Avoiding the Fiscal Cliff with the American Taxpayer Relief Act of 2012

On January 1, 2013, Congress passed the American Taxpayer Relief Act of 2012 (the “Act”), which halts tax increases scheduled to go into effect for most Americans as part of the so-called fiscal cliff. The Act generally allows tax rates to rise on higher-income individuals but extends certain favorable tax provisions for individuals and businesses. This alert briefly summarizes some of the key federal income tax provisions of the Act.

Individual Provisions

Extension of Certain Individual Ordinary Income Tax Rates and Introduction of New High-Income Bracket

The Act preserves the 25%, 28%, 33% and 35% brackets, which were set to rise at the beginning of 2013, and adds a new 39.6% bracket applicable to taxable income exceeding (i) $450,000 for married individuals filing jointly or (ii) $400,000 for individual filers. The income thresholds for each bracket will now be adjusted for inflation. Note that the Patient Protection and Affordable Care Act imposes additional Medicare taxes, also effective on January 1, 2013, of (i) 3.8% upon certain investment income and (ii) 0.9% on certain employee wages and selfemployment income, each of which were previously subject to a 2.9% tax, including the employer portion of the Medicare tax on employee wages. Generally, the additional Medicare tax on investment income applies to the extent that modified adjusted gross income exceeds $250,000 for married individuals filing jointly and $200,000 for individual filers, and the additional Medicare tax on wages and selfemployment income applies above a threshold of compensation income of $250,000 for joint filers and $200,000 for individual filers.

Who doesn’t love a good cliffhanger — especially one with a (relatively) happy ending? After considerable nail-biting and handwringing, on January 1 Congress passed the American Taxpayer Relief Act of 2012 (the “Act”), extending much of the estate, gift, and generation-skipping transfer (GST) tax law developed over the past 12 years and preserving favorable opportunities for individuals and families planning the transfer of their wealth.

Key Provisions of the Act: Estate, Gift and GST Taxes

The maximum exemption from federal estate, gift, and GST taxes on December 31, 2012 was $5,120,000 per donor/decedent ($10,240,000 per married couple). As of January 1, 2013, those exemptions increased for inflation (the new exemption amount is anticipated to be $5,270,000, pending official confirmation from the IRS) per donor/decedent and will continue to increase annually.

On December 31, 2012, the estate, gift, and GST tax rate applicable to nonexempt transfers was 35%. As of January 1, 2013, those rates increased to 40%.

The Act is a fundamental game changer for many families. Had Congress not acted, the gift, estate and GST tax laws would have reverted to the 2001 rules: a $1,000,000 exemption per donor/decedent and a 55% maximum rate. The preservation of the GST exemption and the associated administrative rules is particularly good news for families engaging in multigenerational gift planning, as the Act permits ongoing flexibility and eliminates considerable uncertainty.