The Journal of The DuPage County Bar Association

Back Issues > Vol. 25 (2012-13)

The Average Lawyer’s Guide to The American Taxpayer Relief Act
By Terrence j. Benshoof

On January 1, 2013, the President signed into law P.L. 112-240, known officially as the American Taxpayer Relief Act (ATRA[1]). It was also known under the names H.R. 8 (the designation when first introduced several months ago), and more popularly as the “fiscal cliff” tax law. After many months of press releases, speeches, news articles, threats, and even name-calling, Congress and the White House enacted legislation dealing with the tax rates, deductions, credits and tax incentives which were essentially created in the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), which, under Title IX of that Act, were due to “sunset,” or automatically expire, on December 31, 2012. This article will deal with the practical effects of ATRA for the average lawyer’s knowledge in dealing with the average American taxpayer’s problems, and will not discuss any political or budgetary aspects of the Act.

The Act affected a great number of things in taxation, as well as numerous topics generally unrelated to tax.[2] Those sections dealing with tax issues covered income tax and related exemptions, deductions, rates and credits[3] for individuals, and included estate tax provisions, and the alternative minimum tax. With respect to businesses, the Act dealt with a few general depreciation matters,[4] three Subchapter S gain issues,[5] and extensions of some employment credits.[6] By its silence on the topic, the Act allowed the “holiday” on collection of 2% of the FICA tax due from the employee to expire. There was no change in the percentage due from employer or employee which had existed prior to the collection “holiday.”

For the practitioner dealing with clients who are wage earners, and who have relatively few investments, ATRA will generally leave matters of taxation as they were under EGTRRA. Only those taxpayers who fall into the income range of $400,000 per year (married, $450,000) will feel the change in the new tax rates, which place these taxpayers into a 39.6% bracket.[7] That bracket actually applies to the income exceeding the maximum income in the next lowest (35%) bracket. Similarly, the tax rate on capital gains for the high income bracket taxpayer is increased from 15% to 20%.[8]

The greater tax bite under ATRA comes to the high-incomer taxpayer in the form of the reduction and phase out of both personal exemptions and itemized deductions. While the tax brackets for the high-income group begin at the level of $400,000 taxable income, the phase-outs help the taxpayer get to that level faster. For the single filer, the phase-out begins when adjusted gross income reaches $250,000. The personal exemption is reduced by 2% for each $2,500 (or portion) in excess of the AGI.[9] The itemized deductions are reduced by 3% of the excess of AGI over the threshold amount, up to 80% of otherwise allowable itemized deductions.[10] Essentially, your client with a high income from salary and investment will be subject to a “triple whammy” if the thresholds are exceeded. And, lest it be forgotten, investment income will now be subject to Medicare tax under the Patient Protection and Affordable Care Act.[11] For two-income, higher end married taxpayers, the result could be severe, because the combined income (salaries and investments) can easily increase tax by triggering the threshold amounts for reduced exemptions and deductions, and could also push the couple into a 4.6% bracket increase. The outcome of this new “marriage penalty” is yet to be determined.

Typically, the client more likely to seek advice on the effects of the new tax act will be the small business owner. Often a shareholder in a Subchapter S corporation, careful balancing will be necessary to avoid the high brackets. The Service looks for a reasonable salary to be drawn by the shareholders in the Subchapter S corporation, or it may be viewed as simply a device to avoid FICA and Medicare taxes (since distributions are not subject to these taxes).[12] The combined salary and distribution, however, are income to the shareholder, which, in good business years, push the shareholder into the top bracket under ATRA, and cause a rapid phase out of exemptions and deductions. Worse still, under the pre-ATRA law, the taxpayer was likely to fall under the ambit of the Alternative Minimum Tax.[13]

The Alternative Minimum Tax (AMT) was enacted in 1978 to prevent the high-income taxpayers of that time (about 169 families) from escaping income tax entirely by use of large deductions. But the AMT, as enacted, was not indexed for inflation with respect to the threshold amount.[14] Had another “patch” not been enacted, and the tax laws reverted to pre-EGTRRA times, it is believed that, even with the poor economy, around 30,000,000 taxpayers would have been subject to AMT in 2013. Under ATRA, a permanent “fix” was enacted. The threshold exemption for AMT was placed at $50,600 for single filers, and $78,750 for joint filers, beginning with 2012. Furthermore, there was a new provision inserted which indexes the threshold for inflation, avoiding what has been a constant Congressional sore point for over 40 years.[15]

The individual filer client will, under ATRA, still be able to take credits, deductions, or exclusions which would have expired. Among these are the credit for qualified tuition and expenses,[16] the earned income credit and the child tax credit.[17] With respect to deductions, those for teacher expenses,[18] state and local sales tax,[19] and mortgage insurance premiums as part of residence interest[20] were extended, but only for one year.

On the business side, ATRA did not make any significant changes. It did, however, extend several depreciation related provisions which would apply to many of the typical clients that a practitioner would be working with. Most notably, the Act extended the 15 year straight-line depreciation for qualified leasehold improvements, such as restaurants and retail.[21] It also extended 50% bonus depreciation,[22] energy credits, [23]and §179 expensing, including the $500,000 cap on expensing.[24] Unfortunately, these extensions were only for one year, giving only limited planning opportunities.

Whether the practitioner was dealing with salaried employees, business owners or retirees, an area of major concern had been the estate and gift tax question. Prior to EGTRRA, the exemption under IRC§2001 for the lifetime unified gift and estate tax was to increase, by 2007, to the equivalent of a $1 million estate. Under EGTRRA, the exemption increased gradually to $3 million in 2009, and the tax disappeared entirely in 2010. Congress then, under the Tax Relief Act of 2010, restored the tax, but with a $5 million threshold. Estate planners gritted their teeth throughout 2012, with no clear indication as to what, if anything would be extended, or modified. Finally, under ATRA, the threshold provision of $5 million was restored, but with the graduated unified rate raised to 40% for taxable estates over $1 million above the exemption. The exemption will be adjusted for inflation. In addition, the concept of portability was retained and made permanent. Under that concept, the unused portion of the exclusion available to one spouse may be used by the second to die. Since the first spouse can transfer an unlimited amount to the other (marital deduction), this in effect doubles the excluded amount for the second to die.[25]

Our tax laws continue to be complex, and ever-changing. The beginning of this year saw another set of major changes, many in the form of simply keeping what had been enacted over the past ten years. While the Code, Regulations, rulings and decisions of numerous courts make the tax laws cumbersome to the point of near-insanity, the typical practitioner need only be aware of the types of matters that typically confront his or her clients. It is with this in mind that we present this summary over-view.               

[1]  Not to be confused with the Gillettte Razor of that same name.

[2]  The Act itself is 157 pages long, and only about a third of it covers tax topics.

[3]  Sections 101-104, 201 to 209, 401, 408-409.

[4]  Sections 311, 315, and 331.

[5]  Sections 324-326.

[6]  Sections 301, 308-309.

[7]  Section 101(3)

[8]  Section 102(b)

[9]  Section 101(b)(2)

[10]  Id.

[11]  26 U.S.C. §3101, as amended by P.L. 111-148 and P.L. 111-152

[12]  26 U.S.C. §§1368, 3121

[13]  IRC §55.

[14]  26 U.S.C. §55; P.L. 95-600 (1978); see also P.L. 94-455

[15]  Section 104

[16]  Sections 103, 207

[17]  Section 103.

[18]  Section 201

[19]  Section 205

[20]  Section 204

[21]  Section 311

[22]  Section 315

[23]  Sections 401-412

[24]  Section 315

[25]  Section 101(c)

Terrence J. Benshoof practices from Glen Ellyn, Illinois. He graduated from the University of Illinois at Chicago in 1968, with a B.A. with Honors and Distinction in Political Science. He earned his J.D. from De Paul University College of Law in 1971, where he was an Associate Editor of the De Paul Law Review. He also earned an LLM (Taxation) from De Paul in 1980, and has practiced extensively in property tax litigation and other Federal, State and Local, and Multi-State tax matters.

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