Quarles & Brady Tax Newsletter
This edition contains the following articles:
American Taxpayer Relief Act of 2012
Medicare Tax on Unearned Income (Section 1411 of the Code)
Social Security Wage Base Increase
Home Office Deductions
FROM THE EDITOR
Welcome to the April 2013 edition of the Quarles & Brady LLP Taxation Group's newsletter dedicated to keeping you apprised of newsworthy tax developments.
Of the 142.9 million federal individual income tax returns filed in tax year 2010, 84.5 million (59.1%) were classified as taxable returns or returns with a total income tax greater than $0. (Source IR-2013-26).
Of the 143,399,737 federal individual income tax returns filed in tax year 2011, 1,481,966 (1.03%) were audited by the IRS in the government's fiscal year ended September 30, 2012. Generally the audit percentages increased as the adjusted gross income reported on the return increased. For example,
| Adjusted Gross Income | Audit Percentage |
| $25,000 to $99,999 | .64% |
| $100,000 to $199,999 | .85% |
| $200,000 to $499,999 | 1.96% |
| $500,000 to $999,999 | 3.57% |
| $1,000,000 to $4,999,999 | 8.9% |
| $5,000,000 to $9,999,999 | 17.94% |
| $10,000,000 or more | 27.37% |
(Source: Internal Revenue Service Data Book, 2012 Publication 55B Washington, D.C., March 2013)
AMERICAN TAXPAYER RELIEF ACT OF 2012
The American Taxpayer Relief Act ("ATRA") was enacted on January 2, 2013 to partially deal with the "fiscal cliff." While the ATRA prevented tax increases for many taxpayers, the ATRA significantly raised taxes on higher-income individuals. Among the many provisions of ATRA, some of the highlights from an income tax perspective include:
- Permanent extension of the Bush-era tax cuts for most taxpayers;
- Increased marginal tax rates and capital gains rates for certain high-income taxpayers;
- Phase-outs of itemized deductions and personal exemptions for certain high-income taxpayers;
- Permanent patch of the AMT exemption amount;
- Extension of a variety of individual and business tax provisions; and
- Did not extend the payroll tax reduction.
Increased marginal tax rate for high income individuals. For married taxpayers with taxable income above $450,000 (above $400,000 or more for single filers), the ATRA permanently raised the top marginal rate on ordinary income from 35% to 39.6%. These taxable income thresholds will be indexed for inflation. For taxpayers below these income levels, the ATRA permanently extended the 10%, 15%, 25%, 28%, 33% and 35% tax brackets.
Increased tax rate on capital gains and qualified dividends for high income individuals. The tax rate for capital gains and qualified dividends was increased from 15% to 20% for married taxpayers with taxable income above $450,000 (above $400,000 for single filers). These taxable income thresholds will be indexed for inflation. For taxpayers below these income levels, the ATRA permanently extended the maximum 15% rate on capital gains and qualified dividends.
New Medicare taxes. The ATRA did not repeal or delay implementation of the new 3.8% Medicare tax imposed on net investment income or the additional 0.9% Medicare tax imposed on wages for taxpayers with AGI over $250,000 ($200,000 for single filers). See Medicare Tax On Unearned Income, below. The 3.8% Medicare tax is in addition to the tax rate for capital gains and qualified dividends.
Tax Tables for 2013. As a result of the changes to the tax rates, as well as implementation of the new Medicare contribution taxes, the tax rates for 2013 are as follows:
|
Individual income tax rates for 2013 |
|||||
|
Taxable Income* |
Ordinary Income |
Capital gains and dividends |
Medicare tax |
||
|
Single |
Joint |
Earned income** |
Net*** Investment income |
||
|
$0+ |
$0+ |
10% |
0% |
2.9% |
0% |
|
$8,925+ |
$17,850 |
15% |
|||
|
$36,250+ |
$72,500+ |
25% |
15% |
||
|
$87,850+ |
$146,400+ |
28% |
|||
|
$183,250+ |
$223,050+ |
33% |
|||
|
$200,000+ (AGI) |
$250,000+ (AGI) |
3.8% |
3.8% |
||
|
$398,350+ |
$398,350+ |
35% |
|||
|
$400,000+ |
$450,000+ |
39.6% |
20% |
||
|
*Based on 2013 inflation adjustments. Amounts refer to taxable income except where noted. |
|||||
Deduction and Personal Exemption Limitations. Taxpayers with AGI above $300,000 (above $250,000 for single filers), will be subject to a gradual phase-out of both personal exemptions and itemized deductions. Itemized deductions will be reduced by 3% of AGI over the applicable threshold (not to exceed 80% of itemized deductions). The itemized deduction limitation does not apply to investment interest expense, casualty losses, medical expenses or gambling losses. Personal exemptions will be fully phased-out for married taxpayers with AGI of $422,500 ($372,500 for single filers).
Permanent AMT Patch. The AMT exemption amount has been permanently "patched" and will be indexed for inflation. This was the most costly of ATRA's provisions, as it spared millions of middle income taxpayers from the AMT.
Charitable Contributions from IRA's - Limited Window of Opportunity. ATRA extends through December 31, 2013 the provision allowing individuals age 70½ or older to make charitable donations from their IRA's without being subject to income tax on the distributions.
No Extension of Payroll Tax Holiday. The employee share of the OASDI (Social Security) tax was reduced from 6.2% to 4.2% during 2011 and 2012. Unfortunately, this provision was not further extended by ATRA.
MEDICARE TAX ON UNEARNED INCOME (SECTION 1411 OF THE CODE)
Effective for tax years beginning after December 31, 2012 a new 3.8% tax is imposed on unearned income of individuals, estates and trusts which meet certain income thresholds.
In the case of individuals, the 3.8% tax is imposed on the lesser of (i) "net investment income" for the taxable year, or (ii) the excess of adjusted gross income for the taxable year over $250,000 (for a joint return or surviving spouse), $125,000 (for married filing a separate return) or $200,000 (for any other filing status).
In the case of estates and trusts the 3.8% tax is imposed on the lesser of (i) undistributed "net investment income" for the taxable year; or (ii) the excess of the adjusted gross income (computed under Section 67(e) of the Code) for the taxable year over the dollar amount at which the highest tax bracket in Section 1(e) of the Code begins for such taxable year which for 2013 is $11,950.
For purposes of the 3.8% tax "net investment income" means the following items of income:
(i) interest, dividends, annuities, royalties and rents other than such income derived in the ordinary course of a trade or business which is not a passive activity with respect to the taxpayer;
(ii) other income which is derived from a trade or business which is a passive activity with respect to the taxpayer; and
(iii) net gain from the disposition of property other than property held in a trade or business which is not a passive activity with respect to the taxpayer.
Deductions allowed for income tax purposes which are properly allocable to such items of income can be deducted in arriving at "net investment income". The passive activity rules of Section 469 of the Code are applied to determine whether income is derived from a trade or business, which is a passive activity with respect to the taxpayer. Thus, the 3.8% tax will apply to a S corporation shareholder's share of the S corporation's income where the shareholder meets the income threshold, and the S corporation's trade or business is a passive activity with respect to the shareholder. The 3.8% tax will not apply to such shareholder's share of the S corporation's income if such shareholder materially participates in the S corporation's trade or business so that the S corporation's trade or business will not be a passive activity with respect to the shareholder. Likewise the 3.8% tax will apply to a partner's share of partnership income if the income threshold is met, and the partnership trade or business is a passive activity with respect to the partner, but will not apply if the partner materially participates in the partnership trade or business. Similar rules apply to an S corporation shareholder or partner who realizes a net gain on the sale of such shareholder's S corporation stock or of such partner's partnership interest.
Special rules treat income on investment of working capital and income from a trade or business of trading in financial instruments or commodities as net investment income.
Net investment income does not include any distribution from a qualified plan described in Sections 401(a), 403(a), 403(b), 408, 408A or 457(b) of the Code or any item taken into account in determining self-employment income on which the 3.8% medicare tax of Section 1401(b) of the Code is imposed.
Beginning on January 1, 2013 the standard mileage rates for transportation or travel expenses are 56.5 cents per mile for business miles, 24 cents per mile for medical or moving purposes and 14 cents per mile in service of charitable organizations. (Source: IR-2012-95).
SOCIAL SECURITY WAGE BASE INCREASE
The Social Security Administration announced that the wage base for computing the Social Security tax on 2013 increased to $113,700 from $110,100. (Source: Social Security News Release, 10/16/2012).
The IRS announced a simplified option in the form of a safe harbor for claiming home office deductions starting for 2013. The safe harbor amount is determined by multiplying the square footage, not to exceed 300 square feet in the portion of the home used in a qualified business use of the home by $5 so the maximum deduction is $1,500. A taxpayer electing the safe harbor method for a taxable year cannot deduct any actual expenses or depreciation related to the qualified business use of the home for that tax taxable year. However, if the taxpayer itemizes deductions, the taxpayer may still deduct, to the extent allowed, any expense related to the home that is deductible without regard to whether there is a qualified business use of the home, such as deduction for qualified residence interest, property taxes and casualty losses) (IR-2013-5).
Questions about the subject matter of this communication should be addressed to Thomas J. Phillips at (414) 277-5831 / thomas.phillips@quarles.com, John T. Barry at (414) 277-5825 / jbarry@quarles.com or your Quarles & Brady attorney.