In January, 2013, Congress passed the American Taxpayer Relief Act of 2012 (the “Act”),1 containing numerous individual and business tax changes and extensions. The following discusses a few of these changes and extensions.
Individual Tax Rates
The Act permanently extended (with some modifications) the tax rates contained in the 2001 and 2003 tax relief acts. As a result, the ordinary income rates and the dividend and capital gain rates for single individuals and married individuals filing jointly (for taxable years beginning after December 31, 2012) are as follows:2
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Alternative Minimum Tax
The Act raised the Alternative Minimum Tax exemption amount from $45,000 to $78,750 for married individuals filing jointly; for single individuals the exemption amount was raised from $33,750 to $50,600. The exemption amounts are indexed for inflation.4 This increase is retroactively effective for tax years beginning after December 31, 2011.
Extension of the Research Tax Credit
The Act retroactively reinstated the research and development tax credit for the period from January 1, 2012 through December 31, 2013.5 In addition, the Act made two technical changes. The first simplifies the rules governing the allocation of research expenses among commonly controlled groups. The second change provides that when a taxpayer incurs research expenses in a trade or business and disposes of that trade or business in the same year, the selling taxpayer is allocated the research expenses, not the purchasing taxpayer.
Extension of the Active Financing Exception to Subpart F Income
U.S. persons who own 10 percent or more of a controlled foreign corporation are subject to current taxation on certain types of income earned by the controlled foreign corporation, whether or not distributed (“Subpart F income”). Among other things, Subpart F income includes interest, rents and certain types of insurance income. Congress had passed a temporary exception that provided that income derived from the active conduct of banking, financing, securities dealing, the insurance business or similar businesses was not Subpart F income if other requirements were also satisfied. The Act retroactively reinstates this active financing exception from Subpart F for taxable years beginning after December 31, 2011 but before January 1, 2014.6
Extension of the Exclusion on Gain from Certain Small Business Stock
Section 1202 of the Internal Revenue Code permits noncorporate taxpayers to exclude from income 100 percent of the gain (up to a maximum amount of gain) realized from the sale of “qualified small business stock.” The noncorporate taxpayer must have acquired the stock after September 27, 2010 but before January 1, 2012, and held such stock for more than five years.7The maximum gain a taxpayer can exclude from gross income is limited to the greater of $10,000,000 or ten times the taxpayer’s aggregate adjusted basis in the stock.8
Qualified small business stock is stock in a domestic C corporation that had aggregate gross asset basis of $50,000,000 or less at all times after 1993 (and including any amounts received by the corporation in exchange for its stock).9 In addition, the taxpayer must acquire the stock directly from the issuing corporation (i) in exchange for money or other property (but not stock) or (ii) as compensation for services.10
The Act retroactively extends this provision so that it applies to any qualified small business stock acquired by a noncorporate taxpayer during 2012 in addition to any such stock acquired before January 1, 2014.11
Extension of the S Corporation “Built-in Gain” Tax Relief
In general, when an S corporation sells its assets, the gain on sale flows through to, and is reportable by, the shareholders and is not subject to a corporate level tax. In the case of an S corporation that previously was a C corporation, however, such S corporation is subject to a corporate level tax on its “built-in gain” if the asset sale occurs during the “recognition period.”
Generally, an asset’s built-in gain is the amount of gain that would have been recognized if the corporation’s assets were sold immediately before it converted to an S corporation. The recognition period is the first ten years following the conversion to an S corporation. The recognition period was shortened to seven years for sales occurring during a taxpayer’s 2009 and 2010 tax years, and to five years for sales occurring during a taxpayer’s 2011 tax year. The Act extended this shortened five-year recognition period for any built-in gains recognized during either the 2012 or 2013 tax years. For 2014 and later tax years, the recognition period will again be ten years, unless legislation to the contrary is passed before then.
Thus, an S corporation that converted from a C corporation at least five years ago should consider the tax benefits of an asset sale occurring in 2013 to avoid the corporate level tax on built-in gain.
Extension of Bonus Depreciation
The Act extended bonus deprecation for an additional year. As a result, there is an additional 50 percent bonus depreciation permitted for “qualified property” placed in service during 2013.12The Act did not modify the definition of “qualified property.” Qualified property generally means property which (i) has a recovery period of 20 years or less, (ii) is computer software, (iii) is a water utility property, or (iv) is a qualified leasehold improvement.13 The property must be acquired pursuant to a binding contract entered into after December 31, 2007 and before January 1, 2014.14