Coverdell Education Savings Account And 2011

Tax cliff averted: Congress raises rates on wealthiest, extends many provisions.

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Pulling back from the “fiscal cliff” at the 13th hour,
Congress on New Year’s Day preserved most of the George W. Bush-era
tax cuts and extended many other lapsed tax provisions.

The new law brings a multitude of changes affecting both 2012
returns and, for the new year, tax planning, withholding, and estimated
tax payments, prompting many considerations for CPAs and their clients
concerning implementation of the new measures. In addition, new taxes
and provisions enacted in 2010 by health care reform legislation took
effect Jan. 1.

Shortly before 2 a.m. on Jan. 1, the Senate passed by a vote of
89-8 the American Taxpayer Relief Act of 2012, H.R. 8, which embodied an
agreement that had been hammered out over the preceding two days between
Vice President Joe Biden and Senate Minority Leader Sen. Mitch
McConnell, R-Ky. The House of Representatives approved the bill by a
vote of 257-167 late that evening, after plans to amend the bill to
include spending cuts were abandoned. President Barack Obama signed the
bill Jan. 2.

“The AICPA is pleased that an agreement has been signed into
law,” said Edward Karl, vice president–Tax for the AICPA.
“Besides allowing the IRS and tax software providers to implement
critically needed administrative plans and updates for the current tax
season, the act should now enable taxpayers to make informed decisions
and businesses to get on with their long-term tax and cash flow
planning. The AICPA has been working with our members to help them
understand and implement these changes in the tax law We also will
continue to closely follow tax-related developments as the next chapter
in the legislative saga unfolds.”

The act’s impact on tax season was not immediately known. The
IRS issued a statement on Jan. 2 saying that it was assessing what
effect the act would have. The IRS released updated withholding tables
on Jan. 3.

With some modifications targeting the wealthiest Americans with
higher taxes, the act permanently extends provisions of the Economic
Growth and Tax Relief Reconciliation Act of 2001, P.L. 107-16 (EGTRRA),
and Jobs and Growth Tax Relief-Reconciliation Act of 2003, P.L. 108-27
(JGTRRA). It also permanently takes care of Congress’s perennial
job of “patching” the alternative minimum tax (AMT). It
temporarily extends many other tax provisions that briefly lapsed at
midnight on Dec. 31, 2012, and others that had expired a year earlier.

The act’s nontax features include one-year extensions of
emergency unemployment insurance and agricultural programs and yet
another “doc fix” postponement of automatic cuts in Medicare
payments to physicians. In addition, it delays until March a broad range
of automatic federal spending cuts known as sequestration that otherwise
would have begun immediately

Among the tax items not addressed by the act was the temporary
lower 4.2% rate for employees’ portion of the Social Security
payroll tax, which was not extended and has reverted to 6.2%. Certain
taxpayers also face higher taxes starting in 2013 as a result of
provisions also described below that were enacted by the 2010 health
care reform legislation.

Here are the act’s main tax features:

INDIVIDUAL INCOME TAX RATES

All the individual marginal tax rates under EGTRRA and JGTRRA are
retained (10%, 15%, 25%, 28%, 33%, and 35%). A new top rate of 39.6% is
imposed on taxable income over $400,000 for single fliers, $425,000 for
head-of-household fliers, and $450,000 for married taxpayers filing
jointly ($225,000 for each married spouse filing separately).

PHASEOUT OF ITEMIZED DEDUCTIONS AND PERSONAL EXEMPTIONS

The personal exemptions and itemized deductions phaseout is
reinstated at a higher threshold of $250,000 for single taxpayers,
$275,000 for heads of household, and $300,000 for married taxpayers
filing jointly

CAPITAL GAINS AND DIVIDENDS

A 20% rate applies to capital gains and dividends for individuals
above the top income tax bracket threshold; the 15% rate is retained for
taxpayers in the middle brackets. The zero rate is retained for
taxpayers in the 10% and 15% brackets.

ALTERNATIVE MINIMUM TAX

The exemption amount for the AMT on individuals is permanently
indexed for inflation. For 2012, the exemption amounts are $78,750 for
married taxpayers filing jointly and $50,600 for single fliers. Relief
from AMT for nonrefundable credits is retained.

ESTATE AND GIFT TAX

The estate and gift tax exclusion amount is retained at $5 million
indexed for inflation ($5.12 million in 2012), but the top tax rate
increases from 35% to 40% for decedents dying, gifts made, and
generation-skipping transfers made on or after Jan. 1, 2013. The estate
tax “portability” election, under which, if an election is
made, the surviving spouse’s exemption amount is increased by the
deceased spouse’s unused exemption amount, is made permanent by the
act.

IN-PLAN ROTH ROLLOVERS

The act changes the rules governing in-plan rollovers from Sec.
401(k), 403(b), or 457(b) plans to a Roth 401(k) plan, allowing these
rollovers to be made without a distribution. Under a special rule (new
subparagraph (E) added to Sec. 402A(c)(4)), participants may transfer
any amount not otherwise distributable under the plan to the designated
Roth account as a qualified rollover contribution.

PERMANENT EXTENSIONS

Various temporary tax provisions enacted as part of EGTRRA are made
permanent. These include:

* Marriage penalty relief(i.e., the increased size of the 15% rate
bracket (Sec. 1(f)(8)) and increased standard deduction for married
taxpayers filing jointly (Sec. 63(c)(2));

* The liberalized child and dependent care credit rules (allowing
the credit to be calculated based on up to $3,000 of expenses for one
dependent or up to $6,000 for more than one) (Sec. 21);

* The exclusion for National Health Service Corps and Armed Forces
Health Professions scholarships (Sec. 117(c)(2));

* The exclusion for employer-provided educational assistance (Sec.
127);

* The enhanced rules for student loan deductions introduced by
EGTRRA (Sec. 221);

* The higher contribution amount and other EGTRRA changes to
Coverdell education savings accounts (Sec. 530);

* The employer-provided child care credit (Sec. 45F);

* Special treatment of tax-exempt bonds for education facilities
(Sec 142(a)(13));

* Repeal of the collapsible corporation rules (Sec. 341);

* Special rates for accumulated earnings tax and personal holding
company tax (Secs. 531 and 541);

* Expanded adoption credit (Sec. 23) and adoption-assistance
program (Sec. 137) amounts; and

* Modified tax treatment for electing Alaska Native Settlement
Trusts (Sec. 646).

INDIVIDUAL CREDITS EXPIRED AT THE END OF 2012

The American opportunity tax credit for qualified tuition and other
expenses of higher education is extended through 2017. Other credits and
items from the American Recovery and Reinvestment Act of 2009, P.L.
111-5, that are extended for the same five-year period include enhanced
provisions of the child tax credit under Sec. 24(d) and the earned
income tax credit under Sec. 32(b). In addition, the bill permanently
extends a rule excluding from taxable income refunds from certain
federal and federally assisted programs (Sec. 6409).

INDIVIDUAL PROVISIONS EXPIRED AT THE END OF 2011

The act also extends through 2013 a number of temporary individual
tax provisions, most of which expired at the end of 2011:

* Deduction for certain expenses of elementary and secondary
schoolteachers (Sec. 62);

* Exclusion from gross income of discharge of qualified principal
residence indebtedness (Sec. 108);

* Parity for exclusion from income for employer-provided mass
transit and parking benefits (Sec. 132(f));

* Mortgage insurance premiums treated as qualified residence
interest (Sec. 163(h));

* Deduction of state and local general sales taxes (Sec. 164(b));

* Special rule for contributions of capital gain real property made
for conservation purposes (Sec. 170(b));

* Above-the-line deduction for qualified tuition and related
expenses (Sec. 222); and

* Tax-free distributions from individual retirement plans for
charitable purposes (Sec. 408(d)).

BUSINESS TAX EXTENDERS

The act also extends many business tax credits and other
provisions. Notably, it extends through 2013 and modifies the Sec. 41
credit for increasing research and development activities, which expired
at the end of 2011. The credit is modified to allow partial inclusion in
qualified research expenses and gross receipts those of an acquired
trade or business or major portion of one. The increased expensing
amounts from 2011 under Sec. 179 are extended through 2013. The
availability of an additional 50% first-year bonus depreciation (Sec.
168(k)) is also extended for one year by the act. It now generally
applies to property placed in service before Jan. 1, 2014 (Jan. 1, 2015,
for certain property with longer production periods).

Other business provisions extended through 2013, and in some cases
modified, are:

* Temporary minimum low-income tax credit rate for non-federally
subsidized new buildings (Sec. 42);

* Housing allowance exclusion for determining area median gross
income for qualified residential rental project exempt facility bonds
(Section 3005 of the Housing Assistance Tax Act of 2008);

* Indian employment tax credit (Sec. 45A);

* New markets tax credit (Sec. 45D);

* Railroad track maintenance credit (Sec. 45G);

* Mine rescue team training credit (Sec. 45N);

* Employer wage credit for employees who are active duty members of
the uniformed services (Sec. 45P);

* Work opportunity tax credit (Sec. 51);

* Qualified zone academy bonds (Sec. 54E);

* Fifteen-year straight-line cost recovery for qualified leasehold
improvements, qualified restaurant buildings and improvements, and
qualified retail improvements (Sec. 168(e));

* Accelerated depreciation for business property on an Indian
reservation (Sec. 1680(j));

* Enhanced charitable deduction for contributions of food inventory
(Sec. 170(e));

* Election to expense mine safety equipment (Sec. 179E);

* Special expensing rules for certain film and television
productions (Sec. 181);

* Deduction allowable with respect to income attributable to
domestic production activities in Puerto Rico (Sec. 199(d));

* Modification of tax treatment of certain payments to controlling
exempt organizations (Sec. 512(b));

* Treatment of certain dividends of regulated investment companies
(Sec. 871(k));

* Regulated investment company qualified investment entity
treatment under the Foreign Investment in Real Property Tax Act (Sec.
897(h));

* Extension of subpart F exception for active financing income
(Sec. 953(e));

* Lookthrough treatment of payments between related controlled
foreign corporations under foreign personal holding company rules (Sec.
954);

* Temporary exclusion of 100% of gain on certain small business
stock (Sec. 1202);

* Basis adjustment to stock of S corporations making charitable
contributions of property (Sec. 1367);

* Reduction in S corporation recognition period for built-in gains
tax (Sec. 1374(d));

* Empowerment zone tax incentives (Sec. 1391);

* Tax-exempt financing for New York Liberty Zone (Sec. 1400L);

* Temporary increase in limit on cover-over of rum excise taxes to
Puerto Rico and the Virgin Islands (Sec. 7652(f)); and

* American Samoa economic development credit (Section 119 of the
Tax Relief and Health Care Act of 2006, P.L. 109-432, as modified).

ENERGY TAX EXTENDERS

The act also extends through 2013, and in some cases modifies, a
number of energy credits and provisions, most of which expired at the
end of 2011:

* Credit for energy-efficient existing homes (Sec. 25C);

* Credit for alternative fuel vehicle refueling property (Sec.
30C);

* Credit for two- or three-wheeled plug-in electric vehicles (Sec.
30D);

* Cellulosic biofuel producer credit (Sec. 40(b), as modified);

* Incentives for biodiesel and renewable diesel (Sec. 40A);

* Production credit for Indian coal facilities placed in service
before 2009 (Sec. 45(e)) (extended to an eight-year period);

* Credits with respect to facilities producing energy from certain
renewable resources (Sec. 45(d), as modified);

* Credit for energy-efficient new homes (Sec. 45L);

* Credit for energy-efficient appliances (Sec. 45M);

* Special allowance for cellulosic biofuel plant property (Sec.
168(1), as modified);

* Special rule for sales or dispositions to implement Federal
Energy Regulatory Commission or state electric restructuring policy for
qualified electric utilities (Sec. 451); and

* Alternative fuels excise tax credits (Sec. 6426).

FOREIGN PROVISIONS

The IRS’s authority under Sec. 1445(e)(1) to apply a
withholding tax to gains on the disposition of U.S. real property
interests by partnerships, trusts, or estates that are passed through to
partners or beneficiaries that are foreign persons is made permanent,
and the amount is increased to 20%.

NEW TAXES UNDER 2010 HEALTH CARE REFORM

Apart from the American Taxpayer Relief Act’s provisions, some
new taxes and other provisions also took effect Jan. i as a result of
2010’s health care reform legislation.

Additional hospital insurance tax on high-income taxpayers. The
employee portion of the hospital insurance part of Federal Insurance
Contributions Act tax (FICA), normally 1.45% of covered wages, is
increased by 0.9% on wages that exceed a threshold amount. The
additional tax is imposed on the combined wages of both the taxpayer and
the taxpayer’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.

For self-employed taxpayers, the same additional hospital insurance
tax applies to the hospital insurance portion of Self-Employment
Contributions Act (SECA) tax on self-employment income in excess of the
threshold amount.

Medicare tax on investment income. Starting Jan. 1, Sec. 1411
imposes a tax on individuals equal to 3.8% of the lesser of the
individual’s net investment income for the year or the amount the
individual’s modified adjusted gross income (AGI) exceeds a
threshold amount. For estates and trusts, the tax equals 3.8% of the
lesser of undistributed net investment income or AGI over the dollar
amount at which the highest trust and estate tax bracket begins.

For married individuals filing a joint return and surviving
spouses, the threshold amount is $250,000; for married taxpayers filing
separately, it is $125,000; and, for other individuals, it is $200,000.

Net investment income means investment income reduced by deductions
properly allocable to that income. Investment income includes income
from interest, dividends, annuities, royalties, and rents, and net gain
from disposition of property, other than such income derived in the
ordinary course of a trade or business. However, income from a trade or
business that is a passive activity and from a trade or business of
trading in financial instruments or commodities is included in
investment income.

Medical care itemized deduction threshold. The threshold for the
itemized deduction for unreimbursed medical expenses has increased from
7.5% of AGI to 10% of AGI for regular income tax purposes. This is
effective for all individuals, except, in the years 2013-2016, if either
the taxpayer or the taxpayer’s spouse has turned 65 before the end
of the tax year, the increased threshold does not apply and the
threshold remains at 7.5% of AGI.

Flexible spending arrangement. Effective for cafeteria plan years
beginning after Dec. 31,2012, the maximum amount of salary reduction
contributions that an employee may elect to have made to a health
flexible spending arrangement for any plan year is $2,500.

Editor’s note: An updated version of the JofA’s Filing
Season Quick Guide for tax year 2012, reflecting changes made by the
American Taxpayer Relief Act, is available for download at
tinyurl.com/b2zyjp7.

AICPA RESOURCES

JofA articles

* “Tax and Fiscal Cliff Resources,”
journalofaccountancy.com/News/ Taxmageddon.htm

* “Year-End Tax Planning: Preparing for the Tax Cliff,”
Dec. 2012, page 48

* “Facing the Tax Cliff,” Nov. 2012, page 48

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Paul Bonner is a JofA senior editor, and Alistair M. Nevius is the
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