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By now you may have read more than you care to about the changes to income taxes. We avoided rushing to get you something as so many others did, so that we could provide you with some comprehensive and practical information. It is a long read, but we hope you find it to be worth your time.

In the early morning hours of January 1, 2013, the U.S. Senate passed the American Taxpayer Relief Act (ATRA) of 2012 and at 11:00 p.m. that same evening, the House of Representatives passed the same bill, 257 to 167, with bi-partisan support. By passing the bill, Congress averted at least the revenue side of the so-called fiscal cliff. We find the name of the bill a bit comical, as almost every American’s taxes will go up in the coming year. At least this is true for working Americans, as the bill did not continue to provide for a 2% reduction in Social Security taxes. It did make permanent most of the Bush tax cuts, or shall we say they are “permanent” until Congress decides to change them again at some time in the future.

In the spirit of compromise, neither side got anything close to what they wanted. The President, however, can claim that he is taxing the rich, albeit at a higher level than he had defined earlier. The Republicans, on the other hand, are taking credit for the Bush tax cuts now being permanent, with 98% of Americans avoiding an income tax increase. The political spin has only just begun.

This 25th hour reprieve of avoiding the fiscal cliff goes to show just how dysfunctional and bi-partisan Congress has become. Unfortunately, Congress only solved the easy part of the fiscal cliff, i.e., the revenue side. They kicked the can down the road on entitlement reform, spending cuts, and raising the debt ceiling. These will all come to a head in early March. Treasury Secretary Timothy Geithner informed Congress that the U.S. had breached the debt ceiling limits, but that through internal accounting he could forestall the U.S. defaulting on its debts until early March. Some think it could happen as early as mid-February. Thus, the spending side of the cliff has yet to be debated and it would not surprise us if our elected representatives in both the White House and Congress go through these machinations once again. The President claimed to want a grand bargain this time and did not get it. In fact, the revenue number raised is half of what he said was the minimum acceptable amount. Thus, during the upcoming discussions, don’t be surprised if revenue becomes an issue once again. On the spending cut side, the Republicans probably have a stronger hand since the automatic tax increases have now been averted. How all of this plays out remains to be seen, but we probably won’t be proud of our elected representatives.

Below, we share what the bill does and more importantly what it does not do. We also offer some thoughts concerning its implications along with some strategies that should be considered. Of course all of this needs to be done in consultation with your tax advisors. The information below is meant to be general in nature and is not designed to provide specific advice to any individual.


The bill did not contain a provision to continue the Social Security tax at 4.2% on the first $113,700 of payroll as had been the case for the past two years. It automatically reverts to 6.2%. This means that every working American, which obviously encompasses many more than simply the “rich”, will see taxes go up under this bill, although not necessarily in the form of income taxes. A family with $50,000 of earned income will lose $1,000 in purchasing power, and anyone making $113,700 or more will see a reduction of $2,274 in purchasing power. This will clearly have an impact on consumer spending. When taken in total, it is estimated to be about $125 billion, but fortunately it will be spread out at about a rate of $10 billion per month over the next 12 months. This is a classic example of how an increase in taxes decreases Gross Domestic Product (GDP) as it is anticipated that the impact of this will be a half a point on GDP.

On the other side, the bill extends emergency unemployment benefits for 12 months to approximately 2.1 million people. Congress and the President are hoping that the jobs picture will improve over the next 12 months in such a way that, if this benefit is not extended once again, the negative impact to GDP will have been minimized. This is one of the reasons why it will be extremely important for the employment picture to be better in 2013 than it was in 2012. We anticipate this will happen, but the question is whether it can be something more than 125,000 to 150,000 new private sector jobs per month than we experienced in 2012. Applaud any month this number is higher than 200,000, and cheer any time this number is over 250,000. Be concerned when it is fewer than 150,000, as that level is needed just to absorb the new workers and doesn’t help take people off the unemployment rolls.


Tax Brackets: The American Taxpayer Relief Act of 2012 (ATRA) made permanent the Bush tax cuts for 98% of American income taxpayers. Thus, the 10%, 15%, 25%, 33%, and 35% tax brackets were preserved, but a tax bracket of 39.6% was re-instituted for married taxpayers filing jointly with taxable incomes over $450,000 and for single taxpayers with incomes over $400,000. This takes us back to the Clinton era’s top tax bracket.

The irony is that the 35% tax bracket is estimated to be extremely small. Let us give you an example. In 2012, the 35% tax bracket started at $388,350 for both married filing jointly and single taxpayers. We need to apply a cost of living adjustment to this number for 2013 which is likely to take the top end of the 35% tax bracket to somewhere around $398,000 plus or minus $500. The IRS will come out with affirmative tables shortly. Thus, for a single taxpayer who has taxable income over $400,000, there will only be about $2,000 taxed at the 35% rate. Married filing jointly taxpayers who have over $450,000 of taxable income, will only see approximately $52,000 of the income taxed at 35%. Effectively, for singles, the 35% bracket does not exist, and their bracket almost literally jumps from 30% to 39.6%.

Deductions: In calculating taxable income, a taxpayer can use a standard deduction or itemized deductions, whichever is higher. For 2013, a married couple gets a standard deduction of $12,200 ($14,000 if both are over age 65), while a single taxpayer will get $6,000 ($7,000 if over age 65). There were various proposals bantered about during the Presidential campaigns about how to handle deductions, but at the end of the day, Congress reinstituted the gradual elimination of deductions for certain taxpayers. Did they use the same thresholds - $400,000/$450,000 of taxable income? Of course not. That would have made too much sense. Instead, for those high income earners who exceed $300,000 of AGI, not taxable income for a married couple filing jointly or $250,000 of AGI for a single taxpayer, they will lose a portion of the deductibility, but not to exceed 80%.

Let’s take a taxpayer with taxable income of $350,000 and deductions totaling $40,000. The married couple is $50,000 over the limit and would lose deductions equal to 3% of this excess, or $15,000. Thus, instead of being able to deduct $40,000, they effectively can only deduct $25,000, and thus their taxable income goes up by $15,000, which means an additional tax of approximately $5,000 in the 33% tax bracket. If there is any good news, it is the fact that these thresholds are higher than what existed before, which was approximately $185,000 for a married couple filing jointly.

Due to the elimination of full deductibility for these taxpayers, they may want to consider “bunching” their deductions. In other words, these taxpayers may want to pay no real estate taxes and make no charitable contributions in year one, but then pay them twice in year two, thus significantly increasing their allowable deductions every other year. In the years they don’t bunch, it may be better to use the standard deduction.

Here’s an interesting little twist on itemized deductions. Unreimbursed deductible medical expenses have increased from those that exceed 7.5% of AGI to those that exceed 10% of AGI. Interestingly, Congress gave a tax break to seniors by exempting them from this provision for tax years 2013 through 2016, as long as the taxpayer or the taxpayer’s spouse turns 65 before the end of that tax year. Their threshold remains at 7.5%. Is this perhaps the first of Congress’ recognizing the Baby Boomers influence and the future power they have?

Several years ago relief was provided to taxpayers who paid a sales tax, but did not have a state income tax. State income taxes are deductible on a federal return, but previously sales taxes were not. Unfortunately, the law does not make this sales tax deduction permanent, although it does extend it through 2013. Look for this to be a part of future debates.

Personal Exemptions: Additionally, high income earners will also see a phase-out of their personal exemption. Fortunately, the same AGI thresholds for the reduction in deductions apply here ($300,000 married filing jointly - $250,000 single taxpayers). The personal exemption for 2013 is $3,900 for each taxpayer and their dependents. For every $2,500 above these limits, the taxpayer will lose 2% against the personal exemption ($50 per $2,500). Thus, in the above example, we divide $2,500 into $50,000, which equals 20 and we multiply that times 2%, or 40% of the personal exemption is lost. Again, these thresholds are higher than what they would have been had the Bush era tax cuts been allowed to sunset. The loss of the personal exemptions could also add 1% to the marginal rate.

Capitals Gains/Dividends: Taxpayers in the 10% or 15% tax bracket will pay no long-term capital gains tax, nor will they pay a tax on qualified dividends. Taxpayers in the 25%, 28%, 33%, and 35% tax brackets will pay a rate of 15% for both long-term capital gains and qualified dividends. For anyone above $450,000 filing jointly or $400,000 filing single, the maximum rate for both jumps to 20%. This is a significant win on the dividend side, as it was set to revert to 39.6%. Short-term capital gains will continue to be taxed at ordinary income tax rates for all taxpayers.

Managing capital gains/losses will be even more important now with the higher rates. This could be a challenge for investors who have multiple firms managing their money. But, what seems to be seldom is. Let’s take an example of a couple filing jointly who, after deductions, exemptions, etc., have $460,000 of taxable income. Let’s further assume that $60,000 of this is composed of dividends and long-term capital gains. We know they are over the limit of $450,000, but how is the investment income treated? Only the $10,000 over the limit is taxed at 20%. The remaining $50,000 is taxed at 15%. There is also the 3.8% for the Affordable Care Act that may be applicable. Let’s carry this almost to the absurd level of assuming that 100% of the taxable income is dividend and long-term capital gain income. This could happen if, for example, the taxpayer sold their business. This means that no tax would be due on approximately the first $72,500, and the next $377,500 would be taxed at 15% and the last $10,000 would have capital gains taxed at 20%. Thus, the net tax on the entire pool of money is not the marginal 20%, but rather an average of 12.7%, or $58,625. Similar phenomena would occur for those in lower tax brackets who are over $72,500 for a married couple filing jointly, and about $36,250 for a single taxpayer, in that only the excess attributable to dividends and capital gains above those respective limits will be taxed at 15%. Anything below that level will be taxed at 0%. Think of both cases this way: The dividends and capital gains are added last and only the excess is taxed at the next higher rate.

All of this means that a lot of careful planning will be required in handling capital gains and dividends. Not only do you need to think about minimizing them, but you also need to think in terms of attempting to remain under certain threshold amounts. Further, whereas in the past it has generally made sense when a large capital gain is expected (think a sale of a business), that the taxpayer would take a lump sum and pay the capital gains taxes all at once, it now may make sense to do an installment sale, thereby spreading the capital gains tax out over multiple years.

Interestingly, Congress left in place the so-called Carried Interest Income that is used so frequently by private equity managers, so that it is taxed at long-term capital gains rates. This became a significant topic of conversation the past few years, and especially during the Presidential campaign as it related to Mitt Romney’s income. Let us not forget that the top rate on capital gain and dividend income could be 18.8% for those in the middle brackets and 23.8% for those in the top brackets due to the Affordable Care Act, which adds 3.8% for some taxpayers.

Alternative Minimum Tax (AMT): Finally, Congress did what it should have done a long time ago, and has permanently indexed the AMT exemption for inflation. For 2012, the exemption amount is $78,750 for married taxpayers filing jointly and $50,600 for single taxpayers. This relief is now permanent and will not require Congressional action from year-to-year. It is entirely possible under some future tax legislation that the AMT could be eliminated altogether. This tax originally came about in the mid ‘80s under President Reagan in an attempt to ensure that every person, regardless of the amount of tax credits they had, etc., would have to pay something in taxes. It has been debated for years whether it actually accomplished what it set out to do.

What to Consider: Perhaps we should begin this section with what you should not consider. Start with all of the schemes and one might say scams that will be presented to investors, that are perpetrated by people who are trying to sell you generally high commissioned products for tax motivated reasons. Remember, you should never make an investment decision with the primary motivation being to save taxes. Your motive should always be economic first and foremost. If it has tax benefits, it is an added bonus.

We’ve already heard from the life insurance industry about how this bill makes permanent life insurance a better “investment”. The argument goes something along the lines that permanent life insurance policies allow the policyholder to accumulate cash in the policy that can be withdrawn tax-free in the future. While those indeed are the features of a permanent insurance policy, that hardly makes it a good investment. The primary purpose of permanent insurance is to provide lifetime coverage for the insured. So the first question you should ask is, do you have a need for permanent life insurance. Secondly do you fully understand all of the internal costs associated with life insurance, and have an understanding as to how the money might grow (whole life versus whole life with dividends versus universal life versus variable universal life)? What is the rating of the life insurance company? What are the other alternatives? Do you understand the tax implications if the early withdrawals cause the policy to “blow up” in the future? If you decide to move in this direction, you should also get a written explanation of how the life insurance agent gets paid and just exactly how much he/she is paid in real dollars in the first and subsequent years. In other words, total disclosure of compensation is required. If your life insurance agent presents this idea to you, please keep in mind that it is not a new idea. It’s been around for a long time, and is now being recycled. Of course, before committing to any form of permanent coverage, be sure to visit us first for that absolutely necessary second opinion.

Annuities, both variable and fixed, will also be utilized in a number of situations. In a variable annuity, the underlying investments grow on a tax-deferred basis and thus there are no annual capital gains taxes or dividend taxes. However, when the money is withdrawn from an annuity, you will pay ordinary income tax on the gain, not the lower capital gains rate.

Tax free bonds are likely to become more popular because they are neither taxed as ordinary income, nor are they included in the Affordable Care Act tax. This makes those bond’s tax equivalent yields ever higher than they were previously.

If you have read this far, you must be really interested in exactly how the tax increase can affect you. Consider visiting the Tax Policy Center website at: where you will find a very intuitive calculator which will help you understand fairly well how this new tax law will affect your particular situation.

As we have a chance to look more closely at some of the more subtle parts of ATRA, we will share ideas with you. Of course, don’t hesitate to give us a call before making any tax related decisions.


This is a classic example of reasonable compromise. The Republicans, especially in the Senate, wanted to abolish estate taxes, while the President wanted to have the limit revert to $3.5 million from the current exemption (adjusted for inflation) of $5.12 million person. Further, the President wanted the tax on amounts in excess of $3.5 Million to be 45% instead of the 2012 level of 35%. He also wanted the lifetime gift exemption to revert to $1 million.

Fortunately, the new law keeps the estate and gift tax coupled together with the exemption remaining at the $5.12 million level (indexed for inflation). At the end of last year, a lot of people did a significant amount of gifting for fear that the $5.12 million exemption would go away, and/or the gift tax and estate tax would be uncoupled. Fortunately, neither of these occurred. The tax rate, however, did increase from 35% to 40% on estates for those who die after December 31, 2012. However, Congress made permanent the Portability Election, wherein the surviving spouse can roll over the deceased spouse’s unused exemption amount. Further, the step-up in value for capital gains continued. There are several other provisions that apply to a limited number of taxpayers of decedents, but perhaps the most significant of these was the repeal of the 5% surtax on estates over $10 million.

Using the formality of a Bypass/Family/B Trust may no longer be necessary for many estates. Thus, estate equalization (dividing the estate as equally as possible between spouses), is also challenged as a good strategy. While the estate tax reasons for this type of trust may be diminished, using them for asset protection has not, and needs to be seriously considered. This issue should be reviewed with your ProVise advisor and your attorney.

Further, the legislation did not attack many of the techniques used to reduce estate values as had been threatened in earlier legislation. We can’t leave this section without talking about the generation skipping tax, as most of the provisions of this tax, which were set to expire in 2012, are considered permanent.

Since the estate and gift taxes are unified, the 40% tax applies to any gifts during lifetime that exceed the $5.12 million exemption (annual gifting limit does not apply against this lifetime exemption, only those amounts over the annual exemption need be counted toward the lifetime exemption). Thus, taxpayers who did not transfer a significant amount of wealth last year may still do so, now that the higher exemption is permanent. The benefit to doing this is to move not only the $5.12 million out of the taxpayer’s estate, but all of the growth of that money from the time the gift is made until the date of death.


The following are some, but not all, of the various tax provisions that were temporary in the past which have now been made permanent:

    1. The marriage penalty has been eliminated.

    2. The law permanently extends the $1,000 child tax credit. This tax credit was first introduced in 2003. The child tax credit increases to $1,000 for each child who was under the age of 17 at the end of 2012. This is above and beyond the credit for child and dependent care expenses. It does phase-out, however, for married couples earning more than $110,000, or single taxpayers with more than $75,000 of income.

    3. Child and dependent care credit rules now allow up to $3,000 of expenses for one dependent and up to $6,000 for two or more. The child and dependent care credit can be taken advantage of should a working parent have a dependent under the age of 13, and the credit is equal to 20% to 35% of the child care expenses.

    4. In an effort to encourage taxpayers to adopt children, the law makes permanent the adoption credit on income, expenses, etc. up to $10,000 for all adoptions.

    5. Student loan interest deductions are allowed; although the deductions are phased-out at higher levels of income.

    6. The $2,000 maximum allowable contribution to a Coverdell Education Savings Account is now permanent, rather than reverting to $500. As importantly, qualified educational expenses include those for elementary, secondary, and post-secondary schools.

Further, on the personal tax front, Congress extended, but only through the end of 2013, the following:

    1. The deduction for expenses of school teachers.

    2. The exclusion from income of any discharge of qualified principal residence indebtedness.

    3. The IRA Charitable Rollover, allowing individuals over 70 ½ to directly transfer $100,000 per year from an IRA account to one or more charities. This transfer counts toward the required minimum distribution (RMD) rule for IRA account. Because the law passed after 2012, the bill permits the following: (1) Any qualified distributions made in January directly to charities from IRA accounts will be deemed to have been completed on December 31, 2012, if the taxpayer so chooses, and (2) Individuals who took outright distributions from their IRA accounts in December of 2012 can transfer up to $100,000 of that amount to charities (subject to the rules governing Charitable IRA Rollovers)( and elect to treat it as a direct distribution to charity in 2012.

Congress also extended the tax credit for qualified tuition and other expenses of higher education, but only through 2018, along with the child tax credit and the earned income tax credit.

In a victory for the President, the American Opportunity Tax Credit was extended through 2014 and provides tax credits for higher education expenses and is now available to a much larger group of taxpayers. If one qualifies for the full credit, it is $2,500 per student, assuming their modified adjusted gross income is $80,000 or less (single), or $160,000 or less for those filing jointly.


401(k), 403(b), and other defined contribution retirement plan contributions can now be converted to a Roth at any time as long as the plan has a Roth option. Congress is hoping that people will take advantage of this provision and will pay taxes sooner rather than later. Previously, money could only be withdrawn from these types of plans at the time of a change in employment, retirement, or after age 59 ½. The money can be moved to an IRA if and only if the taxpayer is eligible to do so under these three provisions. It will only make sense for people to take advantage of this provision if they roll over 100% of the money they withdraw from the plan and pay the taxes from money they have accumulated someplace else. Otherwise, this is simply “smoke and mirrors”, as the net amount the taxpayer will have available at retirement will be exactly the same, assuming they are in the same tax bracket. If the money being converted is inside the existing plan, then the taxes will have to be paid with money outside the plan anyway. There are planning opportunities here, but they are not as great as many might think. But the younger one is, the better the opportunity; not only will the money grow tax-free for a longer period of time, but it should not be subject to tax law changes in the future.

Here’s an example. Suppose the taxpayer withdraws $20,000 from the 401(k) and rolls it over. If he or she is in the 25% tax bracket, $5,000 will be owed in taxes, which leaves $15,000 for investment. Assuming a 7% annual return (obviously never guaranteed), and a 10 year time horizon, the money would grow to approximately $29,500. Assuming the taxpayer left the money in the tax-deferred IRA for the same 10 year period at the same 7% rate of return, it would instead grow to approximately $39,350. But, taxes would be owed on this money when it is withdrawn. Assuming the taxpayer is still in the 25% tax bracket when the money is withdrawn, it would be worth the same $29,500 ($39,500 x 75% = $29,500). However, unlike traditional IRAs, the money in the Roth never has to be withdrawn until the IRA owner passes away; not beginning at age 70 ½ as with a traditional IRA.


There were a lot of changes on the business side of the equation, many of which had some “interesting” potential special interests attached to them. Since many of these do not apply to most of our Bullet readers, we will not go through them at this time.


As we said at the beginning, most of these provisions are now permanent, but permanency only exists until its next change. At least many of the provisions which have been year-to-year for the past several years have been taken off the table, thus giving some legitimacy to long-term planning. We applaud Congress and the President for that. But the debate will only heat up in the next few months – not only about reducing expenses, but other ways to raise revenue. During the course of the year we will share other opportunities as a result of this bill and will certainly discuss it in greater detail as we meet with you throughout the year. Should you have any questions or require additional information, please don’t hesitate to contact your advisor at ProVise Management Group, LLC.

As always, we encourage you to give us a call if you would like to discuss anything further. We will visit again soon. Proudly and successfully serving our clients for over 26 years.


© 1/15/13 ProVise Management Group, LLC

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