The 'fiscal cliff' bill and Iowa entrepreneurs
Congress changed the rules of the tax game for 2012 after time expired. About two hours into 2013 they passed HR 8, the "Fiscal Cliff" legislation, finally settling the tax law for 2012 and 2013. The bill raises the top federal tax rate on profitable S corporations to more than 40% starting in 2013, as expected, but it could have been much worse. It fixes two huge flaws in the tax law, and it provides some unexpected benefits to buyers of fixed assets in 2012 and 2013.
First, the bad news. The bill raises the stated top individual income tax rate to 39.6%. This rate will apply to taxable income more than $400,000 for single filers and $450,000 for joint filers. The top rate had been 35%.The bill also raises the top dividend and capital gain rate from 15% to 20%, for taxpayers in the new 39.6% top bracket.
The new tax law also re-enacts the "phase-out" of itemized deductions and personal exemptions for higher-income earners. This has the effect of increasing the top rate an additional 1.188%, to 40.788%.
It's even worse than that, though, with the 3.8% new "net investment income" tax enacted separately with Obamacare also taking effect for 2013. This tax applies to interest, dividends, most capital gains, rental income and "passive" K-1 income. Considering all of these taxes, and taking deductions for taxes paid into account, an Iowa taxpayer could face a marginal rate -- the rate on each additional dollar earned -- as high as 47.6%.
There is good news. The bill permanently "patches" the alternative minimum tax, retroactive to 2012. Without the patch, some taxpayers could have had additional 2012 taxes of more than $9,000.
The bill also permanently sets the estate tax lifetime exemption at $5 million, though it raises the rate on taxable estates to 40%. The rate in 2012 was 35%.
The bill also omits some terrible ideas that had been thrown out, including a hard dollar cap of $25,000 or $50,000 for itemized deductions. This limit would have hit Iowa pass-through owners hard, as it would have restricted their deductions for state taxes paid on business income.
Bonus good news. The bill retroactively increases the "Section 179 deduction" maximum for 2012 to $500,000. That will also be the maximum deduction for 2013. This deduction, which lets taxpayers deduct all of the cost of equipment that would otherwise have to be capitalized and deducted over several years, had been set at $139,000 for 2012 and $25,000 in 2013.
The bill also extends 50% "bonus depreciation" on new fixed assets through 2013. It had been set to expire in 2012.
These silver linings come with their own Iowa cloud. The Section 179 changes and bonus depreciation won't apply in computing Iowa income tax unless the legislature enacts conforming legislation. The legislature has not conformed with bonus depreciation. It has conformed with the federal Section 179 limits in recent years, but Iowa won't accept returns with the new limits until the legislature acts. Depending on how fast the legislature acts, it could delay filings of Iowa returns where Section 179 is an issue.
The bill also extends a raft of "expiring provisions" for another year, including the research credit and the wind energy production credit. It doesn't extend the 2% reduction in employee Social Security tax and self-employment tax.
Be sure to visit with your tax professonal to see how these provisions will affect you and your business.
Tax Update Blog, Senate passes fiscal cliff bill in wee hours; House acts today.