In the early hours of 2013, Congress enacted the American Taxpayer Relief Act of 2012 (ATRA or the "Act") in order to avoid the so-called "fiscal cliff." We've extracted provisions from the 157-page Act that are of most relevance to churches and church employees.
The American Taxpayer Relief Act of 2012 has two major features—an increase in the tax rates paid by the wealthiest Americans, and an extension of several tax benefits that were scheduled to expire at the end of 2011 or 2012.
Some expiring tax benefits were not extended. Most notably, Congress chose not to extend the so-called payroll tax "holiday" that reduced the Social Security taxes for both employees and the self-employed for the past two years. This results in a tax increase for three out of every four Americans in 2013.
Expiration of the reduction in Social Security taxes. Prior to 2011, employees paid a 6.2 percent Social Security tax on all wages earned up to the annual "wage base" and self-employed individuals paid a 12.4 percent Social Security self-employment tax on all of their self-employment income up to the same threshold.
Congress enacted legislation in 2010 providing for a payroll tax and self-employment tax "holiday" during 2011 of two percentage points off the employee share of Social Security tax, and the Social Security component of self-employment taxes. This meant that the employee share of Social Security taxes dropped from 6.2 percent to 4.2 percent of wages, and the Social Security component of self-employment taxes dropped from 12.4 percent to 10.4 percent of self-employment earnings. This reduction in taxes was enacted to stimulate the economy by increasing the take-home pay of millions of workers.
Congress enacted legislation in 2012 temporarily extending the payroll tax cut for employees and self-employed persons through 2012.
The American Taxpayer Relief Act of 2012 does not extend the reduction in Social Security taxes after 2012. This has the following consequences:
- Employees and self-employed workers will have a tax increase of 2 percent of their earned income under $113,700.
- This tax increase will impact an estimated 77 percent of all workers.
- To illustrate, for a church employee earning $40,000 in 2013, the additional tax will be $800.
Churches, like any employer, must take into account the elimination of the reduction in Social Security taxes when withholding Social Security taxes from nonminister employees.
Ministers are self-employed for Social Security, and pay the self-employment tax rather than Social Security and Medicare taxes. Their self-employment taxes will increase 2 percent beginning in 2013. To illustrate, a minister earning $50,000 in 2013 in the exercise of ministry will pay an additional $1,000 in self-employment taxes.
The housing allowance exclusion applies only to income taxes, and not self-employment taxes. As a result, the 2-percent hike in self-employment taxes will apply not only to a minister's salary, but also to any church-designated housing allowance and the annual rental value of a church-provided parsonage.
Ministers should take into account the hike in self-employment taxes when computing their quarterly estimated tax payments for 2013 and future years.
Key point. The Affordable Care Act (the new healthcare law) contains an additional hike in Social Security and self-employment taxes for higher-income taxpayers. It increases the Medicare tax paid by both employees and self-employed persons by an additional 0.9 percent on wages in excess of a threshold amount beginning in 2013. However, unlike the general 1.45 percent Medicare tax on employee wages, or the 2.9 percent Medicare tax on self-employed workers, this additional tax is on the combined wages of the employee and the employee's spouse, in the case of a joint return. The threshold amount is $250,000 in the case of a joint return or surviving spouse, $125,000 in the case of a married individual filing a separate return, and $200,000 in any other case.
Impact on charitable contributions. Some analysts predict charitable contributions will decline as a result of the American Taxpayer Relief Act, for three reasons:
First, charitable contributions are discretionary outlays and many high-income taxpayers may cut back on their contributions to offset the impact of higher taxes. According to the latest IRS statistics, higher-income taxpayers pay a larger percentage of their household income to charity than lower-income taxpayers. Will higher taxes cause the rich to cut back on their contributions? It's too soon to tell, but the possibility exists.
Second, the reinstatement of the "Pease limitation" (addressed below), which caps charitable contributions for the wealthy at 20 percent of the amount of their contributions, may cause higher-income taxpayers to cut back on their giving. Note that the Pease limit impacts taxpayers at a lower level ($300,000 for joint filers) than the higher-income tax rates ($450,000 for joint filers), which may disincentivize charitable giving for a larger group of taxpayers.
Third, many taxpayers make some or all of their contributions by payroll deductions at work. Many of these taxpayers were stunned to see smaller paychecks in the early weeks of 2013 following the expiration of the 2-percent reduction in Social Security taxes that prevailed for the previous two years. Some undoubtedly will seek to offset the financial impact of higher Social Security withholdings by reducing or canceling contributions made by payroll deduction.
Key point. Several studies on the impact of charitable contribution limits on charitable giving have produced conflicting results. Some studies suggest that charitable giving is adversely affected by less favorable deduction rules, while other studies indicate that the effect is minimal.
Permanently extend the 10 percent bracket. Under prior law, the 10 percent individual income tax bracket expired at the end of 2012. Upon expiration, the lowest tax rate would increase to 15 percent. The Act extends the 10 percent individual income tax bracket for taxable years beginning after December 31, 2012.
Permanently extend the 25 percent, 28 percent, and 33 percent income tax rates for certain taxpayers. Under prior law, the 25 percent, 28 percent, 33 percent, and 35 percent individual income tax brackets expired at the end of 2012. Upon expiration, the rates were to increase to 28 percent, 31 percent, 36 percent, and 39.6 percent respectively. The Act permanently extends the 25 percent, 28 percent, and 33 percent rates on income at or below $400,000 (individual filers), $425,000 (heads of households), and $450,000 (married filing jointly) for taxable years beginning after December 31, 2012, but lets the 35 percent rate for income above these amounts expire, which reinstates a tax rate of 39.6 percent for taxable income above these amounts.
Key point. The $400,000, $425,000, and $450,000 amounts are adjusted annually for inflation beginning in 2014.
Key point. The continuation of the lower tax rates for income up to $400,000 (individual filers), $425,000 (heads of households), and $450,000 (married filing jointly) is misleading, since many higher-income taxpayers will have little, if any, tax relief due to the application of the alternative minimum tax.
Key point. Many analysts have noted that the permanent extension of the Bush-era tax cuts for middle- and lower-income Americans will make it more difficult to achieve significant reductions in the $16.5 trillion federal deficit, which many do not believe will be possible without greater contributions from middle- and lower-income taxpayers.
Federal Income Tax Rates for 2013
|39.6%||$400,000 and up||$450,000 and up|
Note that the table reflects marginal tax rates (the tax rates that apply only to the corresponding income described in the table). For example, a married couple with taxable income of $100,000 will not pay the 25 percent rate on this entire amount. Rather, the first $17,850 of taxable income will be taxed at 10 percent, and income from $17,850 to $72,500 will be taxed at 15 percent. Only income from $72,500 to $100,000 will be taxed at 25 percent, meaning that the couple's effective tax rate will be 16.9 percent. This rate will be even lower when deductions, credits, and exclusions are considered.
Permanently repeal the Personal Exemption Phaseout for certain taxpayers. In order to determine taxable income, an individual reduces adjusted gross income by any personal exemptions, deductions, and either the applicable standard deduction or itemized deductions. Personal exemptions generally are allowed for the taxpayer, his or her spouse, and any dependents. For 2012, the amount deductible for each personal exemption is $3,800. This amount is adjusted annually for inflation.
Prior to EGTRRA, the exemption was phased out as a result of the Personal Exemption Phaseout ("PEP") for taxpayers with adjusted gross income (AGI) above a certain level.
EGTRRA repealed the PEP over five years, beginning in 2006. The phase-out was reduced by one-third in taxable years beginning in 2006 and 2007, and by two-thirds in taxable years beginning in 2008 and 2009. The repeal was fully effective for taxable years beginning in 2010. In explaining the reason for repealing the phase-out, a congressional conference committee noted that "the personal exemption phase-out is an unnecessarily complex way to impose income taxes and the hidden way in which the phase-out raises marginal tax rates undermines respect for the tax laws."
The Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (TRUIRJCA) extended the PEP repeal through 2012.
The American Taxpayer Relief Act of 2012 extends the PEP repeal on income at or below $250,000 (individual filers), $275,000 (heads of households), and $300,000 (married filing jointly) for taxable years beginning after December 31, 2012.
Key point. The $250,000, $275,000, and $300,000 amounts are adjusted annually for inflation beginning in 2014.
Permanently repeal the itemized deduction limitation for certain taxpayers. In his acceptance speech during the 1988 Republican National Convention, presidential candidate George H.W. Bush famously pledged, "Read my lips: no new taxes." Two years later, as president, he reluctantly broke his promise and signed the Omnibus Budget Reconciliation Act of 1990. This Act raised taxes in a number of ways, including the so-called "Pease" limit on itemized deductions (named after Ohio congressman Don Pease, who first proposed it). This limit required certain itemized deductions, including charitable contributions, to be reduced by 3 percent of a taxpayer's adjusted gross income over $100,000 (adjusted annually for inflation), but not by more than 80 percent.
In 2001, Congress enacted a law (EGTRRA) that phased out the Pease limit by one-third in 2006 and 2007, by two-thirds in 2008 and 2009, and by 100 percent in 2010. EGTRRA contained a "sunset" provision calling for this and many other provisions to expire at the end of 2010. This would have reinstated the Pease limit beginning in 2011. However, Congress enacted legislation in 2010 extending the elimination of the Pease limit through 2012.
The American Taxpayer Relief Act of 2012 permanently extends the repeal of the Pease limit on income at or below $250,000 (individual filers), $275,000 (heads of households), and $300,000 (married filing jointly) for taxable years beginning after December 31, 2012.
Key point. The $250,000, $275,000, and $300,000 amounts are adjusted annually for inflation beginning in 2014.
Example. A married couple with adjusted gross income of $400,000 in 2013 makes charitable contributions to their church of $50,000. Based on these facts alone, the couple's Pease limitation would be $3,000 (3 percent of the amount by which their AGI exceeds the $300,000 threshold amount for married couples filing a joint return). As a result, the couple's charitable contribution deduction would be $47,000 ($50,000 less $3,000).
Example. A single person with adjusted gross income of $500,000 in 2013 makes charitable contributions to his church of $75,000. Based on these facts alone, the donor's Pease limitation would be $7,500 (3 percent of the amount by which his AGI exceeds the $250,000 threshold amount for single persons). As a result, the donor's charitable contribution deduction would be reduced from $75,000 to $67,500.
Permanently extend the 2001 modifications to the child tax credit. Generally, taxpayers with income below certain threshold amounts may claim the child tax credit to reduce federal income tax for each qualifying child under the age of 17. In 2001, EGTRRA increased the credit from $500 to $1,000 and expanded refundability. The amount that may be claimed as a refund was 15 percent of earnings above $10,000.
The American Taxpayer Relief Act of 2012 permanently extends these provisions for taxable years beginning after December 31, 2012.
Temporarily extend the 2009 modifications to the child tax credit. The American Recovery and Reinvestment Act of 2009 (ARRA) provided that earnings above $3,000 would count toward refundability. The bill extends the ARRA child tax credit expansion for five additional years, through 2017.
Permanently extend marriage penalty relief. In the past, when two persons were married, they often paid more taxes than if they had remained single. This discrepancy is known as the "marriage penalty." This penalty arose in several contexts, including the following: (1) A married couple's combined income often put them in a higher tax bracket than if they had remained single; (2) the standard deduction for a married couple was less than the standard deductions for two single persons; and (3) the earned income tax credit penalized married couples since their combined income placed them in or above the phaseout ranges for the credit. EGTRRA reduced the marriage penalty in the following ways:
- Income tax rates
It increased the 15 percent income tax rate for a married couple filing a joint return to twice the size of the corresponding rate for a single person filing a single return. The increase was phased-in over four years, beginning in 2005.
- The standard deduction
The standard deduction for married persons filing jointly was increased to twice the standard deduction for single persons.
- The earned income tax credit
Prior to EGTRRA, the earned income credit penalized some individuals because they received a smaller earned income credit if they were married than if they were not married. This was due to the fact that the combined income of married couples made it more likely that they would enter or exceed the phaseout limits that reduce the amount of the credit due to higher earned income. In order to minimize this penalty, EGTRRA increased the phaseout amount for married taxpayers who file a joint return. For married taxpayers who file a joint return, EGTRRA increased the beginning and ending of the earned income credit phaseout by $3,000. These beginning and ending points have been adjusted annually for inflation after 2002. For 2012, the threshold phaseout amounts for single taxpayers, and married couples filing jointly, with one child are $17,090 and $22,300, respectively. The completed phaseout amounts are $36,920 and $44,130, respectively.
The American Taxpayer Relief Act of 2012 extends the marriage penalty relief for the standard deduction, the 15 percent bracket, and the earned income tax credit (EITC) for taxable years beginning after December 31, 2012.
Permanently extend expanded Coverdell Accounts. Coverdell Education Savings Accounts are tax-exempt savings accounts used to pay the higher education expenses of a designated beneficiary. EGTRRA increased the annual contribution amount from $500 to $2,000 and expanded the definition of education expenses to include elementary and secondary school expenses. The Act extends the changes to Coverdell accounts for taxable years beginning after December 31, 2012.
Permanently extend the expanded exclusion for employer-provided educational assistance. An employee may exclude from gross income up to $5,250 for income and employment tax purposes per year of employer-provided education assistance. Prior to 2001, this incentive was temporary and only applied to undergraduate courses. EGTRRA expanded this provision to cover both undergraduate and graduate education, and extended the expanded exclusion through 2010. In 2010, Congress extended the expanded exclusion through 2012.
The American Taxpayer Relief Act of 2012 permanently extends the changes to this provision for taxable years beginning after December 31, 2012.
Permanently extend the expanded student loan interest deduction. Certain individuals who have paid interest on qualified education loans may claim an above-the-line deduction for such interest expenses up to $2,500. Prior to 2001, this benefit was only allowed for 60 months and phased-out for taxpayers with income between $40,000 and $55,000 ($60,000 and $75,000 for joint filers). EGTRRA eliminated the 60-month rule and increased the income phase-out to $55,000 to $70,000 ($110,000 and $140,000 for joint filers).
The American Taxpayer Relief Act of 2012 extends the changes to this provision for taxable years beginning after December 31, 2012.
Permanently extend the expanded dependent care credit. The dependent care credit allows a taxpayer a credit for an applicable percentage of child care expenses for children under 13 and disabled dependents. EGTRRA increased the amount of eligible expenses from $2,400 for one child and $4,800 for two or more children to $3,000 and $6,000, respectively. EGTRRA also increased the applicable percentage from 30 percent to 35 percent.
The American Taxpayer Relief Act of 2012 permanently extends the changes to the dependent care credit made by EGTRRA for taxable years beginning after December 31, 2012.
Permanently extend the increased adoption tax credit and the adoption assistance programs exclusion. Taxpayers that adopt children can receive a tax credit for qualified adoption expenses. A taxpayer may also exclude from income adoption expenses paid by an employer. EGTRRA increased the credit from $5,000 ($6,000 for a special needs child) to $10,000, and provided a $10,000 income exclusion for employer-assistance programs. The Patient Protection and Affordable Care Act of 2010 extended these benefits to 2011 and made the credit refundable.
The American Taxpayer Relief Act of 2012 extends for taxable years beginning after December 31, 2012, the increased adoption credit amount and the exclusion for employer-assistance programs as enacted in EGTRRA.
Permanent estate, gift and generation skipping transfer tax relief. EGTRRA phased-out the estate and generation-skipping transfer taxes so that they were fully repealed in 2010, and lowered the gift tax rate to 35 percent and increased the gift tax exemption to $1 million for 2010.
In 2010, TRUIRJCA set the exemption at $5 million per person with a top tax rate of 35 percent for the estate, gift, and generation skipping transfer taxes for two years, through 2012. The exemption amount was indexed beginning in 2012.
The American Taxpayer Relief Act of 2012 makes permanent the indexed TRUIRJCA exclusion amount and indexes that amount for inflation going forward, but sets the top tax rate to 40 percent for estates of decedents dying after December 31, 2012.
Portability of unused exemption. TRUIRJCA allowed the executor of a deceased spouse's estate to transfer any unused exemption to the surviving spouse for estates of decedents dying after December 31, 2010, and before December 31, 2012. The American Taxpayer Relief Act of 2012 makes permanent this provision and is effective for estates for decedents dying after December 31, 2012.
Reunification. Prior to EGTRRA, the estate and gift taxes were unified, creating a single graduated rate schedule for both. That single lifetime exemption could be used for gifts and bequests. EGTRRA decoupled these systems. TRUIRJCA reunified the estate and gift taxes. The American Taxpayer Relief Act of 2012 permanently extends unification and is effective for gifts made after December 31, 2012.
Permanently extend the capital gains and dividend rates. Under prior law, the capital gains and dividend rates for taxpayers below the 25 percent tax bracket was equal to zero percent. For those in the 25 percent bracket and above, the capital gains and dividend rates were 15 percent. These rates expired at the end of 2012. Upon expiration, the rates for capital gains become 10 percent and 20 percent, respectively, and dividends are subject to the ordinary income rates.
The American Taxpayer Relief Act of 2012 extends the lower capital gains and dividends rates on income at or below $400,000 (individual filers), $425,000 (heads of households) and $450,000 (married filing jointly) for taxable years beginning after December 31, 2012. For income in excess of $400,000 (individual filers), $425,000 (heads of households) and $450,000 (married filing jointly), the rate for both capital gains and dividends will be 20 percent.
Key point. The $400,000, $425,000, and $450,000 amounts are adjusted annually for inflation beginning in 2014.
Key point. The effective tax rate for many high-income taxpayers will be 23.8 percent because of the 20 percent capital gains and dividends tax rate plus the new 3.8 percent tax on investment income that was a feature of the Affordable Care Act (the healthcare reform legislation).
Temporarily extend the American Opportunity Tax Credit. The American Opportunity Tax Credit is available for up to $2,500 of the cost of tuition and related expenses paid during the taxable year. Under this tax credit, taxpayers receive a tax credit based on 100 percent of the first $2,000 of tuition and related expenses (including course materials) paid during the taxable year and 25 percent of the next $2,000 of tuition and related expenses paid during the taxable year. Forty percent of the credit is refundable. This tax credit is subject to a phase-out for taxpayers with adjusted gross income in excess of $80,000 ($160,000 for married couples filing jointly).
The American Taxpayer Relief Act of 2012 extends the American Opportunity Tax Credit for five additional years, through 2017.
Temporarily extend third-child EITC. Under prior law, working families with two or more children qualified for an earned income tax credit equal to 40 percent of the family's first $12,570 of earned income. In 2009 Congress increased the earned income tax credit to 45 percent for families with three or more children and increased the beginning point of the phase-out range for all married couples filing a joint return (regardless of the number of children) to lessen the marriage penalty.
The American Taxpayer Relief Act of 2012 extends for five additional years, through 2017, the 2009 expansions that increased the EITC for families with three or more children and increased the phase-out range for all married couples filing a joint return.
Permanently extend refund and tax credit disregard for means-tested programs. Prior law ensured that the refundable components of the EITC and the Child Tax Credit did not make households ineligible for means-tested benefit programs and included provisions stating that these tax credits did not count as income in determining eligibility (and benefit levels) in means-tested benefit programs, and also did not count as assets for specified periods of time. Without them, the receipt of a tax credit would put a substantial number of families over the income limits for these programs in the month that the tax refund is received. A provision enacted as part of TRUIRJCA disregarded all refundable tax credits and refunds as income for means-tested programs through 2012.
The American Taxpayer Relief Act of 2012 permanently extends this provision for any amount received after December 31, 2012.
Permanent AMT patch. Under prior law a taxpayer received an exemption of $33,750 (individuals) and $45,000 (married filing jointly) under the alternative minimum tax (AMT). Prior law also did not allow nonrefundable personal credits against the AMT.
The American Taxpayer Relief Act of 2012 increases the exemption amounts for 2012 to $50,600 (individuals) and $78,750 (married filing jointly) and for future years indexes the exemption and phaseout amounts for inflation. It also allows the nonrefundable personal credits against the AMT. These changes are effective for taxable years beginning after December 31, 2011.
Key point. Some analysts speculate that the reason Congress previously enacted a series of two-year "patches" to the AMT, rather than a one-time permanent fix, was to present a far more positive budgetary outlook based on the tenuous assumption that the AMT would not be patched in the future.
Deduction for certain expenses of elementary and secondary school teachers. The Act extends for two years the $250 above-the-line tax deduction for teachers and other school professionals for expenses paid or incurred for books, supplies (other than non-athletic supplies for courses of instruction in health or physical education), computer equipment (including related software and service), other equipment, and supplementary materials used by the educator in the classroom.
Mortgage Debt Relief. Under current law, taxpayers who have mortgage debt canceled or forgiven after 2012 may be required to pay taxes on that amount as taxable income. Under the Act, up to $2 million of forgiven debt is eligible to be excluded from income ($1 million if married filing separately) through tax year 2013. This provision was created in the Mortgage Debt Relief Act of 2007 to prevent the taxation of so-called "shadow income" from foreclosures and cancelled debts through 2010. It was extended through 2012 by the Emergency Economic Stabilization Act of 2008.
Parity for exclusion from income for employer-provided mass transit and parking benefits. This provision would extend through 2013 the increase in the monthly exclusion for employer-provided transit and vanpool benefits from $125 to $240, so that it would be the same as the exclusion for employer-provided parking benefits.
Deduction for state and local general sales taxes. Congress enacted legislation in 2004 providing that, at the election of the taxpayer, an itemized deduction may be taken for state and local general sales taxes in lieu of the itemized deduction for state and local income taxes. Taxpayers have two options with respect to the determination of the sales tax deduction amount. They can deduct the total amount of general state and local sales taxes paid by accumulating receipts showing general sales taxes paid, or they can use tables created by the IRS. The tables are based on average consumption by taxpayers on a state-by-state basis, taking into account filing status, number of dependents, adjusted gross income, and rates of state and local general sales taxation.
Taxpayers who use the tables may, in addition, deduct eligible general sales taxes paid with respect to the purchase of motor vehicles, boats, and other items specified by the IRS. Sales taxes for items that may be added to the tables would not be reflected in the tables themselves.
This provision was added to address the unequal treatment of taxpayers in the nine states that assess no income tax. Taxpayers in these states cannot take advantage of the itemized deduction for state income taxes. Allowing them to deduct sales taxes will help offset this disadvantage.
This deduction was scheduled to expire after 2005, but Congress extended it through 2009, and again through 2011.
The American Taxpayer Relief Act of 2012 extends for two years (through 2013) the election to take an itemized deduction for state and local general sales taxes in lieu of the itemized deduction permitted for state and local income taxes.
Above-the-line deduction for qualified tuition related expenses. EGTRRA created an above-the-line tax deduction for qualified higher education expenses. The maximum deduction was $4,000 for taxpayers with AGI of $65,000 or less ($130,000 for joint returns) or $2,000 for taxpayers with AGI of $80,000 or less ($160,000 for joint returns).
The American Taxpayer Relief Act of 2012 extends the deduction to the end of 2013.
Tax-free distributions from individual retirement plan for charitable purposes. Congress enacted legislation in 2006 allowing tax-free qualified charitable distributions of up to $100,000 from an IRA to a church or other charity. Note the following rules and conditions:
- A qualified charitable distribution is any distribution from an IRA directly by the IRA trustee to a charitable organization, including a church, that are made on or after the date the IRA owner attains age 70&frac;.
- A distribution will be treated as a qualified charitable distribution only to the extent that it would be includible in taxable income without regard to this provision.
- This provision applies only if a charitable contribution deduction for the entire distribution would be allowable under present law, determined without regard to the generally applicable percentage limitations. For example, if the deductible amount is reduced because the donor receives a benefit in exchange for the contribution of some or all of his or her IRA account, or if a deduction is not allowable because the donor did not have sufficient substantiation, the exclusion is not available with respect to any part of the IRA distribution.
This provision, which was scheduled to expire at the end of 2011, is extended for two more years (through 2013) by the American Taxpayer Relief Act of 2012.
The Act also contains a transition rule under which an individual can make a rollover during January of 2013 and have it count as a 2012 rollover. Also, individuals who took a distribution in December of 2012 will be able to contribute that amount to a charity and count as an eligible charitable rollover to the extent it otherwise meets the requirements for an eligible charitable rollover.
Enhanced charitable deduction for contributions of food inventory. The Act extends for two years (through 2013) the provision allowing businesses to claim an enhanced deduction for the contribution of food inventory.
Need More Information?
Read more about key tax law changes for churches and church leaders in Richard Hammar's 2013 Church & Clergy Tax Guide, available at ChurchLawAndTaxStore.com or by calling 1-800-222-1840.
This article first appeared in Church Law & Tax Report, March/April 2013.
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