By Kevin Hedley, MS, CPA, PFS
At the beginning of the year, Jan. 2 to be precise,
the American Taxpayer Relief Act of 2012 set a new
landscape for taxes. Unfortunately for many this is
not a pretty landscape.
Under the American Taxpayer Relief Act of
2012, higher tax rates apply to ordinary income,
capital gains and dividends, while at the same time
limitations are imposed on the use of personal exemptions
and itemized deductions. While none of
this is completely new it has been sometime since
we have seen many of these rates, phase-out’s and
limitations.
In summary we are now dealing with the following new or increased taxes:
• Increased payroll tax for high-earning workers and self-employed taxpayers. An additional 0.9 percent hospital insurance tax (i.e., a component of the Federal Insurance Contributions Act (FICA) payroll tax imposed on wages) applies to wages received with respect to employment in excess of: $250,000 for joint returns; $125,000 for married taxpayers filing a separate return; and $200,000 in all other cases. The additional 0.9 percent tax also applies to self-employment income.
• An unearned income Medicare contribution tax is imposed on individuals, estates, and trusts. For an individual, the tax is 3.8 percent of the lesser of: (1) net investment income or (2) the excess of modified adjusted gross income over the threshold amount ($250,000 for a joint return or surviving spouse, $125,000 for a married individual filing a separate return, and $200,000 for all others).
• The income tax rates for most individuals stay at 10 percent, 15 percent, 25 percent, 28 percent, 33 percent and 35 percent, as in 2012. However, a new 39.6 percent rate applies for 2013 for income above $450,000 for joint filers and surviving spouses; $425,000 for heads of household; $400,000 for single filers; and $225,000 for married taxpayers filing separately
• The top rate for capital gains and dividends rises to 20 percent for 2013 (up from 15 percent) for taxpayers with incomes exceeding $450,000 for joint filers and surviving spouses; $425,000 for heads of household; $400,000 for single filers; and $225,000 for married taxpayers filing separately. In comparison, for taxpayers whose ordinary income is generally taxed at a rate below 25 percent, capital gains and dividends are subject to a 0 percent rate, and taxpayers who are subject to a 25 percent-or-greater rate on ordinary income, but whose income levels fall below the above thresholds, are subject to a 15 percent rate on capital gains and dividends.
There is a personal exemption phase-out (PEP) for 2013 with a starting threshold of $300,000 for joint filers and surviving spouses; $275,000 for heads of household; $250,000 for single filers; and $150,000 for married taxpayers filing separately. Under the phase-out, the total amount of exemptions that can be claimed by a taxpayer is reduced by 2 percent for each $2,500 (or portion thereof) by which the taxpayer’s adjusted gross income exceeds the above threshold.
• There is also a limit on itemized deductions for 2013 (i.e., the “Pease” limitation) with a starting threshold of $300,000 for joint filers and surviving spouses; $275,000 for heads of household; $250,000 for single filers; and $150,000 for married taxpayers filing separately. Thus, for taxpayers subject to the “Pease” limitation, their itemized deductions are reduced by 3 percent of the amount by which the taxpayer’s adjusted gross income exceeds the threshold amount, with the reduction not to exceed 80 percent of the otherwise allowable itemized deductions.
Considering the items listed above, it is obvious that many higher earning readers will pay more in taxes this year as well as in future years. As an example, for some the tax rate on capital gains or qualified dividends will actually rise to 24.592 percent (from 15 percent) as a result of the new taxes on investment income, the phase-out of itemized deductions and personal exemptions.
Furthermore, even though the highest stated tax rate is now 39.6 percent, the effective rate with the new phase-outs and limitations is actually 44.192 percent.
Timely action could make sure you enjoy some of the individual and business tax provisions that are due to expire at year’s end. An example of a major change for 2014 is the new Section 179 deduction limit will be reduced to $25,000 (as of the writing of this article). The current Section 179 is $500,000.
Many readers can still better their tax position by acting now to make the most of enhanced expensing and depreciation of fixed asset purchases; keep adjusted gross income (AGI ) down to avoid reduction (or elimination) of the many tax breaks that phase out over higher levels of AGI ; make the best tax use of losses; and take full advantage of the available tax credits.
Despite this real threat, readers should keep in mind that it’s almost never too late to better your own tax situation, minimizing taxes to the greatest extent possible. Year-end tax planning is going to be particularly productive this year and we have been especially busy all year planning for these new and increased taxes for our clients.
Kevin Hedley is a partner with Hedley & Co., PLLC in Clifton Park.