Prosper On: The Year-Long Hangover – Tax Changes for 2013

American taxpayers will have more than just a hangover to deal with come January first. With new tax laws taking effect at the start of 2013, even the non-party goers could be feeling the pain. These changes are broad, significant and far more complicated than they have been in years past.

While the details are still up for debate, it’s safe to say there will be some changes. Depending on an individual’s specific situation, it could be a non-event, a missed opportunity, or an event anticipated and planned for. We’re here to help, so don’t hesitate to contact us with any questions you may have about any of this information.

Who’s Affected?

These tax increases will primarily affect high-income individuals, or those who meet the following guidelines:

1. Singles with adjusted gross income of $200,000/year or greater
2. Married filing jointly with adjusted gross income of $250,000/year or greater
3. Married filing separately with adjusted gross income of $125,000/year or greater

Those with an estate valued greater than several million dollars are considered high net worth individuals. Those with investments and significant capital gains will also be affected. For these folks the end of 2012 is an important date.

Those in the upper middle class will also likely see an increase of 3%. These individuals are:

1. Single tax payers above $85,650/year adjusted gross income
2. Married filing joint above $142,700/year adjusted gross income
3. Married filing separately above $71,350/year

There may be additional tax changes for this group going forward, such as lost deductions, but at this time these changes are generally unknown.

Those considering it a non-event are likely not high-income individuals. Their overall estate would be valued below $1,000,000 and their capital gains should be minimal as a percentage of their net worth.

The Changes

Let’s start with the end of the Bush tax cuts. When this takes place the maximum rate applying to long-term capital gains could increase from 15% to 20%. Today, qualifying dividends are taxed at a lower capital gains rate. Beginning in 2013, those dividends could be taxed as ordinary income.

Keep in mind the current 2% reduction in the Social Security portion of the payroll tax is one of the provisions set to expire at the end of 2012.

In addition to the end of the Bush tax cuts, new taxes on income are also a factor. High-income individuals could see an increase in their Medicare payroll tax of 0.9%. In addition there will likely be a new 3.8% Medicare contribution tax imposed on the unearned income of those individuals.

Related to estate planning, the previous $5 million per person estate tax exemption could revert back to $1 million along with the $5 million gift estate tax exemption. We could also see the estate tax rate increasing from 35% to 55%.

Alternative minimum tax (AMT), or the minimum tax rate imposed on the wealthy, is starting to swallow more and more taxpayers. Because these minimums haven’t been adjusted for inflation, more people qualify for the AMT every year. Unless the rules change for 2013, we could see as many as 20% of taxpayers having to pay this rate.

Other Notable Changes

Beginning in 2013, the itemized deduction “threshold” for claiming unreimbursed medical expenses should increase from 7.5% of adjusted gross income to 10%. (There is a temporary exception for individuals who are 65 and older.)

Some deductions are likely reverting to lower limits and less generous rules of application. These include:

1. Earned income tax credit
2. The child tax credit
3. The adoption credit
4. The American Opportunity (Hope) tax credit

Also gone in 2013 is the ability to deduct student loan interest on student loans after the first 60 months of required repayment.

Tax changes originally made to address a perceived “marriage penalty” will also likely expire at the end of 2012. Those married and filing a joint return with their spouse will notice the effect in the form of a reduced 2013 standard deduction amount as well as lower 2013 tax bracket thresholds (i.e. couples will move into higher-rate brackets at lower levels of income).

What’s a person to do? When it comes to year-end tax planning there’s always a lot to think about. This year is more complicated than usual. A financial professional can help you evaluate your situation, keep you apprised of any last-minute legislative developments, and determine if any year-end moves make sense for you.

We’re always here to help, so please give us a call if you’d like to discuss your particular situation.