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Bush-Era Tax Cuts: Capital Gains and Dividends Sunsets
Under current law, reduced tax rates on qualified capital gains and dividends are scheduled to sunset after 2012. The pre-JGTRRA treatment (as extended by the 2010 Tax Relief Act) of qualified capital gains and dividends would apply thereafter.
The 2010 Tax Relief Act extended the reduced maximum tax rate of 15 percent on adjusted net capital gains through 2012. The 15 percent rate had originally been enacted in JGTRRA and was extended by the Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA). Additionally, taxpayers in the 10 percent and 15 percent tax brackets are eligible for a zero percent tax rate on qualified capital gains through 2012.
Impact: Absent extension, the maximum tax rate on net capital gain of noncorporate taxpayers will revert to 20 percent (10 percent for taxpayers in the 15 percent bracket) after 2012. Thus, the acceleration of capital gains into 2012 while the tax rates are lower should be considered. Accelerating the sale of capital assets is generally how taxpayers implement this strategy. As long as the sale is bona fide, and the proceeds are received in 2012, capital gains can be accelerated. The “wash sale” rules that apply to claiming losses do not apply to gains. Accordingly, capital gains can be recognized at any time and, immediately thereafter, the identical asset can be repurchased, with a new tax basis established in the amount of the purchase price.
Comment: Under current law, the 28 percent and 25 percent tax rates for collectibles and recaptured Code Sec. 1250 gain, respectively, are scheduled to continue unchanged after 2012. Also unchanged are the ordinary income rates paid on short-term capital gains; only long-term capital gains realized on assets held for more than one year can benefit from the reduced net capital gain rate.
Caution: Installment payments received after 2012 are subject to the tax rates for the year of the payment, not the year of the sale. Thus, the capital gains portion of payments made in 2013 and later may be taxed at the 20 percent rate.
Five-year holding period for capital
Under the 2010 Tax Relief Act, there is no special capital gain treatment in 2011 or 2012 for property held for more than five years. After 2012, the JGTRRA-based lower capital gain rates for five-year gain of individuals, estates, and trusts are scheduled to be revived. Long-term gain on the sale or exchange of property held for more than five years generally will be taxed at 18 percent (8 percent for taxpayers in the 15 percent bracket).
Impact: For higher-income taxpayers, the 15 percent rate under the 2010 Tax Relief Act applies if the taxpayer has held the asset for more than one year, but only if the taxpayer sells the asset by no later than December 31, 2012. The 18 percent rate for qualified five-year property applies if the taxpayer acquired the asset in 2001 or later, has held the asset for more than five years, and sells it after December 31, 2012. The 20 percent rate applies if the taxpayer acquired the asset in 2001 or later, sells the asset after December 31, 2012, and has held the asset for more than one but not more than five years; or has held the asset for more than five years but acquired the asset by exercising an option, right, or obligation to acquire the property, and the taxpayer has held the asset since before 2001.
The 2010 Tax Relief Act extended the reduced net capital gains tax rates for qualified dividends through 2012. These rates had originally been enacted by JGTRRA and were extended by TIPRA. The maximum tax rate for qualified dividends received by an individual is 15 percent for tax years beginning before January 1, 2013. A zero percent rate applies to qualified dividends received by an individual in the 10 percent or 15 percent income tax rate brackets.
Impact: Absent extension, qualified dividends will be taxed at the applicable ordinary income tax rates after 2012 (with the highest rate scheduled to be 39.6 percent after 2012), despite the highest rate for net capital gains rising to 20 percent. Qualified corporations may want to explore declaring a special dividend to shareholders before January 1, 2013. President Obama’s proposed fiscal year 2013 federal budget recommended increasing the dividends rate to the ordinary income tax rate for higher-income individuals.
Comment: Generally, dividends received from a domestic corporation or a qualified foreign corporation, on which the underlying stock is held for at least 61 days within a specified 121-day period, are qualified dividends for purposes of the reduced tax rate. Certain dividends do not qualify for the reduced tax rates. They include (not an exhaustive list) dividends paid by credit unions, mutual insurance companies, and farmers’ cooperatives.
Other dividend-related provisions
The following business-entity-related tax breaks associated with dividends are also scheduled to sunset after 2012:
- Dividends received from a regulated investment company (RIC), real estate investment trust (REIT), and other qualified pass-through entities are treated as qualified dividends for purposes of the reduced tax rates through 2012.
- Temporary repeal of the collapsible corporation rule would end after 2012.
- The accumulated earnings tax rate imposed on corporations, which had been reduced to 15 percent, would rise to 39.6 percent after 2012.
- The tax on undistributed personal holding company (PHC) income would also rise from its temporary 15 percent rate to the highest individual tax rate.
Alternative minimum tax
EGTRRA and subsequent laws enacted so-called AMT “patches.” The patches increased exemption amounts for the growing number of taxpayers subject to the AMT. The patches also allowed nonrefundable personal credits to the full amount of the individual’s regular tax and AMT. The most recent patch, in the 2010 Tax Relief Act, expired after 2011.
Impact: For 2011, the exemption amounts were $48,450 for unmarried individuals filing a single return, and $74,450 for married couples filing a joint return and surviving spouses. Under current law for 2012, the exemption amounts — unless changed by Congress — drop precipitously to $33,750 for unmarried individuals filing a single return, and $45,000 for married couples filing a joint return, and surviving spouses.
Impact: The “patch” in the 2010 Tax Relief Act provided that all nonrefundable personal credits are allowed to the full extent of the taxpayer’s regular tax and AMT liability. If a similar patch is not enacted for 2012, only certain nonrefundable credits would be allowed against AMT liability, including (not an exhaustive list) the child tax credit, the American Opportunity Tax Credit (AOTC), and the retirement savings contribution credit (saver’s credit).
Comment: The House GOP has proposed to eliminate the AMT. However, proposals to abolish the AMT have stalled in Congress, largely due to the projected loss of revenue. The AMT is a “cash cow” for the federal government and lawmakers under tight budgetary constraints in the 2011 Budget Control Act are reluctant to eliminate the AMT. However, they are expected to patch the AMT for 2012 and possibly 2013, until a more permanent solution is found. The Joint Committee on Taxation has estimated that an AMT patch for 2012 would cost $92 billion over 10 years.
Comment: President Obama has proposed to replace at least part of the AMT with the so-called “Buffett Rule.” The White House has explained the Buffett Rule in general terms as ensuring that taxpayers making over $1 million annually would pay an effective tax rate of at least 30 percent. In April 2012, the Senate rejected the Paying a Fair Share Act, which would implement the Buffett Rule. Democrats are expected to reintroduce the bill.
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