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U.S. Moves to Avoid "Fiscal Cliff" Tax Hikes for 2013 - by Michael Pereira 

Global Tax Adviser

 

January 08, 2013

 

Michael Pereira
Toronto, International Executive Services

 

U.S. President Obama signed the American Tax Relief Act of 2012 (the Act) on January 2, 2013 to avert the much publicized "fiscal cliff" of tax increases and spending cuts (the latter is deferred to March 2013). The new Act makes permanent many tax cuts on income below $400,000 for individuals and $450,000 for married joint filers, providing some much needed certainty for taxpayers. Additionally, the new Act makes permanent major provisions of the federal estate, gift, and generation-skipping transfer taxes. This article highlights personal tax measures, however it's important to note that the Act also includes various corporate tax measures including changes to the look-through treatment of payments between related controlled foreign corporations.

The Act's date of enactment is January 2, 2013, although it is understood that the provisions are retroactive to the beginning of the year.

 

Background - Effect on Canada

In Canada, much attention was given to the potential negative effects that would be felt on the Canadian economy as a result of the United States going over the "cliff". These automatic tax changes would have included, among other personal and business tax provisions:

 

  • Across-the-board personal income tax rate increases
  • Changes to preferential tax treatment of qualified dividends
  • Increased U.S. estate tax through a reduced estate tax exemption and a new top rate of 55%.

 

It was feared that if nothing was done, these changes would drive the United States deeper into recession and also simultaneously reduce Canadian economic growth.

 

Personal Tax Measures - Highlights

The Act includes the following personal income tax and transfer tax provisions.

 

Estate, gift and generation-skipping transfer taxes
The Act brings some much needed permanence to the transfer tax system, which has been controversial and uncertain (it was repealed for 2010).

 

The Act permanently extends the estate and gift tax provisions in effect in 2012, including the gift, estate, and generation-skipping transfer tax exemption amount of $5 million per person (indexed for inflation for calendar years after 2011, thus $5.12 million for 2012), and the ability to transfer any unused exemption to a surviving spouse at death.

 

The Act sets the top tax rate at 40% (rather than 55% as provided under 2012 law as a result of political compromise) for taxable amounts over $1 million and creates two new brackets: 37% on amounts over $500,000 and 39% on amounts over $750,000.

 

Marginal individual income tax rates
The Act permanently extends the 10%, 25%, 28%, 33%, and 35% individual income tax rates in effect in 2012 except for taxpayers with taxable income above a threshold amount for whom the new rate will be 39.6%. The threshold amounts are:

 

  • For married individuals filing a joint return - $450,000
  • For individuals filing as head of household - $425,000
  • For single taxpayers - $400,000.

 

As under current law, the rate structure is indexed for inflation.

 

Although not part of the "fiscal cliff" measures, an additional 0.9% Medicare tax is imposed on higher income individuals' employment income under the Affordable Care Act, from January 1, 2013. The additional Medicare tax will also apply to self-employed individuals.

 

Personal exemption phase-out and itemized deduction limitation
The Act repeals the personal exemption phase-out (PEP) and the limitation on itemized deductions (Pease limitation) for taxpayers with adjusted gross income (AGI) at or below a certain threshold. Itemized deductions include a deduction for mortgage interest, real estate taxes and medical expenses, amongst others. The thresholds are:

 

  • For married individuals filing a joint return - $300,000
  • For individuals filing as head of household - $275,000
  • For single taxpayers - $250,000.

 

Reduced rates on capital gains and dividends
The Act permanently extends the maximum tax rate of 15% (or 0% for those below the 25% bracket) on an individual's adjusted net capital gain, except that the rate will be 20% for taxpayers with incomes above a certain threshold. The thresholds are:

 

  • For married individuals filing a joint return - $450,000
  • For individuals filing as head of household - $425,000
  • For single taxpayers - $400,000.

 

Under the Act, an individual's qualified dividend income is taxed at the same rates that apply to adjusted net capital gain (i.e., 20%, 15% or 0%).

 

Note that, beginning January 1, 2013, an additional 3.8% tax applies to investment income of certain taxpayers under the Affordable Care Act.

 

Alternative minimum tax
The Act includes relief for permanent alternative minimum tax (AMT) by increasing the AMT exemption amounts for 2012 to $50,600 (for single taxpayers) and $78,750 (for married individuals filing jointly). The AMT exemption is phased out when alternative minimum taxable income exceeds certain thresholds. The Act also allows taxpayers to offset non-refundable personal credits against the AMT.

 

The AMT exemption amounts and phase-out threshold are indexed for inflation beginning in 2013.

 

Marriage penalty relief
The Act permanently extends the increase in the basic standard deduction for a married couple filing a joint tax return to twice the basic standard deduction for a single individual. The Act also permanently extends the increase in the 15% regular income tax bracket for a married couple filing a joint return to twice the 15% bracket for a single individual.

 

Other provisions
The Act does not extend the 2% payroll tax holiday that had been in effect for the last two years.

 

Corporate Tax Measures - Highlights

Corporate tax measures in the Act include changes related to bonus depreciation, expensing of certain depreciable property and an extension of several expired corporate tax measures, including the look-through treatment of payments between related controlled foreign corporations. Specifically, the Act retroactively extends the current look-through treatment of payments between related controlled foreign corporations from January 1, 2012 through tax years beginning before January 1, 2014.

 

To learn more about the most recent tax law changes and how they may apply to your personal situation, contact your KPMG adviser.

 

 

 

 

 

Information is current to January 08, 2013. The information contained in this publication is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act upon such information without appropriate professional advice after a thorough examination of the particular situation. For more information, contact KPMG's National Tax Centre at 416.777.8500

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