EY Faculty Connection - Issue 39
From ‘fiscal cliff’ to ‘fiscal minefield’
The American Taxpayer Relief Act of 2012 (ATRA) pulls the United States back from the edge of the fiscal cliff and makes permanent many temporary elements of the tax code, including the “patch” to the individual alternative minimum tax (AMT) that will keep millions of people from having to pay the AMT.
Ernst & Young publishes a new report providing an overview of the key provisions in The American Taxpayer Relief Act of 2012 and offers perspective on the potentially challenging fiscal and planning issues that lie ahead.
However, it leaves what could be termed a “fiscal minefield” of issues that lawmakers still need to negotiate in the short and medium term. Our new report, “From ‘fiscal cliff’ to ‘fiscal minefield’: a business executive’s guide to the fiscal cliff agreement and what lies ahead,” provides an overview of the legislation’s key provisions and offers perspective on the potentially challenging fiscal and planning issues that lie ahead.
Individual tax provisions
ATRA permanently extends the income tax rates enacted in 2001 and 2003 for individuals with taxable annual incomes up to $400,000 (singles) and $450,000 (married couples filing joint returns). Individuals above those income thresholds are now subject to a 39.6% top income tax rate and up to a 20% tax rate on their capital gains and dividends. In addition, ATRA reinstates limits on itemized deductions (“Pease” limitations) and phase outs of personal exemptions (PEP) for individuals with adjusted gross income (AGI) over $250,000 (singles) and $300,000 (married couples filing jointly).
ATRA also makes permanent a number of temporary provisions in the estate and gift tax area and also temporarily extends through 2013 some important tax breaks that apply to individuals, including:
- The deduction for state and local general sales taxes
- The deduction for qualified tuition and related expenses
- Tax-free distributions of up to $100,000 for charitable purposes per year from individual retirement plans held by someone age 70 ½ or older
- Increased limits and carry forward period for contributions of appreciated real property for conservation purposes
Key business tax extenders
The legislation extends through 2013 certain business tax provisions that expired in 2011 and 2012. The extensions apply retroactively, as though the tax provisions never expired. These include:
- The research credit, which was the most expensive of the business extenders.
- The exception under the anti-deferral rules for active financing income, which is significant for multinational financial services companies.
- The so-called CFC look-through rule, which is important to multinational companies generally, and allows deferral of tax on certain interest, dividend, rent and royalty payments made between related CFCs
- 50% bonus depreciation for qualified property, which applies to qualified property placed in service before January 1, 2014
- The Work Opportunity Tax Credit
- The increased expensing limitations under Section 179. Under this Code section, businesses that invest in new property or equipment can deduct part of the cost of property placed in service instead of depreciating those costs over time.
In addition, the legislation extends energy-related tax provisions. Among the key energy tax incentives extended are a modified wind production tax credit, incentives for biodiesel and renewable diesel, incentives for alternative fuels and alternative fuel mixtures, and credits for construction of energy-efficient homes and appliances.
Fiscal ‘minefield’ ahead
While the fiscal cliff legislation resolved some of the most pressing tax issues, it was far from the “grand bargain” for which many had hoped. The deal left some of the toughest policy issues unresolved, and any of those could prove explosive in the months ahead. And together, they present a fiscal minefield of sorts in early 2013. These issues include:
- Federal debt ceiling – The U.S. Department of the Treasury reports that the United States is at the statutory debt ceiling of $16.4 trillion (that is, it may not be able to borrow more money), and it is taking “extraordinary measures” to allow the government to continue to function. By mid- to late February, however, the federal government is likely either to have to borrow money to meet its obligations or risk default.
- Sequestration – These automatic across-the-board spending cuts were set to take place in early January 2013 as a result of the failure in 2011 of the so-called “Supercommittee” to come to an agreement on tax and spending as required by the last deal to raise the debt ceiling (the Budget Control Act of 2011). The fiscal cliff legislation pushes these automatic spending cuts out two months, to March. Whether to let these cuts to defense and other discretionary spending go into effect is an issue of contention among policymakers, and debate on this topic will likely coincide with action on the debt ceiling.
- Continued funding of government programs – The federal government has been operating under a temporary measure known as a 'continuing resolution' to fund government programs. The current continuing resolution expires in late March. Because the debt ceiling, sequestration and the continuing resolution need to be dealt with at around the same time, they may be negotiated collectively, although some think the debt limit and sequestration issues may be dealt with first.
The beginning of 2013 represents a unique juncture in US tax and fiscal policy. In recent years, federal lawmakers from both parties, perhaps anticipating they would gain control of both the White House and Congress in the November 2012 elections, had timed a host of tax, spending, and borrowing measures to require further action at the end of 2012.
When voters endorsed the status quo of divided government, lawmakers lacked both the time and the consensus to deal with all the fiscal cliff issues simultaneously. So they dealt with some of the most pressing issues — expiring tax cuts and the sequester — and left other issues (debt ceiling, spending cuts, tax reform) for another day.
While it is not yet clear how lawmakers will dispose of the remaining fiscal cliff issues, the stakes for businesses in 2013 are every bit as high — perhaps even more so — than they were in 2012.
Download and read the full report and related appendices here.