By Michael Bohigian, EA
The American Taxpayer Relief Act of 2012 rescued the vast majority of Americans from the tax edge of the ?fiscal cliff? and the steep tax increases scheduled to kick in as the Bush tax cuts expired at the end of 2012. This legislation, however, did not entirely spare high-income earners. Here are the key provisions of the Act passed on the first day of 2013, how they may affect you, and strategies you can implement to minimize your tax burden under these new rules:
On The Income Side:
Top Marginal Rate Increases to 39.6%
Beginning on January 1, 2013, the Act raises the top federal marginal income tax rates from the 35% max in place since the Bush tax cuts to 39.6% for taxable income above the following thresholds: $400,000 for Single filers; $425,000 for Heads of Household; $450,000 for Married Filing Jointly and qualifying surviving spouses; and $225,000 for those Married Filing Separately. Translating this provision into real numbers, a married couple with $600k of taxable income will now pay just under $7,000 in additional federal income taxes in 2013 than they did in 2012, while an individual earning at the same income level will pay just over $9,000 more in federal income taxes.
Increase in Federal Income Taxes For 2013 Due To The 39.6% Tax Rate
||Head of Household
||Married Filing Joint
||Married Filing ? Separate
New Investment Tax Rates
Starting in 2013, the top tax rate for dividends and capital gains is permanently set at 20%, a whopping one-third increase from the top rate of 15% in place since 2003, starting at the same income levels as the 39.6% tax rates. The tax rate for dividends was set to revert to one?s marginal tax rate per the pre-2003 Bush rules, so the Act provides some relief to high-wage earners with substantial corporate dividend income.
Keep in mind that the Affordable Care Act enacted an additional Medicare tax of 3.8% on unearned income for married couples with adjusted gross income (AGI) over $250,000 and individuals with AGI over $200,000, effective January 1, 2013. Unearned income includes interest, dividends, capital gains, annuities, royalties, and rents.
Tax Rates for Capital Gains and Qualified Dividends ? 2012 vs 2013
||Married Filing Jointly
||Capital Gains and ? Qualified Dividends -2012 rates
||Capital Gains and ? Qualified Dividends -2013 rates
||Increase in Tax Rates ? on Investments 2012 vs 2013
|$0 – $36,250
||$0 – $72,500
|$36,250 – AGI of ? $200,000
||$72,500 – AGI of ? $250,000
|$200,000 – taxable ? income of $400,000
||$250,000 – taxable ? income of $450,000
If you?re concerned about paying higher taxes on the sale of your personal residence, please note that the first $500,000 of gain on your home for a married couple and $250,000 of gain for unmarried individuals is exempt from all taxes, including this 3.8% Medicare surtax, when your home qualifies for the residence gain exclusion. To qualify, you need to own your home and use it as your primary residence for two out of the five years prior to the date the home is sold.
Stay tuned for Part 2 – What’s Being Deducted from your Deductions
Michael Bohigian, EA, is a staff accountant atSchwartz & Schwartz PC with a MS in Accounting and an MBA from Boston College.
On June 28th, the Supreme Court upheld most of the provisions of The Patient Protection and Affordable Care Act. Here are some of the tax increases that might affect you starting in 2013:
Increased and Expanded Medicare Taxes
High-income taxpayers will be paying higher Medicare taxes. Under the current rules, individuals have Medicare taxes withheld from their salaries at a rate of 1.45% on each dollar earned at work. Since employers match the amount withheld, Medicare receives a total of 2.9% for each payroll dollar paid out. And unlike Social Security taxes which max out at $110,100 (in 2012), there is no cap for Medicare taxes. Self-employed individuals also pay Medicare taxes at a rate of 2.9% on all of their net earnings.
Starting in 2013, the employee portion of the Medicare tax jumps by a whopping 62% – from the current rate of 1.45% to 2.35% – on earned income in excess of $200k for single individuals and $250k for married couples filing a joint tax return. As of now, the employer match is slated to remain at 1.45%, which means the total Medicare tax will be 3.8% for high-income taxpayers.
For example, if you’re single, and earn $500k from your job, expect to pay $2,700 in additional Medicare taxes (($500k – $200k) * .9%) for 2013.
For more information, check out the IRS’s Questions and Answers for the Additional Medicare Tax, which explains:
The statute requires an employer to withhold Additional Medicare Tax on wages or compensation it pays to an employee in excess of $200,000 in a calendar year. An employer has this withholding obligation even though an employee may not be liable for the Additional Medicare Tax because, for example, the employee?s wages or other compensation together with that of his or her spouse (when filing a joint return) does not exceed the $250,000 liability threshold. Any withheld Additional Medicare Tax will be credited against the total tax liability shown on the individual?s income tax return (Form 1040).
To increase taxes for high-income individuals even more, the Medicare tax will also apply to unearned income for the first time since this tax was enacted. People over the $200k or $250k threshold should expect to pay Medicare taxes at a rate of 3.8% on interest, dividends, capital gains, and net rental income beginning in 2013. You will pay this tax in addition to any federal and state income taxes due on this income. We’ll provide you a link to this form when it becomes available.
Reduced Tax Breaks for Medical Expenses
Many employers offer their staff the ability to pay for their family’s healthcare costs with pre-tax dollars through a Flexible Savings Accounts (FSA) included as part of their benefits package. Starting in 2013, the maximum amount of money that you can set aside in an FSA will be cut in half to $2,500 per year. Plus, medical expenses you can pay through the FSA will exclude certain items currently allowed, including OTC medications. Please note, if you are married, both you and your spouse can put away the full $2,500 through your respective employer’s FSA.
The Patient Protection Act also makes it even tougher for individuals to deduct their medical expenses. Starting in 2013, you can only deduct your family’s medical expenses to the extent the allowable expenses exceed 10% of your adjusted gross income. That’s an increase of one-third over today’s threshold of 7.5% of AGI.
This new rule may not impact your taxes, however, thanks to the dreaded AMT. Since the current threshold for deducting medical expenses under the AMT is already 10% of AGI, many people who are hit by this tax every year might not see any tax increase due to this change.
Steps to Consider to Minimize These Taxes:
As with most other tax rules, there are ways to minimize the tax bite that will be caused by soon to be implemented changes to the Tax Code:
- Take a look at a Health Savings Account for your family. Money contributed into an HSA is?tax-deductible, and money withdrawn for your family’s medical expenses is?tax-free (we wrote about HSAs in May 2012).
- Consider selling appreciated investments in 2012 if you would otherwise sell them in 2013. No one know whether the tax rate on long-term capital gains will be higher than 15% in 2013. Add to this the 3.8% Medicare tax you’ll pay once your income exceeds $200k if single or $250k if married, and you could save a decent ???? amount of taxes by selling by December 31st.
- Consider accelerating income into 2012 to reduce your 2013 income. This strategy includes one-time income generators, such as Roth Conversions.