Many higher-income taxpayers are in for a shock when their 2013 income tax returns are prepared. In 2013, a significant number of tax increases, and new limitations on deductions, will impact higher income taxpayers. Before you decide that you are not a higher income taxpayer, keep in mind that your income does not just include your earnings from work—it also includes gains from the sale of property, investments, business assets, and other capital items. So if you have a significant gain from a sale, even though the gain can be attributed to many years of appreciation, it is all taxable in the year of sale, and could place you in the higher income category.
It is important that you are aware of these changes, plan for them in advance, are prepared for the higher taxes, avoid underpayment penalties, and when appropriate, do some tax planning in advance to mitigate the bite of these new taxes. This article highlights many of the tax changes that take effect in 2013.
Higher individual income tax rates for some. Generally, the regular income tax rates remain the same at 10%, 15%, 25%, 28%, 33%, and 35%. But to the extent a single individual’s income exceeds $400,000 it will be subject to a new, 39.6% tax rate. The 39.6% threshold for joint filers and surviving spouses will be $450,000, and $425,000 for those filing as the head of household.
New Hospital Insurance tax. For higher income workers and self-employed individuals, an additional 0.9% hospital insurance (Medicare) tax is added to the FICA payroll tax (for employees), and self-employment tax (for self-employed individuals). This additional tax applies to wages and net self-employment income in excess of $250,000 for joint filers, $125,000 for married filing separately, and $200,000 for all others. For employees, this tax is automatically withheld from their payroll checks.
Surtax on unearned income. As part of the Affordable Care Act, a new tax is imposed upon the net investment income of individuals, estates, and trusts. For single individuals, the tax is 3.8% of the lesser of: (1) net investment income; or (2) the excess of modified adjusted gross income over the threshold amount of $200,000. For joint filers and surviving spouses, the threshold is $250,000, and for married taxpayers filing separately, the threshold is $125,000. Net investment income is investment income less investment expenses. Investment income includes income from interest, dividends, non-qualified annuities, royalties, rents (other than derived from a trade or business), capital gains (other than derived from a trade or business), trade or business income that is a passive activity with respect to the taxpayer, and trade or business income with respect to trading financial instruments or commodities.
Increased Capital Gains. Generally the long-term capital gains and qualified dividends tax rates remain at 0% and 15%, except for the fact that a 20% rate has been added for single taxpayers with incomes exceeding $400,000. For joint filers, the threshold for the 20% rate is $450,000, and $225,000 for married individuals filing separately.
Personal exemption phase-out. The personal exemption allowance for the taxpayer, a spouse, and each claimed dependent for 2013 is $3,900. For example a married couple claiming their two children as dependents would be able to deduct $15,600 (4 x $3,900) in personal exemptions when determining their taxable income. However, beginning in 2013, the exemption allowance begins to phase out for single taxpayers when their adjusted gross income exceeds the threshold amount of $250,000. The starting threshold of joint filers and surviving spouses is $300,000, $275,000 for heads of household, and $150,000 for married taxpayers filing separately. The exemption allowances are reduced by 2% for each $2,500 (or a portion thereof), by which the taxpayer’s adjusted gross income exceeds the thresholds.
Itemized deductions limitations. As with the exemption phase-out explained above, the itemized deductions are also phased out for 2013. The phase-out thresholds are the same as those for exemptions, and the itemized deductions are reduced by 3% of the amount by which the taxpayer’s adjusted gross income exceeds the threshold amount, with the reduction not to exceed 80% of the otherwise allowable itemized deductions. The reduction does not apply to the following deductions: medical and dental expenses, investment interest expense, casualty losses, and gambling losses.
As you can see, for some taxpayers the impact can be quite significant. However, it may not be too late to improve your situation with some year-end planning, and the sooner the better. Options include taking advantage of unrealized losses, business expensing, tax credits, delaying certain deductions and tax prepayments, income deferral, and other techniques.