Buckle up for tax season

For the second year in a row, practitioners will experience a less-than-flying start to tax season. As this article went to press, tax season was expected to begin between Jan. 28 and Feb. 4, a result of the 16-day partial government shutdown in October, although the IRS was hoping to minimize the delay. CPA return preparers, in turn, might encounter snags as they grapple with a number of new or changed provisions. As in past years, the JofA offers this summary intended to highlight new or notable provisions and, as a handy reference, a “Filing Season Quick Guide” with many of the most frequently consulted tax tables, thresholds, credit amounts, and other important benchmarks.

This time around, practitioners can at least feel relieved that the list of temporary provisions that expired at the end of 2012 is relatively short, unlike a year ago, when Congress kept them and taxpayers in suspense until New Year’s Day with passage of the American Taxpayer Relief Act of 2012 (ATRA), P.L. 112-240. Only then could they learn the fate of a number of important individual and dozens of business-related provisions for the year just ended. However, many of ATRA’s extensions were only through the end of 2013 (see the sidebar below, “Looking Ahead,” for details).

Click here to download the “Filing Season Quick Guide.”

INDIVIDUAL PROVISIONS

ATRA also introduced, or reintroduced, several basic provisions starting in 2013, mostly affecting higher-income taxpayers.

New top ordinary income tax rate. A top rate of 39.6% applies to taxable income over $400,000 for single filers, $425,000 for head-of-household filers, and $450,000 for married taxpayers filing jointly ($225,000 for each married spouse filing separately). The last time the income tax brackets had a 39.6% marginal rate on individuals was in 2000.

Itemized deductions limitation and personal exemptions phaseout. The itemized deductions limitation and personal exemptions phaseout (PEP) have been reinstated. If a taxpayer’s adjusted gross income (AGI) exceeds an applicable amount based on his or her filing status, the taxpayer’s allowed itemized deductions will be limited. The applicable amounts for 2013 are $250,000 for single taxpayers, $275,000 for heads of household, $300,000 for married taxpayers filing jointly, and $150,000 for married taxpayers filing separately. The itemized deductions limitation, also known as the Pease limitation, is a 3%/80% formula, under which itemized deductions are reduced by the lesser of 3% of the excess of AGI over the applicable amount above or 80% of the amount of the itemized deductions otherwise allowable for the tax year. (The limitation had been eliminated for 2010 through 2012.)

Under PEP, a taxpayer’s personal exemptions are reduced by 2% for every $2,500 (or fractional amount) (or $1,250 for married taxpayers filing separately) by which AGI exceeds the applicable amounts above (Sec. 151(d)(3), as amended by ATRA). Like the Pease limitation, the PEP didn’t apply for tax years 2010 through 2012.

Alternative minimum tax. Beginning in 2013, ATRA permanently indexed for inflation the alternative minimum tax (AMT) exemption amount and the thresholds for the 28% AMT rate for individuals and made the AMT offset for nonrefundable credits permanent. The increase for inflation of the AMT exemption amounts for individuals had often been late-enacted relief in years past. For 2013, the exemption amounts are $80,800 for married taxpayers filing jointly, $40,400 for married taxpayers filing separately, and $51,900 for single filers. The inflation-adjusted threshold for the 28% AMT rate is $179,500 for married taxpayers filing jointly and unmarried individuals (other than surviving spouses) and $89,750 for married taxpayers filing separately.

Capital gains and qualified dividends. A 20% rate applies to individuals’ long-term capital gains and qualified dividends that would otherwise be taxed at the 39.6% rate; the former top rate of 15% applies to long-term capital gains and qualified dividends that would otherwise be taxed at a rate at or above 25% but below 39.6%. The zero rate continues to apply to long-term capital gains and dividends that would otherwise be taxed at the 10% or 15% rates. Unrecaptured Sec. 1250 gains continue to be taxed at a maximum 25% rate, and collectibles gains and gains on the sale of qualified small business stock held more than five years continue to be taxed at a maximum 28% rate.

For other ATRA provisions affecting individuals, see “Tax Cliff Averted,” JofA, Feb. 2013, page 46. 

Two other provisions new for 2013 also broadly affect higher-income taxpayers. These were part of the Health Care and Education Reconciliation Act of 2010, P.L. 111-152, enacted along with the Patient Protection and Affordable Care Act, P.L. 111-148 (together, PPACA).

Net investment income tax. This 3.8% tax in addition to regular income tax is imposed on the lesser of (1) net investment income or (2) modified AGI over a threshold amount of $200,000 for single taxpayers; $250,000 for married taxpayers filing jointly or surviving spouses; $200,000 for heads of households; and $125,000 for married taxpayers filing separately. Several articles in the JofA and The Tax Adviser have discussed net investment income and related issues, including implications for common types of unearned income. See, for example, “Higher Stakes for Tax Treatment of Rental Real Estate,” JofA, Dec. 2013, page 56, and “Planning for the ‘Parallel Universe’ of the Net Investment Income Tax,” The Tax Adviser, Aug. 2013, page 534. The AICPA also maintains a Net Investment Income Tax page with links to additional articles, advocacy, and resources at tinyurl.com/ojy9jws.

Additional Medicare payroll tax. Beginning in 2013, an additional Medicare tax of 0.9% is imposed on individuals on wages from employment and self-employment income that exceed the same thresholds as for the net investment income tax. Return preparers should review all Forms W-2, Wage and Tax Statement, for clients whose wages and/or self-employment income from all sources for the year are near or over those thresholds to check for under- or overwithholding and make the appropriate adjustments on the return. For situations where withholding may be incorrect and how it may be corrected, see “Case Study: Additional 0.9% Medicare Tax on Earned Income,” The Tax Adviser, Nov. 2013, page 789.

Same-sex marriage. Apart from ATRA, the biggest impact for some taxpayers in 2013 and going forward—and back, if affected taxpayers amend prior tax years that are still open—was from the U.S. Supreme Court’s decision in Windsor, No. 12-307 (U.S. 6/26/13), in which the court held that Section 3 of the Defense of Marriage Act (DOMA), P.L. 104-199, was unconstitutional. Under Section 3 of DOMA, the IRS was prohibited from recognizing a same-sex marriage for federal tax purposes (see previous coverage in “Tax Matters: Supreme Court Strikes Down Defense of Marriage Act in Estate Tax Case,” JofA, Aug. 2013, page 60). Later, in Rev. Rul. 2013-17, the IRS ruled that any same-sex couple married in a state that recognizes same-sex marriages will be treated as married for federal tax purposes, regardless of whether the couple’s current state of residence recognizes same-sex marriages (see “Tax Matters: All Legal Same-Sex Marriages Recognized for Tax Purposes,” JofA, Nov. 2013, page 56).

CPA tax preparers with clients who are same-sex couples whose marriages are recognized under state law will need to discuss with them such ramifications as joint filing status, refund of taxes paid on employer-provided benefits for spouses, gift and estate planning, and potentially much more. Notice 2013-61 gave guidance to employers of employees with same-sex spouses concerning income exclusion of the value of health coverage and tax-exempt fringe benefits and correcting payroll taxes withheld and paid on such benefits (see previous coverage in “Tax Matters: IRS Issues Employment Tax Refund Procedures for Same-Sex Spouses,” JofA, Dec. 2013, page 68). Affected employees may also need to take into account repayment or reimbursement of any overcollected amount of the employee portion of Federal Insurance Contributions Act (FICA) tax and withholding tax attributable to same-sex spousal health coverage and fringe benefits.

Health coverage and deduction. Although most of the PPACA provisions relating to health coverage take effect in 2014, some took effect in 2013 and may be reflected on some taxpayers’ returns. Schedule A, Itemized Deductions, for 2013 will feature a 10%-of-AGI threshold for deductibility of medical expenses for taxpayers under age 65. Those 65 and older (or whose spouse is 65 or older) still have through 2016 to use the 7.5% threshold previously applicable to all taxpayers.

Also, salary reduction contributions to a health flexible spending arrangement under a cafeteria plan were subject to a yearly dollar limit for the first time, $2,500 (which will be adjusted for inflation in subsequent years).

Estate and gift tax changes. ATRA also added a new top estate and gift tax rate of 40% starting in 2013 and made permanent the “portability” election, higher exclusion amount, and other temporary (for 2010 through 2012) provisions of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, P.L. 111-312. Previously, the top rate was 35%. For 2013, the estate, gift, and generation-skipping transfer tax exemption, as indexed for inflation, is $5.25 million, and the annual per-donee gift tax exclusion is $14,000. Under portability, if the executor of the deceased spouse’s estate makes the election, a surviving spouse’s exclusion amount is increased by the unused exclusion amount of the deceased spouse (see “New Portability Rules: A Cure for Incomplete Estate Planning,” JofA, July 2012, page 48).

BUSINESS PROVISIONS

Home office safe harbor. Effective for 2013, the IRS in Rev. Proc. 2013-13 provided an optional safe-harbor method of calculating a deduction for expenses for the business use of a taxpayer’s residence under Sec. 280A. The safe harbor is a simplified method of $5 per square foot of the portion of the home used for business, rather than the actual expenses for the portion of the home used for business. The safe-harbor method deduction is capped at 300 square feet, or $1,500; a comparison with the amount claimed on prior-year returns should give a quick estimate to help clients decide whether they wish to elect it.

There is no carryover of an excess deduction caused by the gross income limitation of Sec. 280A(c)(5) under the safe harbor, so preparers should take current or prospective carryover amounts into account when advising clients on which method to use. In addition, clients should be advised that, like the actual-expense method, the safe-harbor method requires that the claimed home or portion of it be used exclusively for business. For more, see “IRS Offers New Method for Home Office Deductions,” JofA, July 2013, page 30.

Expiring provisions. Because ATRA extended most business tax credits and other business-related provisions through the end of 2013, there should be few changes for 2013 business returns from expiring provisions. But see the sidebar, “Looking Ahead”; congressional inaction as this article went to press on any further extensions of these many provisions for 2014 and beyond that were scheduled to expire at the end of 2013 may need to be taken into account in tax planning. Along with many narrowly targeted provisions, they include several more broadly employed ones:

• Sec. 179 expensing. ATRA extended to 2012 and 2013 the higher expensing limit and phaseout threshold for property purchased and placed in service during a tax year ($500,000 and $2 million, respectively).
• Bonus depreciation. Similarly, additional first-year depreciation of 50% of the adjusted basis of qualified property (bonus depreciation) was extended by ATRA for 2012 and 2013 but is scheduled to expire again after that. ATRA did not extend 100% bonus depreciation, which expired at the end of 2011.
• BIG tax holiday. Similarly retroactive to 2012 (and scheduled to expire again at the end of 2013) was the shorter five-year built-in gain recognition period for S corporations. ATRA’s technical amendment limiting carryover of built-in gain over taxable income (Sec. 1374(d)(2)(B)) may have implications for some S corporation taxpayers in 2013 as well.

CPAs probably remember that at ATRA’s passage, these provisions had expired at the end of 2011, and their retroactive application to 2012 was frequently a source of confusion and perhaps, in some instances, a planning opportunity lost.

Looking Ahead
As this article went to press, the intentions or ability of Congress to extend past 2013 a handful of individual tax provisions and a slew of business-related ones expiring at the end of the year was unclear. Most of these could be called “long-term temporary” provisions, with several used by broad swaths of taxpayers. The individual taxpayer provisions include the deduction for state and local sales taxes (Sec. 164(b)(5)) and the Sec. 163(h)(3)(E) deduction for qualified residence mortgage insurance premiums treated as interest. Another provision relating to taxpayers’ principal residence also faced an uncertain future after 2013: the income exclusion for discharge of indebtedness for a qualified principal residence under Sec. 108(a)(1)(E).

Business-related provisions, besides those mentioned in the main part of this article, include the credit for increasing research activities under Sec. 41; the work opportunity tax credit; and 15-year straight-line cost recovery for qualified leasehold, restaurant, and retail improvements.

Tax Provisions Expiring in 2013 

Individual Provisions

Sec. 35. Credit for health insurance costs of eligible individuals

Sec. 62(a)(2)(D). Above-the-line deduction for certain expenses of elementary and secondary school teachers

Sec. 108(a)(1)(E). Exclusion of discharge of principal residence indebtedness from gross income

Sec. 132(f)(2). Parity for exclusion for employer-provided mass transit and parking benefits

Sec. 163(h)(3)(E). Mortgage insurance premiums treated as qualified residence interest

Sec. 164(b)(5). Election to deduct state and local sales taxes

Sec. 222. Above-the-line deduction for qualified tuition and related expenses

Business Provisions

Sec. 41. Tax credit for research and experimentation expenses

Sec. 42. Temporary minimum low-income housing tax credit rate for non-federally subsidized new buildings

Sec. 45A. Indian employment tax credit

Sec. 45G. Credit for railroad track maintenance

Sec. 45P. Employer wage credit for activated military reservists

Sec. 51. Work opportunity tax credit

Sec. 142(d)(2)(B). Treatment of military basic housing allowances under the low-income housing credit

Sec. 168(e)(3)(A). Three-year depreciation for race horses two years or younger

Sec. 168(e)(3)(C). Seven-year recovery for motorsport racing facilities

Sec. 168(e)(3)(E). Fifteen-year straight-line cost recovery for qualified leasehold, restaurant, and retail improvements

Sec. 168(j). Accelerated depreciation for business property on Indian reservations

Sec. 168(k). Additional 50% first-year bonus depreciation

Sec.168(k). Election to accelerate AMT credits in lieu of additional first-year depreciation

Sec. 170(b). Special rules for contributions of capital gain real property for conservation purposes

Sec. 170(e). Enhanced charitable deduction for contributions of food inventory

Sec. 179. Increase in expensing to $500,000/$2 million and expansion of definition of Sec. 179 property

Sec. 181. Special expensing rules for certain film and television productions

Sec. 199(d). Deduction with respect to income attributable to domestic production activities in Puerto Rico

Sec. 408(d). Tax-free distributions from individual retirement accounts for charitable purposes

Sec. 512(b). Modification of tax treatment of certain payments to controlling exempt organizations

Sec. 871(k). Treatment of certain dividends of regulated investment companies

Sec. 897(h). Regulated investment company qualified investment entity treatment under the Foreign Investment in Real Property Tax Act

Sec. 953(e). Exceptions under subpart F for active financing income

Sec. 954. Look-through treatment of payments between controlled foreign corporations under the foreign personal holding company rules

Sec. 1202. Temporary exclusion of 100% of gain on qualified small business stock

Sec. 1367. Basis adjustment to stock of S corporations making charitable contributions of property

Sec. 1374(d). Reduction in S corporation recognition period for built-in gains tax

Sec. 7652(f).Temporary increase in limit on cover-over of rum excise tax revenues to Puerto Rico and the Virgin Islands

Energy Provisions

Sec. 30C. Alternative fuel vehicle refueling property

Sec. 30D. Credit for two- or three-wheeled plug-in electric vehicles

Sec. 40(b). Cellulosic biofuel producer credit

Sec. 40A. Incentives for biodiesel and renewable diesel

Sec. 45(d). Construction date for eligible facilities (including wind) to claim the production tax credit (PTC), or investment tax credit in lieu of the PTC

Sec. 45(e)(10). Credit for production of Indian coal

Sec. 45L. Credit for construction of energy-efficient new homes

Sec. 45M. Credit for energy-efficient appliances

Sec. 45N. Mine rescue team training credit

Sec. 48. Credit for nonbusiness energy property

Sec. 168(l). Special depreciation allowance for cellulosic biofuel plant properties

Sec. 179C. Placed-in-service date for partial expensing of certain refinery property

Sec. 179D. Energy-efficient commercial building deduction

Sec. 179E. Election to expense mine-safety equipment

Sec. 451(i). Special rule to implement electric transmission restructuring

Sec. 6426. Incentives for alternative fuel and alternative fuel mixtures

Community Assistance Provisions

Sec. 45D. New markets tax credit

Sec. 54E. Qualified zone academy bonds—allocation of bond limitation

Section 119 of the Tax Relief and Health Care Act of 2006, P.L. 109-432, as modified. American Samoa economic development credit

Sec. 1391. Empowerment zone tax incentives

Disaster Relief Provisions

Sec. 1400L. New York Liberty Zone—tax exempt bond financing

Source: Table 2, “Tax Provisions Expiring in 2013 (‘Tax Extenders’),” Congressional Research Service, June 27, 2013, and the American Tax Relief Act of 2012, P.L. 112-240, which previously extended many of these provisions.

Paul Bonner is a JofA senior editor, tax. To comment on this article or to suggest an idea for another article, contact him at pbonner@aicpa.org or 919-402-4434.

AICPA RESOURCES

JofA articles

• “Higher Stakes for Tax Treatment of Rental Real Estate,” Dec. 2013, page 56
• “Tax Matters: IRS Issues Employment Tax Refund Procedures for Same-Sex Spouses,” Dec. 2013, page 68
• “Tax Matters: All Legal Same-Sex Marriages Recognized for Tax Purposes,” Nov. 2013, page 56
• “Tax Matters: Supreme Court Strikes Down Defense of Marriage Act in Estate Tax Case,” Aug. 2013, page 60
• “IRS Offers New Method for Home Office Deductions,” July 2013, page 30
• “Tax Cliff Averted,” Feb. 2013, page 46
• “New Portability Rules: A Cure for Incomplete Estate Planning,” July 2012, page 48

The Tax Adviser articles

• “Case Study: Additional 0.9% Medicare Tax on Earned Income,” Nov. 2013, page 789
• “Planning for the ‘Parallel Universe’ of the Net Investment Income Tax,” Aug. 2013, page 534

To find articles from The Tax Adviser, go to thetaxadviser.com and search by year in the left-hand column.

Publications

• The 2014 Cumulative Tax Guide (#PTX1308D, online access)
• The Adviser’s Guide to Innovative Tax Planning for Individuals and Sole Proprietors (#PTX1211PHI, paperback; and #PTX1211E, ebook)
• Managing Your Tax Season (#090560)
• Tax Planning After the Healthcare Surtax: Tools, Tips, and Tactics (#PTX1302M, online access)

CPE self-study

• 1040 Tax Return Update: The Latest Individual Tax Developments (#735228)
• 2013 Hot Tax Topics: Get Up to Speed on the Hottest Tax Topics (#733137)
• 2013 Individual Tax Returns Videocourse (#113634, DVD/manual)
• Complete Guide to Preparing Limited Liability Company, Partnership and S Corporation Federal Income Tax Returns (#738782)
• Health Care Reform Act 2013: Critical Tax and Insurance Ramifications (#745813, text; and #155812, one-year online access)

Webcasts

Advanced Tax Quarterly webcast series (#TAXWS12)

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

The Tax Adviser and Tax Section

The Tax Adviser is available at a reduced subscription price to members of the Tax Section, which provides tools, technologies, and peer interaction to CPAs with tax practices. More than 23,000 CPAs are Tax Section members. The Section keeps members up to date on tax legislative and regulatory developments. Visit the Tax Center at aicpa.org/tax. The current issue of The Tax Adviser is available at thetaxadviser.com.