Mid-Year Update: Federal & State Taxes

State Taxes

While there were not that many major tax law changes in Pennsylvania this year, it appears as if there are big changes on the horizon as House Bill 465 is inundated with tax provisions.  Pending Governor Corbett’s signature, one key provision would close the “Delaware loophole” that allows corporations to minimize tax obligations by transferring assets to out-of-state holding companies.

Pennsylvania House Bill 761, which was signed into law on July 2, 2012, made a number of tax law changes, especially to corporate income tax.  One significant change is that all business income will be apportioned to Pennsylvania through the use of single sales factor.  Additionally, if a federal tax return or change has been made, the period of time to notify the Department of Revenue has changed from 30 days to six months.  An automatic extension will be given to those filing Pennsylvania corporate net income tax returns if they have also been granted an extension to file their federal returns.  The Pennsylvania return will be due 30 days after the federal extension period has expired.

Federal Taxes

With the fiscal cliff looming, Congress was able to finally reach an agreement and passed the American Taxpayer Relief Act of 2012 (ATRA).  Effective January 1, 2013, this act gave some clarity to the tax rate increases that would have otherwise automatically began at the start of the new year.  This act included some major provisions that will directly impact the amount of taxes paid by higher-income individuals.

The Bush-era tax cuts were extended to all taxpayers except for those in the highest tax bracket.  In reaching a compromise, Congress determined that this would apply to individuals earning $400,000 a year or more, $450,000 or more if married and filing jointly, and $425,000 a year or more if filing as head of household.  Those making up the highest tax bracket are now subject to a new 39.6 percent marginal tax rate on income over the specified thresholds.

Essentially, this means that such individuals will only be taxed at the 39.6 percent rate on income above the threshold amount.  So, an individual earning $455,000 per year would only pay taxes at the 39.6 percent rate on the $55,000 he or she has earned over the threshold level of $400,000.  If the same amount of annual income was earned by those married and filing jointly, they would only be taxed at 39.6 percent on $5,000.  Different marginal rates are assigned to the various tax brackets and they would be applied accordingly.  It is still possible to lower this rate if deductions, such as a 401(k) contribution, bring the taxpayer(s) into a lower tax bracket.

The capital gains and qualified dividends tax rate rose permanently from 15 to 20 percent for those in the highest tax bracket.  Those whose income is taxed at rates between 25 percent up to the highest tax bracket threshold will be subject to a 15 percent tax on their capital gains and qualified dividends.  Those whose income is taxed at a rate of lower than 25 percent will be subject to a permanent rate of 0 percent.

A provision of the ATRA will phase out deductions and personal exemptions for higher earners.  If a person’s adjusted gross income (AGI) is over $250,000 or if it is over $300,000 for those married and filing jointly, for every $2,500 that is earned over this threshold, his or her personal exemptions will be reduced by 2 percent.  If an individual’s AGI is greater than $372,501 or a married couple’s exceeds $422,501, their personal exemptions will be fully phased out.  For all others, the personal exemption amount is increased by $100 to $3,900.

Additionally, the phaseout of itemized deductions (called the “Pease” phaseout) will reduce the value of itemized deductions by 3 percent for taxpayers whose AGI is greater than $300,000 if they are married and filing jointly and $250,000 for single filers.  This is limited up to a maximum reduction of 80% in value.  Certain itemized deductions will be exempt from this phaseout including medical expenses, investment interest, and casualty, theft or gambling loses.

The Alternative Minimum Tax (AMT) exemption amounts have been permanently patched for inflation.  The exemption amount is $51,900 for single filers and $80,800 for joint filers.  The ATRA made it so that from now on, as inflation rises, so too will the exemption amounts.