Facing the tax cliff

You can’t pick up a newspaper or go online this fall without seeing stories about the coming “tax cliff” or “taxmageddon”—the time at the end of this year when the current tax rates for income, capital gains, gifts, and estates are scheduled to expire. Mostly overlooked by the news media are a large number of other tax provisions that are also scheduled to expire or have already expired.

The country faced a similar situation at the end of 2010, when, after having had nine years to prepare for the sunset of the lower income, estate, and gift tax rates enacted in the Economic Growth and Tax Relief Reconciliation Act (EGTRRA), P.L. 107-16, and seven years to prepare for the sunset of the lower capital gains tax rates enacted by the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA), P.L. 108-27, Congress had to scramble to prevent the rates from rising. The House and the Senate finally enacted a short-term solution in mid-December 2010 in the form of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (2010 Tax Relief Act), P.L. 111-312, which extended the ordinary income tax rates and the capital gains tax rates, reinstated the estate tax at a reduced rate, and extended a large number of expired or expiring provisions.

This year the country faces the same prospect. Many of the 2010 Tax Relief Act extensions expired at the end of 2011, and the rest expire at the end of this year. This article details what has expired and will expire if Congress does not act.

What Congress’s solution will look like was still hard to gauge as this article went to press, and it will depend to a large extent on the results of this month’s presidential and congressional elections, which could affect tax law for years to come. And while the major parties have expressed strong positions on which income tax brackets should or should not be extended and for whom, they have largely been quiet on issues such as the estate and gift tax rates and the various other expiring tax provisions.

In August, the Senate Finance Committee approved a bill, the Family and Business Tax Cut Certainty Act of 2012, that would extend some, but not all, of the expired provisions through 2013. This may signal that, when Congress does act, it will not extend every expired provision because of the cost in lost federal revenue. Tax provisions for individuals that the bill focused on included restoring the alternative minimum tax (AMT) patch, the deduction for state and local sales tax, and parity for employer-provided mass transit and parking benefits. Provisions for businesses included extending the research and development credit, the work opportunity credit, and the increased Sec. 179 expensing amounts. In all, the bill would extend or restore 11 provisions for individuals, 28 for businesses, and 13 energy incentives. It did not address the impending changes to income, estate, and capital gains tax rates.

The Joint Committee on Taxation estimated that renewing even this smaller list of provisions would cost more than $192 billion in lost revenue from fiscal year 2013 through fiscal year 2017 (Joint Committee on Taxation Rep’t No. JCX-70-12 (Aug. 2, 2012)). The fate of this bill is hard to predict.

PROVISIONS SET TO EXPIRE AT THE END OF 2012

Tax rates. EGTRRA introduced a new 10% tax bracket below the 15% bracket for individuals and reduced the other tax brackets to 25%, 28%, 33%, and 35%. Those changes are scheduled to sunset after 2012 so that in 2013 the 10% rate will disappear (with income in that bracket reverting to the 15% bracket) and the other rates will revert to 28%, 31%, 36%, and 39.6%, respectively.

In 2003, JGTRRA also lowered the capital gains tax rate to 15% (0% for taxpayers in the 10% and 15% income tax brackets). These rate changes are also scheduled to expire after 2012. The rates will revert to 10% for taxpayers in the 15% income tax bracket and 20% for other brackets (8% or 18% for property held more than five years (but to qualify for the 18% rate, the holding period must begin after Dec. 31, 2000)). The taxation of qualified dividend income at capital gains rates will also expire at the end of 2012.

EGTRRA’s repeal of the itemized deduction phaseout (Sec. 68(g)) and the personal exemption phaseout (Sec. 151(d)(3)) is also scheduled to expire after 2012.

Payroll tax reduction. The lower 4.2% rate for employees’ portion of the Social Security payroll tax will expire at the end of 2012 and revert to 6.2%.

AMT provisions. The 0% and 15% capital gains rates for the AMT, the AMT offset of the child tax credit, and the 7% AMT preference for excluded gain on the disposition of qualified small business stock are scheduled to expire at the end of 2012.

Bonus depreciation and Sec. 179 expensing. The 2010 Tax Relief Act sets the expensing limitation under Sec. 179 at $125,000 and the phaseout threshold amount at $500,000 for 2012. For tax years beginning after 2012, these amounts reduce to $25,000 and $200,000, respectively.

The availability of an additional 50% first-year bonus depreciation (Sec. 168(k)) expires at the end of 2012. The election to accelerate AMT credits in lieu of bonus depreciation (Sec. 168(k)(4)) also expires at the end of 2012.

Estate, gift, and GST tax. The 2010 Tax Relief Act reinstated the estate, gift, and generation-skipping transfer (GST) tax at a rate of 35% and an estate, gift, and GST tax exemption of $5 million ($5.12 million in 2012, adjusted for inflation). In addition to the increase in the exemption amount, for decedents dying after 2010, the estate tax exemption of the first spouse to die is “portable.” That is, if an election is made, the surviving spouse’s exemption amount is increased by the deceased spouse’s unused exemption amount.

After 2012, if Congress does not act, the estate, gift, and GST tax regime that existed in 2000 will return. The exemption amount will be $1 million, and the top rate will be 55%.

OTHER EXPIRING PROVISIONS

A variety of other temporary tax provisions are scheduled to expire at the end of 2012. These include tax credits, deductions, and various tax incentives.

Individual provisions:

• Marriage penalty relief (i.e., the increased size of the 15% rate bracket (Sec. 1(f)(8)) and increased standard deduction for married taxpayers filing jointly (Sec. 63(c)(2)));
• The liberalized child and dependent care credit rules (allowing the credit to be calculated based on up to $3,000 of expenses for one dependent or up to $6,000 for more than one) (Sec. 21);
• The $1,000 child tax credit amount (scheduled to revert to $500) and the expanded refundability of the credit (Sec. 24);
• The American opportunity tax credit (Sec. 25A);
• The increased starting and ending points for the earned income tax credit and the increase in the credit amount for families with three or more qualifying children (Sec. 32);
• Refundability of the credit for prior-year minimum tax liability (Sec. 53(e));
• Exclusion from gross income for discharge of indebtedness on a principal residence (Sec. 108(a)(1)(E));
• The exclusion for National Health Services Corps and Armed Forces Health Professions Scholarships (Sec. 117(c)(2));
• The exclusion for employer-provided educational assistance (Sec. 127);
• The enhanced rules for student loan deductions introduced by EGTRRA (Sec. 221);
• The higher contribution amount and other EGTRRA changes to Coverdell Education Savings Accounts (Sec. 530); and
• The disregard of taxpayers’ refunds in the administration of certain federal programs (Sec. 6409).

General business-related credits. The employer-provided child care credit (Sec. 45F) expires at the end of 2012. The returning heroes and wounded warriors work opportunity tax credits (versions of the expired work opportunity credit for veterans) also expire at the end of 2012.

Foreign provisions. The IRS’s authority under Sec. 1445(e)(1) to apply a 15% withholding tax to gains on the disposition of U.S. real property interests by partnerships, trusts, or estates that are passed through to partners or beneficiaries that are foreign persons expires at the end of 2012.

Other miscellaneous expiring provisions:

• The cellulosic biofuel producer credit (Sec. 40(b)(6)(H));
• The wind facilities electricity production facility credit (placed-in-service date) (Sec. 45(d));
• Indian coal production credit (Sec. 45(e));
• Election for wind facilities to claim energy credit in lieu of electricity production credit (Sec. 48(a)(5));
• Special treatment of tax-exempt bonds for education facilities (Sec 142(a)(13));
• Special depreciation for cellulosic biofuel plant property (Sec. 168(l));
• Repeal of the collapsible corporation rules (Sec. 341);
• Special rates for accumulated earnings tax and personal holding company tax (Secs. 531 and 541); and
• Modified tax treatment for electing Alaska Native Settlement Trusts (Sec. 646).

EXPIRED PROVISIONS

In addition to the large number of provisions scheduled to expire, many provisions expired at the end of 2011 and have not been reenacted.

PROVISIONS FOR INDIVIDUALS

Increased AMT exemption (Sec. 55(d)). Congress has temporarily increased the AMT exemption amount several times in recent years. These successive increases are commonly referred to as the “AMT patch.” The 2010 Tax Relief Act increased the AMT exemption amounts, but only for 2010 and 2011. With the AMT patch amounts now expired, the AMT exemption has reverted to its statutory amount: $45,000 for married individuals filing jointly, less 25% of alternative minimum taxable income (AMTI) exceeding $150,000; and $33,750 for unmarried individuals, less 25% of AMTI exceeding $112,500.

Personal credits allowed against regular tax and AMT (Sec. 26(a)). Starting in 2012, nonrefundable credits generally cannot be used to offset AMT. A few exceptions apply, including the adoption credit (Sec. 23); the child tax credit (Sec. 24); the American opportunity tax credit (Sec. 25A(i)); the retirement savings credit (Sec. 25B); the residential energy-efficient property credit (Sec. 25D); the nondepreciable property portion of the alternative motor vehicle credit (Sec. 30B); and the nondepreciable property portion of the new qualified plug-in electric drive motor vehicle credit (Sec. 30D).

Transit pass parity with parking benefits (Sec. 132(f)). The maximum amount an employee can exclude from income for employer-provided transit passes and transportation in a commuter highway vehicle for 2012 is $125 per month, down from $230 per month in 2011.

Other expired items affecting individuals include:

• The expanded adoption credit (Sec. 23) and adoption-assistance program (Sec. 137) amounts;
• The nonbusiness energy property credit (Sec. 25C);
• The deduction of up to $250 for certain elementary and secondary school teacher expenses (Sec. 62(a)(2)(D));
• Deductibility of mortgage insurance premiums as interest (Sec. 163(h));
• Deductibility of state and local sales tax instead of state income taxes on Schedule A (Sec. 164(b));
• The above-the-line deduction of up to $4,000 for qualified tuition and related expenses (Sec. 222);
• The tax-free treatment of charitable distributions from IRAs (Sec. 408(d)(8));
• The District of Columbia first-time homebuyer credit (Sec. 1400C); and
• The temporary 100% exclusion of gain from the sale of certain small business stock (Sec. 1202(a)).

BUSINESSES

Many business tax incentives expired at the end of 2011. Perhaps the most significant of these are the expiration of the allowance for 100% first-year bonus depreciation (it is reduced to 50% for 2012) (Sec. 168(k)) and the expiration of the increased deduction amounts under Sec. 179. The Sec. 179 expensing limitation was reduced to $125,000 for 2012, and the phaseout threshold amount was lowered to $500,000. The inflation-adjusted amounts for 2012 are $139,000 and $560,000, respectively (Rev. Proc. 2011-52).

The Sec. 41 research and development credit also expired at the end of 2011, as did the work opportunity tax credit (Sec. 51(c)) (but portions were extended through 2012 for certain veterans by the Three Percent Withholding Repeal and Job Creation Act, P.L. 112-56).

Various other tax credits aimed at businesses also expired:

• The credit for plug-in electric vehicles (Sec. 30);
• The plug-in electric vehicle conversion credit (Sec. 30B(i));
• The alternative fuel (nonhydrogen) vehicle refueling property credit (Sec. 30C);
• The alcohol fuels income tax credit (Secs. 40(e) and (h));
• The biodiesel and renewable diesel fuel credits (Sec. 40A);
• The refined coal production facility credit (placed-in-service date) (Sec. 45(d));
• The Indian employment tax credit (Sec. 45A);
• The new markets tax credit (Sec. 45D);
• The railroad track maintenance credit (Sec. 45G);
• The new energy-efficient homes credit (Sec. 45L);
• The energy-efficient appliances credit (Sec. 45M);
• The mine rescue team training credit (Sec. 45N);
• The military reservist employer wage credit (Sec. 45P);
• The alcohol fuel mixture, biodiesel, alternative fuel, and alternative fuel mixture excise tax credits (Secs. 6426 and 6427); and
• The American Samoa economic development credit (P.L. 109-432).

Expired deductions and special depreciation rules (in addition to the expiration of 100% bonus depreciation) include:

• 15-year straight-line cost recovery for qualified leasehold improvements, qualified restaurant buildings and improvements, and qualified retail improvements (Sec. 168(e)(3)(E));
• Seven-year recovery period for motorsports entertainment complexes (Sec. 168(i)(15));
• Accelerated depreciation for certain Indian reservation property (Sec. 168(j)); Special rules for charitable contributions of real property for conservation purposes (Sec. 170(b));
• Charitable deduction for food inventory contributions (Sec. 170(e)(3)(C));
• Increased charitable deduction for contributions of book inventory to public schools (Sec. 170(e)(3)(D));
• Increased charitable deduction for corporate contributions of computer equipment to schools (Sec. 170(e)(6));
• The election to expense advanced mine safety equipment (Sec. 179E);
• Special film and television production expensing rules (Sec. 181);
• Brownfields environmental remediation expensing (Sec. 198);
• The deduction for domestic production activities in Puerto Rico (Sec. 199(d)(8)); and
• Suspension of 100%-of-net-income limitation on percentage depletion for oil and gas from marginal wells (Sec. 613A(c)).

Finally, a number of other special business incentives and other tax items expired, including:

• Grants in lieu of tax credits for specified energy property (Sec. 48(d));
• Qualified zone academy bonds (Sec. 54E);
• Low-income housing credit special treatment of military housing allowances (Sec. 142(d));
• The special rule for sales or dispositions to implement Federal Energy Regulatory Commission or state electric restructuring policy for qualified electric utilities (Sec. 451);
• Modified tax treatment of certain payments to controlling tax-exempt organizations (Sec. 512(b));
• Special treatment of dividends from regulated investment companies (Secs. 871 and 881);
• Regulated investment company treatment under FIRPTA (Sec. 897(h));
• Subpart F active financing income exceptions (Secs. 953(e) and 954(h));
• Foreign personal holding company lookthrough rules for payments between related controlled foreign corporations (Sec. 954(c));
• Basis adjustments for S corporation charitable contributions of property (Sec. 1367(a));
• Reduced S corporation recognition period for built-in gains tax (Sec. 1374(d));
• Various Empowerment Zone tax incentives (Secs. 1202, 1391, 1394, 1396, 1397A, and 1397B);
• District of Columbia investment incentives (Secs. 1400(f), 1400A, 1400B, and 1400C);
• Definition of gross estate for regulated investment company stock owned by nonresident noncitizens (Sec. 2105(d)); and
• Disclosure of prisoner return information to certain prison officials (Sec. 6103(k)).

STAY TUNED

Whatever Congress ends up doing, many of these tax provisions will affect the upcoming tax season. The IRS will need to program its computers and possibly redesign tax forms. The later in the year legislation is passed, the harder it will be for the IRS to have everything in place. And it is possible that Congress will not resolve things until sometime in 2013, leading to retroactive reinstatement of tax provisions and many amended returns.

Parts of the impending cliff, of course, go beyond taxes: As a result of the debt ceiling agreement reached last year, automatic government spending cuts are scheduled to take effect in 2013. The Supreme Court’s upholding of 2010’s health care legislation means many health care reforms (and some taxes) will go into effect over the next few years. Together, these issues will have a large impact on all taxpayers.

Alistair M. Nevius is the JofA editor-in-chief, tax. To comment on this article or to suggest an idea for another article, contact him at anevius@aicpa.org or 919-402-4052.

Check the tax and fiscal cliff resources page daily to follow the latest news on tax-law developments.

AICPA RESOURCES

JofA articles

• “Tax and Fiscal Cliff Resources”
• “Tax Relief and Health Care Acts Shape 2011 Returns,” Jan. 2012, page 24
• “Tax Season Brings New Twists,” Jan. 2011, page 24

Publications

• The Adviser’s Guide to Innovative Tax Planning for Individuals and Sole Proprietors (#PTX1211P, paperback; and #PTX1211E, ebook)
• CPA Client—Advances in Tax Planning (#PCN1202D, Adobe PDF; and #PCN1202W, Microsoft Word)
• CPA Client Bulletin (#CB_FI12, #CB_FN12, #CB_LN12, #CB_IF12, #CBDXX12, and #CBEXX12)
• CPA Client Tax Letter (#CTLFI12, #CTLFN12, #CTLLF12, #CTLLN12, and #CTLDXX12)
• Interactive Tax Checklists (#INITC12)
• Preparing Your Client for the 2013 Tax Increases: Tools, Tips, and Tactics (#PTX1215M, on-demand)

Conferences

• National Tax Conference, Nov. 7‒8, Washington
• National Tax Conference virtual options (#FTAX12VIRTUAL (Nov. 7‒8); #FTAX12VIRTUAL1 (Nov. 7 only); and #FTAX12VIRTUAL2 (Nov. 8 only))

Webcasts

• “Post-Election: Now What? How CPA Financial Planners Can Advise Their Clients,” Nov. 14, 1:30–2:45 p.m. ET
• “2012 AICPA National Tax Conference Highlights” (#FTAX12Highlight), Nov. 29, 1–4 p.m. ET, 3.5 hours CPE (tax)

For more information or to make a purchase or register, go to cpa2biz.com or call the Institute at 888-777-7077.

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