Congress approved a fix to the “fiscal cliff” over the New Year’s holiday that was a long time coming but in the end swiftly developed and passed. The package includes a variety of individual income and business tax changes which will especially impact businesses organized as pass-through entities such as S corporations and LLCs.
Here is how these new changes impact Wisconsin businesses:
Individual Income Tax Rates
The previous top bracket of 35% was permanently increased to 39.6% for individuals earning more than $400,000 and $450,000 for married couples. The four lower brackets were all permanently extended (10%, 25%, 28%, and 33%) while the 15% bracket remains in place. These changes all apply for 2013.
In addition, the federal Affordable Care Act (ACA) tax increase of 0.9% on income above $200,000 for individual income and $250,000 for married couples also takes effect in 2013.
Individual Income Tax Phase-Outs
Two of the earlier lesser-known tax cuts were the elimination of personal exemption phase-outs (“PEPS”) and limits on itemized deductions (known as “Pease”). In 2013, taxpayers earning $250,000 as individuals or $300,000 as married couples will again be subject to these provisions. These changes are effective tax increases that will generate literally billions for the federal government.
Investment Income Taxes
For those earning $400,000 as individuals or $450,000 as married couples, rates on capital gains and dividends will increase to 20% in 2013 from the prior 15% rate. Those with lesser incomes will retain the two present rates of 0% (which applies to those in the 10% and 15% individual income brackets) and 15% (for those in the other brackets up to the new 39.6% bracket). All of these rates were permanently extended.
In addition, the ACA tax increase of 3.8% on capital gains and dividends takes effect in 2013 for those earning $200,000 as individuals or $250,000 as married couples.
Estate Tax (Death Tax)
The $5 million per person exemption and inflation indexing in current law were extended permanently, but the top rate was increased to 40% from 35%. Portability of the unused exemption (allowing a spouse to claim any unused exemption from the deceased) and unifying the estate and gift taxes were both made permanent. These changes take effect in 2013.
Permanent AMT Patch
The alternative minimum tax (AMT) is finally being indexed for inflation. Developed in the 1970s to ensure those with high incomes couldn’t avoid taxation under the normal tax structure, the AMT was not previously indexed for inflation and impacted an increasing number of taxpayers. A higher exemption amount was adopted for 2012 along with indexing for inflation. Both of these changes were made permanent. This is a significant improvement for many taxpayers.
Business Tax Incentives
The research and development tax credit was finally restored for 2012 and extended for 2013. Extending the credit will again be considered by Congress later this year as it was not made permanent.
The Section 179 expense deduction and bonus depreciation were also extended. The maximum amount of the Section 179 deduction was increased to $500,000 and the investment limit was raised to $2 million for 2012 and 2013. These are the same limits that existed in 2010 and 2011.
The existing 50% bonus expensing provision for property purchased and placed into service during 2012 was extended through 2013. The allowance extends an additional year (through 2014) for certain long-term and transportation assets.
Social Security Payroll Tax
After a “holiday” of employees being taxed 4.2% instead of the regular 6.2% employee share of Social Security taxes in 2011 and 2012, the payroll tax reverts back to the normal rate for 2013.
Aside from these major tax changes, a wide array of small changes were adopted that could be of interest to narrow investments, hires, or employee benefits.
Many businesses previously ineligible for credits may now be able to claim them due to the confluence of the higher top income rate, the income tax phase-outs, and 2012 AMT relief. You should meet with your accountant and discuss these changes before filing your 2012 tax returns.
Finally, for the many Wisconsin manufacturers who export goods or components for foreign-made goods, major tax savings may be realized under a federal incentive known as IC-DISC. That stands for Interest Charge Domestic International Sales Corporation. Using an IC-DISC may allow the tax liability on 50% of export income to be reduced by nearly half by taxing profits at the dividend rate rather than ordinary income. Figuring in the fiscal cliff and ACA tax increases for 2013, dividends will be taxed at 20% plus the 3.8% ACA tax while ordinary income will be taxed at 39.6% plus the 0.9% ACA tax. Another good reason to see your accountant!
As you can see, the recent changes by President Obama and Congress have not resulted in any tax simplification nor rate reductions (other than avoiding increases at the lower tax brackets). Given the two month deferral of the spending cuts now set to take effect in March and the federal government reaching its debt limit again, the battle over taxes and spending is likely to rekindle again before spring arrives.
Related Material:
Summary of Tax Provisions
WMC Staff Contact: Jason Culotta
