On January 1, 2013, Congress passed the American Taxpayer Relief Act of 2012, and the next day, President Obama signed it into law. What relief the act gives is to low and middle-income households, largely by extending the Bush-era rate on income taxes and capital gains (although everyone lost the two-year, two-percentage-point reduction in payroll taxes). The law keeps intact the rates on the lower six brackets (10%, 15%, 28%, 33%, and 35%). However, rates were raised for higher-income earners.
What the Taxpayer Relief Act Means
A new highest income tax bracket. The Act reestablishes the 39.6% tax bracket for the highest incomes. It applies to single filers with taxable income of $400,000 or more and married couples who file jointly and have taxable income of at least $450,000. As unpopular as the very idea of raising taxes is, it’s important to keep in mind that the new highest income tax bracket is below the century-long average of just over 59% (Source: Tax Foundation, 2013). Secondly, it’s a marginal rate, which means that the effective income tax rate is weighted for lower levels of income taxed at lower rates. Finally, the effect of the Act is to lower taxes or keep them flat for most Americans.
Higher taxes on capital gains and investment income. While the Act retains the favorable long-term capital gains tax rate of 0% for those in the lowest two income brackets and 15% for the middle-income brackets, it raises it to 20% for households in the new 39.6% bracket. The 2010 Affordable Health Care Act also ushers in a new net investment income surtax of 3.8% for single filers with adjusted gross incomes about $200,000 and for married couples filing jointly above $250,000. The surtax, designed to support Medicaid, applies to dividend and interest income, rent, royalty, annuity, and trust income in addition to capital gains.
Higher Medicare payroll tax rate. In addition to the Medicare surtax, under the new law, an additional Medicare payroll tax of 0.9% applies on income above $200,000 for single filers and above $250,000 for married couples filing jointly.
Limits on itemized deductions and personal exemptions. By reinstating these limits—suspended the last two years—the new tax law exposes more of high-earners’ income to taxation. Broadly called the Pease limitations for the Congressman who proposed it in the 1990s, it phases out the ability to take personal exemptions and limits the ability to take the full amount of itemized deductions for single filers with $250,000 or more and married couples filing jointly with $300,000 or more in adjusted grow income (AGI). The tax code allows most Americans to claim a #3,900 exemption for themselves, their spouses, and dependents. But under the new law, the value of personal exemptions is reduced by 2% for every $2,500 of AGI above the relevant threshold. That means that if you have adjusted gross income (AGI) of $125,000 above those thresholds, the personal exemption is zeroed out. As for itemized deductions, they apply to every category except medical expenses. The limit kicks in at the applicable thresholds, and limits those filers to the lesser of the results of either a reduction in the itemized deductions of 3% of adjusted gross income above the threshold or 80% of the deductions.
Higher estate tax rate. The new tax law raises the federal estate and gift tax rate from 35% to 40% and sets the threshold for taxability at $5,000,000. That threshold is now permanently indexed for inflation, with the limit set at $5,250,000 for 2013. Not every feature of the act is more costly for high-income households. For one thing, it indexes the alternative minimum tax threshold to inflation, and it extends the portability of a spouse’s unused estate tax and uniform gift exclusion to the surviving spouse’s estate. Nevertheless, the new tax law may necessitate a variety of changes in your tax strategy. Now is the time to begin mapping out your strategies to minimize their bite. Please call to assess your tax situation.
Copyright © Integrated Concepts 2013. Some articles in this newsletter were prepared by Integrated Concepts, a separate, nonaffiliated business entity. This newsletter intends to offer factual and up-to-date information on the subjects discussed, but should not be regarded as a complete analysis of these subjects. The appropriate professional advisers should be consulted before implementing any options presented. No party assumes liability for any loss or damage resulting from errors or omissions or reliance on or use of this material.
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