The American Tax Payer Relief Act of 2012 (HR 8) is a huge bill with many provisions, but it is not tax reform. It does, however, enact many tax changes—some permanent, some simply extended—that are very important to taxpayers. The bill actually has very few tax increases, but the way the government does budgeting allows politicians to claim that they are increasing revenue and reducing the deficit.
For example, one of the provisions of the bill is the expiration of the employee portion of the payroll tax reduction from 2009. The tax will revert to 6.2 percent, where it was in 2009. The government treats this as a “new” tax revenue generator instead of simply a reversion to the previous level.
For the most part, the current tax brackets will remain the same (10, 15, 28, 33 and 35 percent) with one notable exception. The 35 percent bracket has been subdivided to include a 39.6 percent bracket for single filers with taxable income of $400,000 and above, and joint filers with taxable income of $450,000 and above. Because it raises rates on a very narrow group of taxpayers, the bill is really an income redistribution plan, not a revenue enhancer or deficit reducer.
The marriage penalty relief (standard deduction) which was scheduled to expire will remain intact for tax year 2012. That means that taxpayers who are married and filing jointly will only be able to claim a deduction that is a percentage (instead of twice) of the deduction for single filers.
Long-term capital gains and dividend income rates remain the same (0 and 15 percent depending on income) except for filers making more than $400,000 (single filers) or $450,000 (joint filers) who will pay 20 percent.
By David L. Blain, CFA
There are several significant changes to the tax code that will take effect in 2013. These changes revolve around two main events: (1) previously scheduled increases in investment and marginal income tax rates, and (2) implementation of several new taxes enacted in prior years.
NOTE: Some or all of the changes discussed below will more than likely change prior to filing 2013 taxes in the spring of 2014.
As a firm, we’ve already started tax planning for our clients, and as a thought leader in the community on tax issues, we think it’s important to share this information with our friends and colleagues. To make that easier, we’ll separate the changes into bite-sized chunks of similar provisions.
Effective January 1, 2013 several new forms of taxation will be in place, including the following:
Medicare surtax–The current individual Medicare tax on earned income is 1.45% (your employer also contributes 1.45% of your wages). Under the new law, if you make more than $200,000 ($250,000 for joint earners) you will pay an additional 0.9% for a total of 2.35%.
NOTE: Individuals who operate their business as a sole proprietorship, partnership, or LLC taxed as either a sole proprietorship or partnership, will pay a total of 3.8%.
Surtax on investment income–If Congress extends the current law passed in 2010, those of you who have modified adjusted gross income (MAGI) of $200,000 or more (again, $250,000 for joint earners) will be assessed a 3.8% surtax on investment income including dividends, interest, capital gains, rental income, etc.
NOTE: If you are a passive investor in a private business, the surtax rules become quite complex. Please contact our office for an individualized discussion of this new tax.
Tax on “Cadillac” healthcare plans–Employer-paid comprehensive healthcare plans costing more than $10,200 for individuals or $27,500 for family coverage, will be charged a 40% tax on the amount the employer pays.
Tax on medical devices–Manufacturers of medical equipment will pay a 2.3% excise taxes on all devices costing $100 or more.
Cap on Flexible Spending Accounts (FSAs)–Beginning in 2013, FSA contributions will be capped at $2,500. Currently, there is no cap.
Penalty for non-medical withdrawals from Health Savings Accounts (HSAs)–The penalty for making a non-medical withdrawal from your HSA has doubled from 10% to 20%.
Itemized deductions for medical expenses–The threshold for claiming medical and dental expense deduction will be increasing from 7.5 percent of AGI to 10 percent (the 7.5 percent will remain in effect for taxpayers 65 years or older through 2016).
Penalty tax for not buying insurance–Starting in 2014, if you decide not to buy health insurance, you will be assessed a tax of between $95 and $5,000, depending on your income (see sidebar). The minimum tax goes up to $695 in 2016.
As always, there are exemptions and exceptions for the tax changes mentioned above.
Personal Income Tax
Personal incomes taxes will go up in several different ways. Most of the changes begin for tax year 2013. Let’s take a look.
Tax brackets–Tax brackets will go up across the board (see Table). But, the lowest bracket would go up 50% while the highest bracket would rise only 13%. That’s a huge burden for those who can scarcely afford it.
Itemized deductions–The majority of itemized deductions will be reduced to 3% of adjusted gross income (AGI)—above an inflation-adjusted threshold (estimated to be $174,450 for all taxpayers except those married filing jointly)—or 80% of all allowable deductions, whichever is less.
Personal exemption–Under current law, high earners receive a $3,800 personal exemption for each taxpayer, their spouse (if filing jointly) and children/other dependents. For tax year 2013, taxpayers filing jointly with inflation-adjusted AGI over $261,650 ($174,450 for individuals) will no longer receive the personal exemption.
Marriage penalty–The standard deduction currently enjoyed by married taxpayers filing jointly is 200% of the standard deduction for individual taxpayers. That goes down to 167% next year.
Child credit–The child credit will be reduced to $500 from the current $1,000. Also, the credit cannot be used to offset alternative minimum tax (AMT).
Student loan interest deduction–The deduction for student loan interest will apply only to interest paid during the first 60 months in which it is required. Under current law, there is no such time limitation. Also, the deduction will phase out for lower AGI payers. These amounts are projected to be $75,000 for joint filers and $50,000 for all other filers.
Household and dependent care credit–The credit given for household and dependent care expenses will go from $3,000 to $2,400 for one qualifying individual and $6,000 to $4,800 for two or more qualifying individuals. Also, the maximum credit will decrease from 35% to 30% of creditable expenses. Finally, the reduction in the credit (based on AGI) will begin at $10,000 instead of the current $15,000.
Home sale exclusion–The current home sale exclusion of $250,000 will no longer be available to heirs, estates or qualified revocable trusts after the sale of a decedent’s home.
Deduction for educational assistance–Employees will no longer be able to deduct the amount of employer-provide educational assistance directly from their income.
Taxes on Investment Income
Taxes on investment income will go up on several fronts, most notably on capital gains and dividend income.
Capital gains tax–For most investors, the tax rate on long-term capital gains will increase from 15% to 20%. Investors in the 10%-15% brackets do not pay tax on dividend income right now, but they will be subject to a 10% tax beginning in 2013.
Dividend income–Dividend income is currently taxed at either a 15% or 35% rate. Next year, all dividend income will be subject to a 39.6% tax rate.
Changes to business-related taxes will be fairly dramatic next year. This includes changes to depreciation allowances, taxes on medical equipment, the withholding rate for unemployment benefits and S corporation taxation, just to name a few.
Depreciation expense–For tax year 2013, businesses will still be able to expense certain depreciable assets (machinery, equipment, computer software, etc.) for the tax year in which they are placed into service. However, the amount that can be expensed will again be subject to an investment ceiling. Both will go down in 2013 from the current $139,000 and $560,000, to $25,000 and $200,000, respectively.
Backup withholding–Backup withholding rates* relating to dividend and interest income will go up to 31% from 28%. For employers using the flat rate method, withholding rates for wages up to $1 million will go from 25% to 28%, and for wages over $1 million, the rates will go from 35% to 39.6%. Employers will also see the voluntary withholding rate for unemployment benefits will go from 10% to 15%.
S corporations–If you converted your business from a C corporation to an S corporation, you have potential exposure to a 35% built-in gains (BIG) tax. Whether or not you owe a BIG tax depends on the value of the corporation’s assets on the day of conversion and when the anniversary date falls in relation to the end of the corporation’s fiscal year.
*Backup withholding for employees typically applies when W-9 information does not match IRS records, if dividend and interest income is not reported, or if federal income tax is owed.
Needless to say, it is a very challenging environment for tax planning as we head into 2013. Now more than ever it is extremely important to plan ahead and not wait until April 2014 to find out which of the new taxes apply to your particular situation.
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