Commentary 1/21/2013

Passed by Congress shortly after midnight on New Year’s Eve, The American Taxpayer Relief Act (“ATRA”) reorients planning for taxes and investing. ATRA raises tax rates to 39.6% for taxable income above $400,000 for individuals and $450,000 for married couples. The tax on “qualified” dividends and long-term capital gains increases to 20% for individuals and couples above the same income levels. All other income tax brackets and the lower 15% rate on “qualified” dividends and long-term capital gains for these tax brackets are unchanged.

ATRA brings back the phase-out of itemized deductions, including deductions for mortgage interest, charitable donations and taxes. These deductions are reduced by 3% of adjusted gross income above $250,000 for individuals and $300,000 for couples with a maximum reduction of 80%. ATRA also restores the phase-out of personal exemptions above these same thresholds.

Beginning in 2013, in addition to the higher tax rates and the phase-out of itemized deductions and exemptions that ATRA imposes, the previously enacted Affordable Care Act adds a Medicare surtax of 3.8% on investment income above adjusted gross income of $200,000 for individuals and $250,000 for couples as well as a 0.9% Medicare surtax on wages and self-employment income above these same levels.

The estate and gift tax exclusion is retained at $5 million indexed for inflation, but the estate and gift tax rates rise to 40% from 35%. The estate and gift tax exclusion is $5,250,000 for 2013. ATRA permanently raises the exemption for the alternative minimum tax (“AMT”) and indexes it for inflation.

All of the above provisions are permanent. ATRA finally provides some clarity about income taxes, the AMT and taxes on investments and estates. However, Congress has not addressed the “sequester” spending cuts, which were put off for two months, and the continuing resolution to keep the government funded, which expires on March 27. Only a few days ago, Congress may have temporarily sidestepped deficit reform when House Republicans proposed raising the debt ceiling for three months.

The certainty about taxes will soon give way to the uncertainty about fiscal issues and probably more political brinkmanship. As the scheduled spending cuts and the government funding resolution come more into focus, investors can expect more market volatility.

ATRA did extend several personal income tax credits as well as credits and deductions for businesses, most notably the expense deduction for depreciable business property, bonus depreciation, and research and energy credits. However, these credits and deductions are extended only through 2013, and their extension requires future negotiations and perhaps more uncertainty and controversy.

We will discuss investment planning under ATRA in an upcoming commentary.