"The American Taxpayer Relief Act of 2012 - A Result of the 'Fiscal Cliff,' What it Did and Did Not Do," Dayton Association of Tax Professionals

THE AMERICAN TAXPAYER RELIEF ACT OF 2012
(“ACT”)
A RESULT OF THE “FISCAL CLIFF”
WHAT IT DID AND DID NOT DO

Presentation to the Dayton Association of Tax Professionals

Frederick J. Caspar, J.D.
Dinsmore & Shohl LLP
10 Courthouse Plaza, S.W., Suite 1100
Dayton, Ohio 45402
(937) 449-2818
fred.caspar@dinsmore.com

January 14, 2013
14

© 2013 Frederick J. Caspar

INCOME TAX (CON’T)
 BRIEF SUMMARY OF SELECT CHANGES

2

BUSINESS PROVISIONS
 Section 179 Deduction for Equipment
○ Annual limit for 2012 (made retroactive) and 2013
is increased to $500 000 with a phase out
$500,000, phase-out
beginning at $2,000,000 of investment.
○ Previously for 2012 the limit was $139,000
(inflation adjusted), with a phase-out starting at
$560,000 (inflation adjusted).
○ Annual limit decreased to $25,000 in 2014.
$ ,
○ Phase-out starts at $200,000 in 2014.

3

INDIVIDUAL TAX PROVISIONS
 50% Bonus Depreciation was to expire in 2013 (with an
exception through 2013 for longer-produced property).
This was extended to 2014.

 Collapsible corporation provisions (IRC §341) reinstated
in 2013
2013.
○ Essentially taxes sales of C corporation stock as
ordinary income (vs. capital gain) if corporation formed
for th
f the principal purpose of packaging ordinary income
i i l f k i di i
assets for sale.

 Extends 15-year straight-line depreciation on qualified
leasehold improvements through 2013. 4

Income Tax (Con’t)
I T (C ’t)
 Alters the taxation of S corporation “Built-in Gains” (“BIG”):
o For 2012 and 2013 BIG, the recognition period is
reduced from 10 years to 5 years.
o If an installment sale of BIG assets occurs in 2012
a sa e sa e o G asse s occu s 0
or2013, the 5-year rule will apply even if the installment
note is collected after 2013

 The smaller basis adjustment to S corporation stock for
charitable contributions of appreciated property by such
corporation is extended for contributions made in 2012 and
p
2013.

5

I T (C ’t)
 Extends the 9% low-income housing credit applicable
g pp
percentage to all credit allocations made prior to 2014.
 Extends a number of other expiring provisions through
2013. E.g.:
0 3 g
o 100% exclusion for gain on sale of “qualified/small
business stock (§1202).
o Research tax credit
credit.
o Work opportunity credit.
o New Markets Tax Credit.
o Subpart F exception for active financing income.
o Various energy credits extended; “RIC,” “CFC”
extenders.

6

I T (C ’t)
INDIVIDUAL PROVISIONS
 Increased, and made permanent, the AMT patch
o From $45,000 (married/$33,750 single) in 2012
p e ous y, o $ 8, 50/$50,600, de ed o
previously, to $78,750/$50,600, indexed for inflation
a o
after 2012.
o Allowing non-refundable personal credits to offset AMT.

 Reinstated the ability to deduct state and local sales taxes
in lieu of income taxes from 2011 through 2013
(retroactive for 2012)
2012).

7

I T (C ’t)
 Extended, from 2011 through 2013 (retroactive for
, g (
2012) the ability of individuals 70½ or older to direct
traditional IRA distributions to charities, up to
$
$100,000 each year.
, y
o A distribution already received in December of 2012
can be so treated if equivalent cash is contributed
to charity in January 2013
January, 2013.
o A January 2013 IRA distribution to charity can be
treated as a 2012 rollover, effectively allowing a
second $100 000 charitable distribution to be made
d $100,000 h it bl di t ib ti t b d
in 2013.

8

I T (C ’t)
o Such distributions are treated as required minimum
q
distributions (RMD).
o Distributions to donor advised funds do not qualify
under this provision
provision.
o Benefits to the donor include:
 Effectively in charitable deduction with no AGI
limitation.
 Avoids the 2013 itemized deduction phase-out if
it were to limit such deduction.
 Effectively a state tax charitable deduction.

9

I T (C ’t)
 Extends the exclusion from gross income of discharge
g g
of qualified principal residence indebtedness (up to
$2,000,000) to December 31, 2013.
 Permanently extends “relief” from the “marriage
relief marriage
penalty”
o Allowing a standard deduction twice the single
deduction.
deduction
o Increases the 15% bracket, over time, to twice the
corresponding single individual bracket.

10

I T (C ’t)
 Extends through 2013 certain other deductions
g
o School teachers expenditures
o Employer provided mass transit and parking as
excludible working condition fringe
fringe.
o Deduction of mortgage insurance premiums as
qualified residence interest.
o Extension of contribution of certain conservation
easements.
o Deduction of certain qualified tuition payments
payments.

11

I T (C ’t)
Some Things the Act Did Not Extend
g
 Phase-out of itemized deductions reinstated in 2013;
3% of AGI over threshold (est. in 2013 $300,000
married filing joint, $250 000 single, adjusted for
joint $250,000 single
inflation after 2013) up to 80% of total deduction).
o What is practical impact on discretionary (e.g.,
charitable) itemized deductions?
 Phase-out of personal exemptions reinstated in 2013;
2% for each $2,500 that AGI exceeds threshold
amounts (est. $300,000 married filing joint, $250,000
single). Reduced to $0 if $125,000 over threshold.

12

SELECTIVE HEALTH REFORM ACT EMBEDDED TAXES
 Employee (including for self-employed) FICA (“payroll”)
tax rate allowed to increase from 4.2% to 6.2%.
 In 2013 forward:
• Additional tax of 0.9% on earned income over
$200,000/$250,000 for single/joint taxpayers,
bringing total “surtax” from 2.9% to 3.8%.
• Additional tax of 3.8% on unearned
(passive/investment) i
( i /i t t) income t th extent modified
to the t t difi d
AGI exceeds $200,000/$250,000.
 In 2018 forward: 40% excise tax on health insurance
premiums in excess of $10,800/$27,500 for
$10 800/$27 500
individual/family coverage.
 AGI threshold for medical expense deduction increased
from 7.5% of AGI in 2012 to 10% in 2013 (7 5% remains
7 5% (7.5%
if age 65 or over).
13

INDIVIDUAL INCOME TAX RATE CHANGES
2012 Joint Tax Rates -- Ordinary

$0 to $17,400 10% of amount over $0
$17,400 to $70,700 $1,740 + 15% of amount over $17,400
$70,700 to $142,700 $9,735 + 25% of amount over $70,700
$142,700 to $217,450 $27,735 + 28% of amount over $142,700
$217,450 to $388,350 $48,665 + 33% of amount over $217,450
Over $388,350 $105,062 + 35% of amount over $388,350

14

EXPECTED 2013 INDIVIDUAL TAX RATES
If taxable income (married filing jointly)

Is over But not over The tax is:*
$0 $17,850 10% of taxable income
$17,850 $72,500 $1,785 plus 15% of the amount over $1,785
$72,500
$72 500 $146,400
$146 400 $9,982
$9 982 plus 25% of the amount over $72,500
$72 500
$450,000 and
$ d over $125,846 plus 39.6% of the amount over $450,000
$ l f h $

_____________________
* Plus 0.9% on earned income over $200,000/$250,000
Plus 3.8% on unearned income to extent AGI is over $200,000/$250,000

15

OTHER 2012/2013 INCOME TAX RATE CHANGES
/
 Long-term Capital Gain
2012 2013
15% 20.0%*
with 3.8% surtax 15% 23.8%

 Collectibles and Real Property Recapture Rates stay at 28%/25%,
respectively.

 Qualified Dividends (Max. Rate)
2012 2013
15% 20.0%*
with 3 8% surtax
ith 3.8% t 15% 23.8%
23 8%

* The extra 5% applies only to the extent taxable income exceeds $450,000
(married, joint)/$400,000 (single)).

16

Choice f Entity D i i R i it d
Ch i of E tit Decision Revisited
NON-CORPORATE FLOW THROUGH ENTITIES

 Sole Proprietorship
o C
Can b 100% owned limited liability company
be d li it d li bilit
(LLC), formed to limit liability but treated as
disregarded entity for tax purposes.
 General Partnership
 Limited Liability Partnership
 Limited Partnership
 LLC taxed as Partnership

17

Choice f Entity Decision Revisited (Con’t)
Ch i of E i D i i R i i d (C ’ )
CORPORATE FLOW THROUGH ENTITIES
 S Corporation
 “Check the Box” LLC that has made an S election

NON FLOW THROUGH ENTITIES
 C Corporation
 “Check the Box” LLC that has not made an S election.

18

SOME NON-TAX FACTORS TO CONSIDER
 Limited liability
 “Corporate” formalities
 E
Ease i accessing capital markets
in i it l k t
o Private money
o Public markets
 Ownership restrictions (number and type)
o Applicable to S corporation
 Flexibility in multiple classes of stock/equity
o More limited for S corporations

19

TAX FACTORS TO CONSIDER
 Primary Advantages of Flow Through Structure
o Avoidance of double tax
 O stock sale (f
On t k l (from increased basis attributable
i d b i tt ib t bl
to retained earnings).
 On asset sale, from retained earnings basis
, g
bump, and avoidance of double tax on unrealized
appreciation in assets (subject to “BIG” tax for
recently elected S corporations).
y p )
 On current withdrawals of cash.

20

o Lower individual maximum capital g
p gain rates.
 20% (23.8% if passive capital gain) vs. 35%
corporate rate.
o Flexibility to withdraw cash
o Avoids unreasonable accumulation of earnings penalty
tax.
o Avoids
A id unreasonable compensation i
bl ti issues
o Possible ability to avoid “Medical surtax” of 3.8%
 “Obamacare” surtax of 3.8% on S corporation
p
pass-through income does not apply to materially
participating shareholders.
 This is a potential advantage of S corporations over
other flow through structures.
21

o More flexibility in choosing method of accounting (cash
vs. accrual) than C corporations.
 Primary Disadvantages of Flow Through Structure
o Higher maximum immediate federal ordinary income tax
g e a u ed a e ede a o d a y co e a
rates.
 39.6%/43.4% if “passive” income vs. 35%
 Bracket creep through C corporation brackets will
result in lower rate than 35% if under $18,833,333 of
taxable income.
o Generally a calendar year is required
required.
o Limited ability to implement deferred compensation
plans for owners.

22

o Inability to use §1202 100% qualified sale exclusion of
small business stock through 2013.
o Disability insurance premiums not deductible for
owners/but benefits are not taxable.
 Primary Differences Between Corporations and other Flow
Through Structures
o Inability to add entity debt to S corporation stock basis
y y p
 For loss flow through.
 For tax deferred distributions.
o Triggering of tax on appreciated assets if distributed
from S corporations (§311).

23

o Less flexibility on contributing appreciated assets tax
free to S corporations (§351 vs. §721).
o Less flexibility on structuring equity participation for key
executives of S corporations (subject to carried interest
proposals)
o More flexibility in structuring a tax deferred
(reorganization) exit for S corporations.

24

TAKE AWAYs
 The choice of entity analysis has not fundamentally
changed, and in most instances a flow through structure
will still be preferred even in light of the increased spread in
individual vs. corporate tax rates. However, for start-up
companies
o That want to minimize current taxes;
o That have an exit plan that allows conversion from “C” to
“S” status in sufficient time to avoid the “BIG” tax; and
o For which S corporation status is an acceptable flow
p p
through structure (vs. partnership) the balance may shift
to a C corporation structure initially.

25

 Note that if an S corporation converts to a C corporation,
absent IRS consent it cannot return to S corporation status
for five years.

26

ESTATE/GIFT TAX
 ESTATE AND GIFT TAX RATE CHANGES

Year Exemption Top Rate

2012 $5,120,000 35%

2013 $5,250,000 (inflation 40%
adjusted)

27

OTHER ESTATE/GIFT TAX PROVISIONS
/
 Spousal p
p portability retained.
y
 All other sunset provisions of the 2001 and 2010
changes have been eliminated, and such otherwise
sunsetted provisions made permanent (ACT
§101(a)(1) and (2)). E.g.,
o $250,000 home sale gain exclusion for qualified
bypass trusts in §121(d)(ii)(C) retained
retained.
o Accommodative provision in IRC §6166 rules
(installment payment of estate taxes for tax
attributable to closely held business) retained.

28

OTHER ESTATE/GIFT TAX PROVISIONS (CON’T)
 Other possible future changes:
 Elimination of discount planning.
 Elimination of “defective” grantor trust planning.
 Elimination of GRATs under 10 years in length
length.
 Limitation of Dynasty Trusts to 90 years.

29
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"The American Taxpayer Relief Act of 2012 - A Result of the 'Fiscal Cliff,' What it Did and Did Not Do," Dayton Association of Tax Professionals

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