By J. Haden Werhan, CPA/PFS
Call me a news junkie. I was glued to the television during the final days of 2012 and New Year’s Day watching the Administration and Congress spar over the impending “fiscal cliff.” On DentistryIQ.com, November 19, 2012 (“The Fiscal Cliff and Dentistry: What Dentists and Dental Team Members Need to Know”), I speculated that, like Thelma and Louise, we could drive off the fiscal cliff. In our alternate ending, however, we were pulled back up with the passage of the American Taxpayer Relief Act of 2012 (ATRA).
So, what does this legislation mean to dentists? First and foremost, the Sunset Provision of the Bush tax cuts was eliminated and many of the provisions of the temporary Tax Relief Act of 2010 were extended for two years. For dentists earning less than $250,000, not much will change. For those earning over $250,000, the phase out of personal exemptions and itemized deductions will come back into play – basically increasing one’s income. The greatest impact from ATRA will be on single taxpayers earning over $400,000 and married taxpayers filing joint returns earning over $450,000.
For tax years beginning after 2012, the Taxpayer Relief Act maintains the income tax rates for most individuals at 10%, 15%, 25%, 28%, 33% and 35% (instead of moving to 15%, 28%, 31%, 36% and 39.6% as would have occurred under the sunset provisions). However, a 39.6% rate will apply to taxable income above a certain threshold (specifically, taxable income in excess of the threshold over the dollar amount at which the 35% bracket begins). The applicable threshold is $450,000 for joint filers and surviving spouses; $425,000 for heads of household; $400,000 for single filers; and $225,000 for married taxpayers filing separately. These dollar amounts are inflation-adjusted for tax years after 2013.
For tax years beginning after 2012, PEP (Personal Exemption Phaseout), which had previously been suspended, is reinstated with a starting threshold of $300,000 for joint filers and a surviving spouse; $275,000 for heads of household; $250,000 for single filers; and $150,000 for married taxpayers filing separately. Under the phaseout, the total amount of exemptions that can be claimed by a taxpayer subject to the limitation is reduced by 2% for each $2,500 (or portion thereof) by which the taxpayer’s AGI exceeds the applicable threshold. These dollar amounts are inflation-adjusted for tax years after 2013.
Also for tax years beginning after 2012, ATRA provides that the Pease limitation on itemized deductions (named after former Congressman Donald Pease), which had previously been suspended, is reinstated with the same thresholds as those for PEP. Thus, for taxpayers subject to the Pease limitation, the total amount of their itemized deductions is reduced by 3% of the amount by which the taxpayer’s AGI exceeds the threshold amount, with the reduction not to exceed 80% of the otherwise allowable itemized deductions. These dollar amounts are inflation-adjusted for tax years after 2013.
For 2012 and forward, ATRA permanently increases the Alternative Minimum Tax (AMT) exemption amounts. As a result, the AMT exemption amounts are as follow:
• Married individuals filing jointly and surviving spouses: $78,750, less 25% of AMTI exceeding $150,000 (exemption phased out when AMTI is $465,000);
• Unmarried individuals: $50,600, less 25% of AMTI exceeding $112,500 (exemption phased out when AMTI is $314,900); and
• Married individuals filing separately: $39,375, less 25% of AMTI exceeding $75,000 (exemption phased out when AMTI is $232,500).
For tax years beginning after 2012, ATRA indexes these exemption amounts for inflation – somewhat correcting the flaw in AMT, which was originally designed to capture only the wealthiest of taxpayers.
Of significant importance to dentists contemplating the sale of their practices whose ordinary income is taxed at a rate below 25%, capital gains (and dividends) will permanently be subject to a 0% rate. Those who are subject to a 25% or greater rate on ordinary income, but whose taxable income falls below the applicable threshold — $450,000 for joint filers and surviving spouses; $425,000 for heads of household; $400,000 for single filers; and $225,000 for married taxpayers filing separately — will continue to be subject to a 15% rate on capital gains and dividends. For dentists with income above these thresholds, meaning, subject to the highest 39.6% income tax rate, the capital gain rate is 20%.
Not part of ATRA but coming into play in 2013 are:
• The expiration of the 2% payroll tax cut created in the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 and extended through the end of 2012 year by the Middle Class Tax Relief and Job Creation Act of 2012. This affects all working taxpayers.
• The Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act of 2010 (“Obama Care”) is the .9% Medicare tax increase. There will be a number of provisions phasing in between now and 2020. This tax is the most costly to single taxpayers earning over $200,000 and married taxpayers earning over $250,000. It also calls for 3.8% surtax on investment income (rental, interest, dividends, and capital gains) for these same taxpayers.
These taxes along with higher capital gain tax rates make planning for the sale of a practice especially important to you and your dental CPA since there will be situations in which a dentist could pay 23.8% tax on the sale of assets that would previously be taxed at 15%.
There are numerous other provisions of ATRA including the one-year extension of an exclusion for discharged home mortgage indebtedness, treatment of mortgage insurance premiums (PMI) as deductible home mortgage interest, and nontaxable IRA transfers to eligible charities which qualify as required minimum distributions (RMDs). There is also good news concerning gift, transfer and estate taxes with most provisions of the Bush tax cuts made permanent. Also, many of the energy related tax provisions set to expire at the end of 2011 were extended through 2013.
All in all, things could have been a lot worse for dentists, but there are so many moving parts in our current tax code, careful planning is more critical than ever. My next article will provide a summary of practice (business) related changes under ATRA including Section 179 and bonus depreciation.
Feel free to contact J. Haden Werhan, CPA/PFS, principal and owner of Thomas Wirig Doll, an accounting and wealth management firm that works with dentists. He can be reached at [email protected] or (877) 939-2500.
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