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The text below became obsolete with the American Taxpayer Relief Act (ATRA). An unprecedented number of tax provisions were set to expire on December 31, 2012; this “fiscal cliff”” would have increased taxes by $500 billion, with most of the increase falling on small businesses and individuals. CribSheet 13-1 explains ATRA.

Learn the essential facts about these increases in this NFIB Research CribSheet.

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Most small businesses are taxed at individual rates. Small-business income flows through to individual business owners. Most small businesses are organized as pass-through entities, not C corporations. Pass-through owners report business income on their individual tax returns. Thus, the expiration of lower individual rates first instituted in 2001 will directly increase the taxes that small businesses pay.
Individual tax rates are set to rise. Almost all individual income tax rates are set to expire at the end of 2012. Under current law, individual income tax rates stand at 10%, 15%, 28%, 33% and 35%. Unless the 2001 rates are extended, individual rates will increase in 2013 to 15%, 28%, 31%, 36% and 39.6%.
The Alternative Minimum Tax (AMT) will hit more businesses. The Alternative Minimum Tax (AMT) can greatly expand the “regular” tax liability of small businesses because the exemption amounts are not indexed for inflation. (Periodic adjustments to the exemption amount is often called the “AMT Patch.”) Before this year, the exemption is $74,450 for joint filers returns and $48,450 for individuals. In 2013, the exemption amounts revert to $45,000 for joint filers and $33,750 for individuals.
The payroll tax holiday ends. The payroll tax cut reduced the employee’s share of Social Security payroll taxes from 6.2% to 4.2% for employees and from 12.4% to 10.4% for the self-employed on the first $110,000 in wages in 2012. This payroll tax holiday will expire in 2013.
Estate (“death”) taxes will increase. In 2012, the estate tax, also called the “death tax,” has a $5 million exemption and a 35% rate. In 2013, the exemption will plunge to $1 million, and the tax rate will increase to 55%.
Dividend tax rates will rise. In 2012, stock dividends face a tax rate of 15%. In 2013, dividends will be taxed at ordinary income rates. Thus the rate will rise for all except those in the lowest tax bracket. The highest rate will be 43.4%, which is the 39.6% top-bracket income tax rate plus the 3.8% investment tax in the healthcare law.
Capital gains tax rates will rise. In 2012, the tax rate on capital gains is 15%. In 2013, the rate will rise to 20%. Like the dividend tax rates, the capital gains tax rates will also be augmented by the 3.8% investment tax in the healthcare law.
Various credits, exemptions, and deductions expire. The 2001 tax rates reduced income limitations on personal exemptions and itemized deductions, which reduced the amount of income subject to taxation. The marriage penalty also returns, and popular credits, such as the child tax credit, are reduced.
Expensing limits will shrink. Certain provisions benefiting small business will expire before 2013. Congress has steadily increased allowable expensing limits under Section 179, and it has expanded the provision to include real property. However, in 2013, the limits will fall back to $25,000 and real property will no longer be included.
Health insurance deductibility ends for self-employed. The Small Business Jobs Act of 2010 allowed self-employed business owners to deduct the cost of health insurance for themselves and their family in the calculation of their self-employment tax. This provision has already expired.
The required holding period for S Corp assets rises. The Small Business Jobs Act of 2010 reduced the holding period for built-in gains on appreciated S corporation assets to 5 years. This tax on capital assets is triggered when a C corporation converts to an S corporation, locking in capital assets for the holding period. The 5-year holding period increased to 10 years in 2012.
The small business startup deduction shrinks. The start-up deduction for small businesses was increased to $10,000 under the Jobs Act. The deduction shrank to $5,000 in 2012. The startup deduction allows new businesses to deduct expenses such as advertising, licenses, permits, rent, and employee training.
State and local sales tax deductions expire. The itemized deduction for state and local sales taxes is due to expire in 2013.
Fewer 1040 deductions are allowed. The healthcare law increases several taxes and creates several others. In 2012, taxpayers filing income tax may deduct healthcare expenses above a floor of 7.5 percent of Adjusted Gross Income (AGI). In 2013, this floor rises to 10%.
There are new limits on FSAs. PPACA imposes a $2,500 annual limit on health Flexible Saving Account (FSA) deferrals. Currently, there is no such limit.
Pass-through business owners face a new “Medicare” wage/salary tax. Owners of unincorporated “pass-through” businesses report business income on their household 1040s. Pass-throughs are vulnerable to PPACA’s 0.9% “Medicare” surtax on wage/salary income above $200,000 for individuals or $250,000 for joint filers. This surtax is paid on top of the longexisting 1.45% Medicare payroll tax. Despite the name, the proceeds of the new tax will not go to Medicare.
Pass-throughs also face a new “Medicare” investment tax. Pass-through business owners with modified adjusted gross income over $200,000 for individuals or $250,000 for joint filers face a 3.8% tax on investment income (rents, dividends, interest, royalties, capital gains on property sales other than primary residence, etc.) above the threshold. Once again, revenues do not go to Medicare.
A new medical device tax raises costs. Medical device manufacturers will pay a new 2.3% tax on their products but will pass the tax on to insurance purchasers through higher premiums. An industry analysis suggests losses of more than 43,000 jobs and over $3.5 billion in compensation losses.