit and the Employer-Provided Child Care Credit, which were all extended through 2013.

The group of businesses that have been most affected by the Act are flow-through entities such as S Corporations, Partnerships, and LLCs. Given that a large number of businesses, especially privately held businesses, in the U.S. are structured as flow-through entities, it is very important that owners and operators understand every detail of the Act. The changes in tax rates applicable to individuals will have a direct impact on the tax paid by these business owners on the business income. 

The following provisions are applicable to individual owners of flow-through businesses: 

First, beginning in 2013, the ordinary income tax rate for individuals was permanently set for top earners at 39.6 percent (up from 35 percent in 2012) for single taxpayers with taxable income more than $400,000 and married filing joint taxpayers with taxable income more than $450,000.  These amounts will be increased annually for inflation.  This is better than some may have expected as the threshold is higher than the $200,000/ $250,000 level proposed by President Obama. The 2012 Act also allows lower tax brackets to apply to income below the above mentioned thresholds.

Second, beginning in 2013, the capital gain and qualified dividend tax rates were permanently set to 20 percent for individuals. This rate is applicable to single taxpayers with taxable income of $400,000 and married filing joint taxpayers with taxable income annually of $450,000. For taxpayers below these limits, the 15 percent tax rate on capital gains and qualified dividends is still applicable. If taxable income falls below the 15 percent bracket, capital gains and qualified dividends will continue to be taxed at 0 percent.  This compromise was seen as a win as it avoided the increase in tax rates on qualified dividends to ordinary tax rate levels (as much as 39.6 percent) and avoided a tax rate of 20 percent on long-term capital gains.

Third, there was a permanent increase in the individual alternative minimum tax (“AMT”) exemption. For 2012, the AMT exemption will be $50,600 for single taxpayers and $78,750 for married joint-filing taxpayers. These amounts will be increased annually for inflation and will continue to allow certain nonrefundable personal credits against the AMT.  This move is a welcome change to avoid what had become the annual last-minute passage of the “AMT patch.” Without the AMT patch or an increase in the AMT exemption amount, some taxpayers would have had an increased liability of up to $9,450 in 2012.

Finally, there was some relief related to the phaseout of exemptions and itemized deductions.  Exemptions and itemized deductions will begin to be phased out for single taxpayers with adjusted gross income (“AGI”) of more than $250,000 and married joint-filing taxpayers with AGI of more than $300,000.  These amounts will be increased annually for inflation.  This phaseout threshold is higher than expected. Without the legislation, the expiration of the Bush-era tax cuts would have provided a phaseout threshold of approximately $178,750 for married joint-filing taxpayers.

Many were relieved that President Obama’s proposed limitation on the effective benefit of some itemized deductions (at 28 percent) was not included in the final legislation.

The debate is not over, though. It is important to note that the upcoming negotiations on the debt ceiling and federal spending could force Congress to change its view on some of these provisions.  While many provisions are “permanent” in the sense that they do not “sunset” like the Bush-era tax cuts, Congress could make sweeping changes to the overall tax structure.  Many questions regarding future tax increases, closing “loopholes,” and who should bear the tax cost still are open. While uncertainty remains, it is important that business owners stay diligent in understanding the new tax laws. 

Jennifer Flinchum is a partner with Keiter PC. She has significant experience in tax compliance and strategic consulting for privately held businesses and their owners. Her expertise also includes tax accruals, mergers and acquisitions, multi-state tax issues and executive compensation. She is both a Certified Public Accountant and Certified Financial Planner. She can be contacted at [email protected].