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.” The 157-page Act 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.
Here are some tax benefits that have been extended through 2012 (and in some cases longer):
- The lower income tax rates for most Americans that were enacted by Congress in 2001.
- The lower capital gains and dividends rates for most Americans.
- The enhanced child tax credit.
- Marriage penalty relief.
- Enhancements in the dependent care credit and earned income tax credit. Enhancements in Coverdell Education Savings Accounts.
- Expansion of the credit for employer-provided educational assistance.
- Extension of the American Opportunity Tax Credit.
- Increased exemption amounts in computing the alternative minimum tax.
- An extension of the $250 above-the-line tax deduction for teachers and other school professionals for expenses paid or incurred for books and equipment used in the classroom.
- The deduction of state and local general sales taxes.
- Extension of tax-free distributions from individual retirement plans for charitable purposes.
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. 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 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 to 4.2 percent of wages, and the Social Security component of self-employment taxes dropped from 12.4 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 early in 2012 temporarily extending the two percentage point 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.
- 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 are predicting that 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.
The elimination of the reduction in the employees’ share of Social Security taxes will result in a tax hike for an estimated 77 percent of all 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.
Tax-free distributions from individual retirement plans 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 is made on or after the date the IRA owner attains age 70½.
- 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 it as an eligible charitable rollover to the extent it otherwise meets the requirements for an eligible charitable rollover.