Guidance on New 2013 Tax Law

The following are highlights of the major provisions of the “American Taxpayer Relief Act,” which was negotiated and passed over the past few days (and nights!).

While the top federal income tax rates will increase only for those earning greater than $400-450,000, there are other measures that were previously enacted as part of the Health Care reform legislation that will cause nearly all working taxpayers to pay more Social Security taxes effective January 1, 2013.

Tax rates:

  • Tax rates remain the same, except for taxable incomes above $450,000 for married taxpayers and $400,000 for single filers. A new top rate for taxable income above these levels is raised from the current 35% to 39.6%.
    • Note that someone’s income can be well above $450,000 before the 39.6% rate is effective, as that rate is after itemized deductions, such as mortgage interest and charitable contributions.
  • For those with taxable incomes of less than $400-450,000, there will be no increase of current federal income tax rates.
  • As part of the health care reform passed in 2010, an additional Medicare tax of 3.8% will apply to unearned income (investment income, such as interest and dividends; capital gains and rental income), for married couples with income above $250,000 and single taxpayers above $200,000. This is already law, and is not part of the recent legislation.
  • Also as part of the 2010 health care legislation, income from self-employment and wages will be subject to an additional FICA tax of 0.9% (employee portion only). This applies to the combined compensation of married couples in excess of $250,000 and single individuals in excess of $200,000.

Payroll Tax Cut not extended: There was NOT an extension of the Social Security payroll tax cut. This represents a tax increase for all workers as of January 1, 2013, from 4.2% to 6.2%.

Capital Gains and Dividend Tax Rates:

The capital gains and dividend income rate will increase from the current 15% to 20% (plus the above 3.8% tax rate increase from the health care reform act), only for taxpayers with incomes that fall into the 39.6% rate (as stated above). For married taxpayers, if your taxable income is less than $450,000, then the capital gains and dividend rates will remain at 15%.AMT (Alternative Minimum Tax): The legislation provides a permanent fix by enacting AMT indexing for inflation. This has been an issue for years, and has frequently been temporarily extended. This provides needed clarity and corrects a measure that Congress usually fixed anyway.

Itemized Deductions and Personal Deductions:

There will be a phase out of these benefits, for incomes above $250,000 – $300,000, which is an indirect tax increase.

Estate taxes: The estate and gift tax exclusions were retained at $5 million, indexed for inflation. The top tax rate increases from 35% to 40%, effective January 1, 2013. This is a significant compromise by both sides, as it permanently (at least for now) increases the exemption amount, so most estates will not be affected by the estate tax, in exchange for a rate increase on those who are impacted. The portability “election” provision, which allows an unused exemption amount to be used by the surviving spouse, was made permanent.Other items:

  • Tax credits were extended for 5 years, such as college tuition, child and dependent care and the child credit.
  • Tax free distributions will be permitted for 2013 from IRAs to charitable organizations (one year extension, not permanent).
Impact on Investment Strategy: The increased tax rates on top income levels, in addition to the Medicare tax of 3.8% on investment income (such as capital gains), makes our firm’s investment strategy, which is very tax efficient, even more valuable.

If you would like to discuss any of these matters further, please contact our office.

Also, please feel free to forward this post, or a link to this post, to others who may find this information valuable.

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