In our March “Tax Strategist” we highlighted two areas of American Taxpayer Relief Act of 2012 (ATRA): Personal Exemption Phase-out and Itemized Deduction Phase-out. There are at least four other major provisions of this act that will affect many of you. This month we want to make you aware of two other provisions of ATRA and we will highlight the final two next month.
Ordinary Income Tax Rate Increase
Beginning in 2013, the ATRA retained the graduated tax marginal rates that are adjusted annually for inflation, and added a new top rate of 39.6% (previously the top rate was 35%). Thus, higher-income taxpayers who fall within this new bracket will be subject to an additional 4.6% tax on their income above the threshold for this new bracket. The thresholds are:
- $450,000 for joint filers and surviving spouses;
- $425,000 for heads of household;
- $400,000 for single filers, and
- $225,000 for married filing separately.
Example: Jack and Sally who are filing jointly have an ordinary taxable income of $600,000. Their income above $450,000 will be subject to the 39.6% tax rate. Thus, they will see a tax increase of $6,900 (($600,000 – $450,000) x 4.6%) as a result of the new tax bracket.
Capital Gains and Dividends
Beginning in 2013, ATRA permanently increased the top rate for long-term capital gains and qualified dividends to 20% (up from 15%) for taxpayers with incomes exceeding the following for 2013 (inflation adjusted for future years):
- $450,000 for joint filers and surviving spouses;
- $425,000 for heads of household;
- $400,000 for single filers, and
- $225,000 for married filing separately.
This results in a 5% increase in capital gains rates for higher-income taxpayers.
Example: Howard, a single individual, retired this year and sold his rental, which he had owned for a long time, for a profit of $700,000. Even though his income is generally in a lower-income tax bracket, the profit from the sale itself pushed his income above the $400,000 threshold for single taxpayers, and to the extent his income exceeds the $400,000 threshold, he will be subject to the increased capital gains rate. If Howard’s other taxable income was $50,000, then his total income would be $750,000, of which $350,000 exceeds the 20% long-term capital gains rate threshold. As a result, Howard pays the 20% rate on $350,000. That is an increase of $17,500 ($350,000 x 5%) over what he would have paid in 2012.
Caution: Generally, sales that are subject to long-term capital gains rates are also investment income subject to the 3.8% unearned income Medicare contribution tax that is part of the Affordable Care Act.
Planning Tip: If Howard had utilized an installment sale, he could have spread the gain over multiple years and possibly avoided the higher CG rate. He might have also utilized a tax-deferred exchange to defer the gain into other real estate property.
If you are subject to these increased taxes on higher-income taxpayers, it may be appropriate to review your situation. For assistance, contact the Tax Experts at Henssler Financial: experts@henssler.com or 770-429-9166.
Disclosures
This article is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
