Next year, Americans are facing numerous tax changes, including expiring tax breaks. To start with, tax rates on ordinary income are going up for everyone, unless Congress acts to extend the lower rates currently in effect. At the low end of the income scale, the existing 10 percent bracket will become 15 percent. At the top of the scale, the existing 35 percent bracket will be replaced by a 39.6 percent bracket.
Below are some of the other tax breaks that will expire on December 31, and those that expired on December 31, 2011.
Of course, no one can predict with certainty whether Congress will extend some of these deductions, credits and rates. It depends on what happens in Washington. As we’ve learned in the past, Congress could pass laws to bring some of these tax breaks back — even retroactively after the new year. Stay tuned.
What Could Happen?
|Reduced Social Security Tax Rate (also Known as the Payroll Tax Holiday)||For 2012, the Social Security tax hits the first $110,100 of wages and/or self-employment income. The withholding rate for the employee’s share of the Social Security tax is temporarily reduced by 2 percent from 6.2 percent to 4.2 percent.For self-employed people, the Social Security tax component of the self-employment tax is also temporarily reduced by 2 percent, from the usual 12.4 percent to only 10.4 percent. The maximum savings is $2,202 (2 percent times $110,100). A working couple could save up to $4,404 (2 percent times $2,202).||Expiring December 31, 2012||While it would further threaten the stability of the Social Security system, the payroll tax holiday could be extended through 2013. The goal of keeping more cash in consumers’ hands in order to spur the economy might be an overriding consideration. For 2013, Social Security tax will hit the first $113,700 of wages and/or self-employment income. So if the tax holiday is extended through 2013, the top tax savings per worker would be $2,274 (2 percent times $113,700) while a working couple could save up to $4,548 (2 times $2,274).|
|Reduced Long-term Capital Gains Rates||For 2012, the maximumfederal income tax rate on most long-term capital gains is 15 percent.(Short-term gains are taxed at ordinary income tax rates.)||Expiring December 31, 2012||Unless Congress extends the current rates, the top rate will increase to 20 percent. An 18 percent top rate will apply to most long-term gains from investments acquired after December 31, 2000 and held more than five years. The existing rates could be extended if lawmakers believe it will help the economy.|
|Reduced Dividend Rate||For 2012, qualified dividends are taxed at a maximum rate of only 15 percent.||Expiring December 31, 2012||Unless Congress acts, for 2013, dividends will be treated as ordinary income taxed at regular rates of as high as 39.6 percent. Congress could extend the existing rates in order to improve the economy.|
|Alternative Minimum Tax (AMT) Patch||Every year, Congress “patches” the AMT rules to prevent millions more households from getting socked with this add-on tax. The annual patch consists of allowing bigger AMT exemptions and allowing various personal tax credits to offset the AMT. Without a new patch for 2012, many more taxpayers will face higher tax bills.||Expired December 31, 2011||It is likely that a new AMT patch will be installed for 2012.|
|Option to Deduct State and Local Sales Taxes||For 2011, individuals had the option of claiming an itemized deduction for general state and local sales taxes instead of claiming an itemized deduction for state and local income taxes. This option can be beneficial if a taxpayer lives in a state with no personal income tax or a very low state income tax rate.||Expired December 31, 2011||The option will probably be extended through at least 2012.|
|Tax-Free Treatment for Forgiven Principal Residence Mortgage Debt||For federal income tax purposes, cancelled debts generally count as gross income: so-called cancellation of debt (COD) income. However a temporary exception applies to COD income from cancelled mortgage debt that was used to acquire a principal residence. Under the temporary favorable rule, up to $2 million of COD income from principal residence acquisition debt that is cancelled in 2007-2012 is treated as a federal-income-tax-free item.||Expiring December 31, 2012||It appears doubtful that this break will be extended through 2013 in its current form. However an exception for smaller amounts of post-2012 forgiven principal residence mortgage debt might prove to be acceptable to lawmakers.|
|Charitable Donations from IRAs||For 2011, IRA owners who had reached age 70 1/2 by year end were allowed to make charitable donations of up to $100,000 directly out of their IRAs. The donations count as IRA required minimum distributions. So, charitably inclined seniors with more IRA money than they need could reduce their taxes by arranging for IRA donations to take the place of taxable required minimum distributions.||Expired December 31, 2011||It may be too late to bring this one back for 2012. In any case, it would not be surprising if it is reinstated for the 2013 tax year.|
|Favorable Child Credit Rules||For 2012, the maximum credit for an eligible under-age-17 child is $1,000. For 2013, the top credit is scheduled to drop to only $500. The current liberalized rules for calculating the refundable portion of the credit are also scheduled to expire at the end of 2012. The refundable amount is generally limited to the lesser of: (1) 15 percent of the taxpayer’s earned income in excess of the applicable threshold or (2) the amount of credit remaining after the taxpayer’s liability is reduced to zero. For 2012, however, a reduced $3,000 earned income threshold is in effect, which allows more households to claim the credit.||Expiring December 31, 2012||The current rules will likely be extended through at least 2013.|
|Favorable Earned Income Credit Rules||Legislation enacted in 2009 and 2010 increased the earned income credit (EIC) percentage for families with three or more qualifying children from 40 to 45 percent through 2012 and increased the income threshold for the phase-out rule that can reduce or eliminate EICs for married joint-filing couples (the threshold was made $5,000 higher than the threshold for singles). These provisions allow larger EICs for affected families.||Expiring December 31, 2012||The current rules will probably be extended through at least 2013.|
|Favorable Dependent Care Credit Rules||For the past few years, parents have been allowed to claim a credit of up to $600 for costs to care for one under-age-13 child or up to $1,200 for costs to care for two or more kids under 13 so both parents can work. Lower-income parents could claim larger credits of up to $1,050 and $2,100, respectively. For 2013 and beyond, the top credit amounts are scheduled to drop to only $480 and $960, respectively ($720 and $1,440 for lower-income parents). Note: This credit can also be claimed for costs to care for a qualified individual who is not an under-age-13 child, such as a disabled spouse or dependent parent, so a taxpayer can work.||Expiring December 31, 2012||The current rules will probably be extended through at least 2013.|
|Tax Breaks for Adoptive Parents||An earlier tax law included a major liberalization in the adoption credit rules and the establishment of tax-free employer adoption assistance payments. Beginning in 2013, the maximum adoption credit is scheduled to basically be cut in half. In addition, only special-need children will qualify and stricter income phase-out rules will apply. Tax-free employer reimbursements for adoption expenses will disappear.||Expiring December 31, 2012||The current rules will probably be extended through at least 2013.|
|The American Opportunity Higher Education Credit||The 2009 stimulus law created the American Opportunity credit which can be worth up to $2,500 for 2012, can be claimed for up to four years of undergraduate study, and is 40 percent refundable. The credit is scheduled to be replaced by the Hope Scholarship credit which is smaller, can only be claimed for the first two years of undergraduate study, is subject to phase-out at lower income levels, and is not refundable.||Expiring December 31, 2012||The existing credit and rules will probably be extended through 2013.|
|Higher Education Tuition Deduction||For 2011, this write-off was up to $4,000 or $2,000 for higher-income folks.||Expired December 31, 2011||This deduction will probably be extended through at least 2012.|
|Favorable Student Loan Interest Rules||This deduction can be up to $2,500 annually, whether the taxpayer itemizes or not. Less-favorable rules are scheduled to kick in for 2013 and beyond. Specifically, a 60-month limit on deductible interest will apply and stricter phase-out rules will reduce or eliminate write-offs for many middle-income households.||Expiring December 31, 2012||The current rules will likely be extended through at least 2013.|
|Favorable Coverdell Education Savings Account Contribution Rules||After 2012, the maximum contribution to federal-income-tax-free Coverdell education savings accounts (CESAs) is scheduled to drop to only $500 (down from the current $2,000 maximum). In addition, a stricter phase-out rule would reduce or eliminate contributions for many taxpayers.||Expiring December 31, 2012||The current rules will probably be extended through at least 2013.|
|Section 127 Educational Assistance Plans||For the last few years, employers have been allowed to provide up to $5,250 in annual federal-income-tax-free educational assistance to each eligible employee under Section 127 plans. Both undergraduate and graduate school costs are covered and the education need not be job-related. Employers can deduct the cost of running plans as an employee benefit expense.||Expiring December 31, 2012||Section 127 plans will probably be extended through at least 2013.|
|$500 Energy-Efficient Home Improvement Credit||For 2011, taxpayers could claim a tax credit of up to $500 for certain energy-saving improvements to a principal residence.||Expired December 31, 2011||This credit will probably stay dead.|
|Larger Salary Reduction Opportunity for Transit Passes||An employer may allow employees to sign up to reduce their taxable salaries to pay for transit passes to get to and from work. In 2011, the maximum monthly amount you could set aside on a tax-free basis was $230. The maximum monthly amount for 2012 is only $125, unless Congress decides to allow a larger amount at the last minute. If that happens, the amount would be $240.||Expired December 31, 2011||It may be too late to bring a larger amount back for 2012. In any case, a larger amount could be allowed for 2013.|
|$250 Deduction for Teachers’ School Expenses||For 2011, teachers and other personnel at K-12 schools were able to deduct up to $250 of school-related expenses they paid out of their own pockets — whether they itemized or not.||Expired December 31, 2011||This will probably be extended through at least 2013.|
|Deduction for Home Mortgage Insurance Premiums||For 2011, eligible taxpayers were allowed to treat qualifying personal residence mortgage insurance premium amounts as deductible home mortgage interest.||Expired December 31, 2011||It is unclear if this deduction will be extended.|
|Charitable Qualified Conservation Contributions||Qualified conservation contributions are donations of real property interests (including remainder interests and easements) that restrict the use of the property. For individuals, the maximum write-off for 2011 qualified conservation contributions of long-term capital gain property was increased from 30 to 50 percent of adjusted gross income (AGI). Qualified contributions also weren’t counted when calculating allowable 2011 write-offs for other charitable contributions. Qualified contributions in excess of what could be deducted could be carried forward for 15 years (only a five-year carryover period is allowed under the normal rules). For a qualified farmer or rancher, the qualified conservation contribution write-off for 2011 donations of farm or ranch property could be up to 100 percent of AGI.||Expired December 31, 2011||It may be too late to bring these provisions back for 2012. However, Congress could resurrect them for the 2013 tax year.|
Eric Cohen, CPA is the President and Founder of E. Cohen and Company CPAs, a full-service CPA firm serving nonprofit organizations, government contractors, professional service companies and other industries with audit, tax and business advisory services for over 26 years. The firm was commended as a SmartCPA Reader’s Choice by SmartCEO magazine and a “Best Accounting Firm to Work For” by AccountingToday magazine. For more information, visit www.ecohencpas.com or call 301-917-6200.