HUGE TAX INCREASES IN STORE FOR 2013 SMALL BUSINESS BEWARE HUGE TAX INCREASES IN STORE FOR 2013 October 17, 2012 Joseph P. Nicola, Jr. Sisterson & Co., LLP Pittsburgh, PA 412-594-7006 jpnicola @ sisterson.com

FISCAL CLIFF The most compelling issue facing Congress is the so-called “fiscal cliff.” According to the Tax Policy Institute (TPI), if Congress fails to act on expiring tax cuts by the end of 2012, nine out of 10 Americans will see their taxes go up, as average households would see a $3,500 increase.

Without legislative action, most tax cuts enacted since 2001 will expire on January 1, 2013, raising tax rates, reducing deductions and credits, and exposing millions of taxpayers under the alternative minimum tax (AMT), according to a TPI report. The estate tax would hit more than 10 times as many estates as in 2012.

The two-percentage point cut in the payroll tax rate would lapse, raising taxes on more than 120-million households with workers. Short-term tax breaks that Congress regularly renews, some of which have already lapsed, would disappear, boosting taxes for both individuals and businesses. In addition, the 2010 healthcare legislation would impose new taxes on high-income taxpayers.

For most households, the two biggest increases would be the expiration of the temporary cut in Social Security taxes and the expiration of the 2001/2003 tax cuts. The wealthy would be hit hard by the expiration of the 2001/2003 tax cuts that apply at upper income levels and the start of the new health care reform taxes.

However, the resulting macroeconomic tightening could well push the country back into recession in 2013, according to a report by the Congressional Budget Office.

Candidate and Legislative Proposals Both candidates favor a reduction in tax rates in the mid-term, to be followed by more comprehensive tax reform in the long-term. During their debates, President Obama affirmed that he favors tax cuts for all but the wealthiest taxpayers, while Mitt Romney affirmed that he would maintain the Bush tax cuts for all taxpayers, while reducing or eliminating certain deductions.

Individual Tax Rates, Deductions and Credits Under current law, the reduced individual income tax rates are scheduled to sunset after 2012. Unless extended, the individual marginal tax rates, currently at 10, 15, 25, 28, 33, and 35 percent, are scheduled to revert to 15, 28, 31, 36, and 39.6 percent, effective for tax years beginning after December 31, 2012.

President Obama, in his Blueprint for America and other proposals, has called for making permanent the 10, 15, 25, and 28 percent rates for tax years beginning after December 31, 2012 for all but the wealthiest taxpayers ($200K/$250K thresholds).

Similar to the favorable graduated rate schedule, under current law, there is no marriage penalty or Pease limitation through 2012. Numerous proposals favor an extension of the penalty relief for all but the wealthiest taxpayers, though Republicans (in decreasing numbers) would retain this benefit for all taxpayers. The Pease limitation appears to be on its way back.

Under current law, the Earned Income Credit and the Child Tax Credit are enhanced through 2012. Both candidates for President have advocated an extension of both enhancements.

15% Rate Bracket for Married Filers Current Law: No marriage penalty January 1, 2013: Marriage penalty

Capital Gains Rates For Individuals Current Law: Generally 15% (or 0%) January 1, 2013: Generally 20%

Dividends Current Law: Generally 15% (or 0%) January 1, 2013: Ordinary income

Dependent Care Credit Current Law: Dollar Limit $3K/$6K 35% credit Phase out at $15,000 January 1, 2013: Limit $2,400/$4,800 30% credit Phase out at $10,000

Child Tax Credit Current Law: $1,000 per child Offset AMT January 1, 2013: $500 per child No offset AMT

American Opportunity Tax Credit Current Law: Max is $2,500 Partially refundable Available first 4 years January 1, 2013: Hope credit Max TBA No refund Available 2 years

Energy Credit Home Construction Current Law: No credit (expired for homes acquired after 12/31/11) January 1, 2013: No credit

Credit for Energy Efficient Appliances Current Law: No credit (expired after 2011 January 1, 2013: No credit

Work Opportunity Tax Credit Current Law: 40% through end of 2011 (2012 for veterans) January 1, 2013: Credit for certain veterans hired through 2012

Refundable Minimum Tax Credit For Individuals Current Law: Long-term credit unused credit through 2012 January 1, 2013: No credit

AMT Exemption Amount Through 2011 : Generally indexed with one-year patches. January 1, 2013: $45,000 joint filers; $33,750 single filers

For 2011, the exemption amounts were $48,450 for unmarried individuals filing a single return, and $74,450 for married couples filing a joint return and surviving spouses.

School Teacher Deduction Current Law: Deduction through 2011 January 1, 2013: No deduction

Overall Limit on Itemized Deductions Current Law: No limit January 1, 2013: 3% rule applies

Discharge of Principal Residence Debt Current Law: Not income for pre- 2013 discharges January 1, 2013: Discharge is taxable

Flexible Spending Accounts Current Law: Generally no limit on contributions January 1, 2013: $2,500 annual limit

Employer Education Assistance Current Law: $5,250 exclusion through 2012 January 1, 2013: No exclusion

Phase-Out Personal Exemptions Current Law: No phase out January 1, 2013: Phase-out at higher income levels

State and Local Sales Tax Deduction Current Law: Expired in 2011 January 1, 2013: None

15-Year Depreciation of Qualified Leaseholds and Certain Retail Realty Current Law: Expired in 2011 January 1, 2013: 39 years

Bonus Depreciation Current Law: 100% in 2011; 50% in 2012 January 1, 2013: No bonus (except certain long-lived property)

Section 179 Current Law: 2011 was $500,000 ($2 million investment limit); 2012 is $139,000 ($560,000 investment limit) January 1, 2013: $25,000 maximum ($200,000 investment limit)

Medical Expense Deduction Current Law: Deduct excess over 7.5% AGI January 1, 2013: Deduct excess over 10% AGI

Student Loan Interest Current Law: Phase-Out at $60K AGI January 1, 2013: Phase-Out at $40K AGI

Deduction for Tuition and Expenses Current Law: Expired in 2011 January 1, 2013: None

Tax-Free Transfer from IRA to Charity Current Law: Expired in 2011 January 1, 2013: None

Section 1202 Stock Current Law: 100% exclusion of gain on stock bought 9/27/2010 – 12/31/2011; 50% thereafter January 1, 2013: 50% exclusion

Payroll Tax Cut Current Law: SS rate 4.2% January 1, 2013: SS rate 6.2%

Estate Tax Rate Current Law: Max rate 35% January 1, 2013: Max rate 55%

Estate and Gift Tax Exemption Current Law: $5,120,000 exemption January 1, 2013: $1 million exemption

Portability Current Law: Surviving spouse can use decedent spouse’s unused exclusion amount January 1, 2013: No such provision

Legislation of Top Priority: Extenders Congress will act to jealously guard certain expiring benefits. President Obama has advocated an extension of most of the following: 15-year straight-line cost recovery for qualified leasehold improvements, qualified restaurant buildings and improvements, and qualified retail improvements. Work opportunity tax credit. Treatment of certain dividends of a regulated investment company (RIC). Refined coal credit.

Alternative fuel and alternative fuel mixtures credit. Suspension of limitation on percentage depletion for oil and gas from marginal wells. Energy and ethanol credits. Bonus depreciation. R&D credit.

2012 2013 Top individual tax rate 35% 39 2012 2013 Top individual tax rate 35% 39.6% Capital Gains 15% 20% Dividends 15% Ord Income Top estate tax rate 35% 55% Child tax credit $1,000 $500 AOTC Up to $2,500 Unavailable Section 179 dollar limit $139,000 $25,000 Bonus depreciation 50% Unavailable Research tax credit Unavailable Unavailable

On June 28, 2012, the U. S. Supreme Court upheld the constitutionality of the Patient Protection and Affordable Care Act (PPACA).

Additional Medicare Tax Starting in 2013, an additional 0.9 percent Medicare tax is imposed on wages and self-employment income of higher-income individuals (single $200,000; married $250,000).

Employers must withhold on the higher rate if the employee receives wages in excess of $200,000. The employer may disregard the amount of wages received by the employee's spouse. If the Medicare tax is not withheld by the employer, the employee is required to pay the tax.

Medicare Tax On Investment Income Starting in 2013, 3.8 percent Medicare tax applies to unearned income. The tax is imposed on the lesser of an individual's net investment income or modified adjusted gross income in excess of $200,000 ($250,000 for married couples).

Net investment income is the excess of the sum of the following items less related deductions: Interest Dividends Annuities Rents and royalties Nonbusiness gains Home sale in excess of exclusion

Questions and Planning Does the new 3.8% Medicare tax apply to Section 409A distributions? Do passive losses offset passive income for purposes of the 3.8% Medicare tax Should carried interest returns be subject to the 3.8% Medicare tax?

S corporation with accumulated earnings and profits and C corporations with earnings and profits should consider dividend distributions in 2012. Generate capital gains before year-end. Generate capital losses to offset capital gains taxed at the higher rates beginning in 2013.

AOTC-qualifying tuition and other payments. Bunch itemized deductions into 2012.

Forms W-2 The PPACA generally requires employers to disclose the aggregate cost of applicable employer-sponsored coverage on an employee's Form W-2 for tax years beginning on or after January 1, 2011.

In Notice 2010-69, the IRS made reporting optional for all employers for 2011.

In Notice 2012-9, the IRS provided transition relief for small employers. For 2012 and future Forms W-2, an employer is not subject to reporting for any calendar year if the employer was required to file fewer than 250 Forms W-2 for the preceding calendar year.