INDIVIDUAL TAX LAW CHANGES: 2013
October 15, 2013 T 2013- 1
The last fiscal crisis resulted in a compromise that was (tongue-in-cheek?) entitled the American Taxpayer Relief Act of 2012. This followed tax changes contained within the Patient Protection and Affordable Care Act (PPACA or Obamacare), numbers 5 and 6 below. The focus of the tax changes were upper income taxpayers and a combination of déjà vu reversions to older laws and entirely new taxes.
1. Personal Exemption: Under the old rules, the personal exemption was phased out for taxpayers with adjusted gross income over $300,000; that rule was suspended for several years, and has now been brought back.
2. Itemized Deductions Reduced by 3% AGI: The old rule is back; itemized deductions are reduced by an amount equal to 3% of adjusted gross income, if the adjusted gross income is over $300,000.
3. Tax Rates: Taxable income over $450,000 will now be subject to a tax rate of 39.6%.
4. Capital Gains (Qualified Dividends): If you are in the 39.6% tax bracket, then the capital gains rate is now back to 20% rather than 15%.
5. High-Income Hospital Insurance Tax (new): There are two Obamacare taxes; one on earned income and one on investments. The earned income tax is an additional 0.9% Medicare tax on earnings over $250,000. It is only assessed on the employee so the company does not have to match the tax. If the wages exceed $250,000, there will be withholding but there is no withholding on lesser amounts. This could be a surprise for married couples that individually earn less than $250,000, and therefore not subject to withholding, but who earn more than $250,000 jointly and therefore will be subject to the tax.
6. Medicare Investment Income Tax (new): This is an additional 3.8% tax on net investment income (interest, dividends, capital gains, and passive income). If the total Modified Adjusted Gross Income (essentially gross income reduced by IRA contributions, alimony, and certain self-employed expenses) exceeds $250,000, then the lesser of net investment income or MAGI over the threshold is taxed at 3.8%.
The biggest surprises will come to individuals with large capital gains, where the tax changes result in a net rate of at least 23.8% (and probably higher). A later article will discuss capital gains in more detail.
The future concern is the two Obamacare taxes. Once a concept is enacted, changing rates and thresholds are just refinements. For now, April of 2014 could be a cruel month for some taxpayers, mixing memory of lower tax rates with the desire for a better economy.
*References: The Waste Land. T.S. Eliot 1922.
*All discussions assume taxpayers filing joint tax returns; single, married filing separate and head of household taxpayers may have different rates and/or limitations.
*IRS CIRCULAR 230 DISCLOSURE: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing, or recommending to another party any transaction or matter addressed herein.