As part of the 2012 American Taxpayer Relief Act (ATRA), both ordinary and capital gains tax rates increased in 2013 for higher income taxpayers whose taxable income exceeds the income threshold for their filing status. The thresholds at which taxpayers are subject to the top ordinary and long-term capital gains tax rates 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. These increases will have the following effect:
Ordinary Income Rates
Prior to the law change, there were six tax brackets: 10%, 15%, 25%, 28%, 33% and 35%. The ATRA added a new top rate of 39.6%. Thus, higher-income taxpayers, to the extent their taxable income exceeds the income threshold for their filing status, will be subject to the new 39.6% rate (up 4.6% from former 35% top rate).
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
Prior to the law change, the long-term capital gain was zero for taxpayers in the 10% and 15% ordinary income tax bracket and 15% for taxpayers with taxable income above the 15% bracket. The ATRA increased the top rate for long-term capital gains and qualified dividends to 20% (up from 15%) for taxpayers with income exceeding the threshold for their filing status. Thus, for years beginning in 2013, there will be three long-term capital gains rates: 0%, 15%, and 20%, with the 20% applying to higher-income taxpayers.
Example: Howard, a single individual, retired this year and sold rental property he 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. To the extent his income exceeds the $400,000 threshold, he will be subject to the increased capital gains rate. Let’s further assume Howard’s other taxable income was $50,000, this would result in a total income of $750,000, of which $350,000 exceeds the 15% long-term CG rate threshold. As a result, Howard pays the 20% capital gains rate on $350,000—an increase of $17,500 ($350,000 x 5%) over what he would have paid in 2012.
Generally, sales that are subject to long-term capital gains rates are considered investment income with the potential of being subjected to the 3.8% unearned income Medicare contribution tax also part of the 2012 American Taxpayer Relief Act.
If Howard 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.
If you have questions, 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.
