Tax Increases Looming in 2013

Without congressional action before year end, almost everyone—rich and poor alike—will be hit by tax increases, which will affect each of us in one way or another. These increases are the result of temporary tax benefits that will expire at the end of 2012. The following lists the expiring benefits and how taxpayers will be affected. Check the list for items that will apply to you to get an idea of how your taxes will be affected.

Exemption Phaseout—Affected: Higher income families
Each taxpayer is entitled to a $3,800 (2012) tax exemption (deduction) for him or herself, his or her spouse, and each dependent. Beginning in 2013, a phaseout (reduction) of the exemptions will return for higher income taxpayers. The otherwise allowable exemption amounts will be reduced by 2% for each $2,500 or part of $2,500 ($1,250 for married filing separately) that the taxpayer’s AGI exceeds the AGI threshold for the year based on the taxpayer’s filing status. The threshold amounts for 2013 have not been announced yet, but it will be inflation-adjusted amounts from 2009 (the last year when this rule applied). These amounts were $372,700 for married taxpayers filing jointly, $186,350 for married taxpayers filing separately; $331,000 for head of household filers, and $289,300 for single filers.

Itemized Deduction Phaseout—Affected: Higher income families who itemize their deductions
Beginning in 2013, higher income taxpayers will again be subject to the phaseout of itemized deductions. Not all itemized deductions are subject to phaseout. The following are the ones subject to phaseout: taxes, interest (except investment interest), charitable contributions, employee job expenses and other miscellaneous itemized deductions (excluding gambling and casualty or theft losses). If the itemized deductions are subject to the limit, the total of all itemized deductions is reduced by the smaller of: (1) 3% of the amount by which the AGI exceeds the annual limit, or (2) 80% of the itemized deductions that are affected by the limit. The threshold amounts for 2013 have not been announced yet, but will be inflation-adjusted amounts from 2009, which were $83,400 for married taxpayers filing separately and $166,800 for all others.

Payroll Tax & Self-Employment Tax—Affected: All working taxpayers
Both the payroll withholding tax and self-employment tax rates have been reduced by 2 percentage points for two years. Payroll FICA withholding will return to 6.2% (up from 4.2%) and self-employment tax will return to 12.4% (up from 10.4%) beginning in 2013.

Long-Term Capital Gains Rates Increase—Affected: All taxpayers with long-term capital gains
Taxpayers have enjoyed reduced long-term capital gains rates for several years, as a result of the Bush-era tax cuts. However, those reduced rates will return to the higher rates in effect prior to 2003. The following table compares the current long-term capital gains rates to the anticipated rates for 2013 and subsequent years.

Taxpayers, with unrealized gains in investment property, held for more than one year may want to consider selling some or all of those assets in 2012 to lock in the lower long-term capital gains rate on their gains.

*8% if held more than five years
**18% if held more than five years

Regular Tax Rates—Affected: All taxpayers
In addition to lower long-term capital gains rates, the regular marginal tax rates have been declining since 2001. However, without congressional action, those reduced rates will return to the higher rates that were in effect prior to 2001. The table below compares the current marginal individual tax rates to the anticipated rates for 2013 and subsequent years.

These increased rates will apply to all varieties of ordinary income, including interest, dividends, short-term capital gains, employment income, etc. Marginal tax rates increase, as a taxpayer’s overall income increases, taxing the first block of income received at the lowest rate and each subsequent block at ever-increasing rates, until the maximum rate is reached. As with assets eligible for the long-term capital gains rates, it may be appropriate for some taxpayers to accelerate ordinary income into 2012 to take advantage of the lower rates.

Alternative Minimum Tax (AMT)—Affected: Generally, middle income taxpayers
Congress, originally, implemented the AMT to impose a minimum tax on higher income taxpayers who were avoiding taxes through tax shelters and other legal means. However, years of inflation without corresponding adjustment to the AMT components have, each successive year, caused an increasing number of taxpayers to be subject to the AMT. Much as the regular income tax allows personal exemptions, the AMT calculation allows an exemption, but based upon filing status. For the past several years, Congress has, on a year-to-year basis, increased that exemption for inflation. However, should they fail to provide an increase for 2012 and 2013, the exemption amounts should revert to levels not seen since the early 2000s, which, depending upon filing status, should result in an approximate 30% to 40% decrease in the exemption amount. For example, the exemption amount for joint filers would drop from 2011’s $74,450 to $45,000. The reduction of the exemption amount should snare a significantly greater number of taxpayers for 2012 – estimated to be around 31 million versus 4 million for 2011.

In addition to the expiring benefits listed above, the following provisions of the Heath Care law will take effect in 2013:

Increased Hospital Insurance Tax—Affected: Higher income working families
The Hospital Insurance (HI) tax rate (currently at 1.45%) will be increased by 0.9 percentage points on individual taxpayer earnings (wages and self-employment income) in excess of compensation thresholds for the taxpayer’s filing status. Thus, the wage withholding HI rate will be 1.45% up to the income threshold and 2.35% (1.45 + 0.9) on amounts in excess of the income thresholds. The hospital insurance portion of the Self-Employment tax rate will be 2.9% up to the income threshold and 3.8% (2.9 + 0.9) on amounts in excess of the threshold. The income thresholds where this increase begins is $250,000 for married taxpayers filing jointly; $125,000 for married taxpayers filing separately, and $200,000 for all other taxpayers.

Surtax on Unearned Income—Affected: Higher income families
A new surtax called the Unearned Income Medicare Contribution Tax is imposed on the unearned income of individuals, estates and trusts. For individuals, the surtax is 3.8% of the lesser of:

The taxpayer’s net investment income, or

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).

“Net” investment income is investment income reduced by allowable investment expenses. Investment income includes: Income from interest, dividends, annuities, royalties, rents (other than those derived from a trade or business), capital gains (other than those 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 the trading of financial instruments or commodities. For surtax purposes, modified adjusted gross income does not include excluded items, such as, interest on tax-exempt bonds, veterans’ benefits, and excluded gains from the sale of a principal residence.

Employer Health FLEX-Spending Plan Contributions Limited—Affected: All taxpayers participating in health FSAs
In order for a health FSA to be a qualified benefit under a cafeteria plan, the maximum amount available for the reimbursement of incurred medical expenses of an employee, the employee’s dependents, and any other eligible beneficiaries with respect to the employee under the health FSA for a plan year (or other 12-month coverage period) cannot exceed $2,500.

Medical Itemized Deductions Limited—Affected: Higher income taxpayers
The AGI threshold percentage for claiming medical expenses on a taxpayer’s Schedule A will be increased from 7.5% to 10%, which is the same as the current threshold percentage for alternative minimum tax (AMT) purposes. Individuals (and their spouses) age 65 (before close of year) and older will continue to use the 7.5% rate through 2016.

Henssler Financial believes you should Live Ready. While Congress could and probably will extend some of the provisions, it may be appropriate to review your tax situation and plan for all eventualities. If you need assistance planning the steps you can take now to mitigate the changes that may come in 2013, contact the Tax Experts at Henssler Financial: experts@henssler.com or 770-429-9166.

Disclosures:

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