2012/2013 Tax Law Changes12/02/2013 | Winter 2013 Newsletter
While many of us were still recovering from our end of year celebrations, Congress and the President were hard at work making significant changes to our system of income, gift and estate taxation. For the first time in more than a decade we have in place a tax code that is “permanent,” meaning that for the moment, and for the most part, the Internal Revenue Code no longer contains provisions that expire or sunset.
The changes that became effective on January 1, 2013, not all of which were contained in the new legislation, affect all Americans, not just those having incomes over certain thresholds, as the media would have us believe. What follows is a summary of the most significant changes. A more detailed analysis will follow in future newsletters.
FICA Tax – The employee portion of the FICA tax returns to 6.2%. In 2011 and 2012 this rate was 4.2%. Self-employed individuals will once again be paying 12.4% on their self-employment income, rather than the 10.4% they paid in 2011 and 2012. The FICA tax is payable on the first $113,700 of salaries/self-employment income received in 2013 (up from $110,100 in 2012). In addition, both employees and those that are self-employed will continue to pay a Medicare tax of 1.45 % on their salaries/self-employment income.
Individual Income Tax Rates – The basic income tax rates for those having less than $200,000 of adjusted gross income (“AGI”) remain unchanged from what they were in 2012. Beginning in 2013, single taxpayers having AGI of more than $200,000, and married taxpayers having combined AGI of more than $250,000, will face a new Net Investment Income Tax of 3.8% on the lesser of their combined passive and net investment income, or the amount by which their AGI exceeds their respective threshold amount. Interestingly, this computation is independent of the taxpayer’s taxable income, so taxpayers that have no taxable income may nonetheless be required to pay this new tax.
Taxpayers with AGIs over these thresholds whose income is comprised only of salaries or self-employment income, are not necessarily exempt. These taxpayers will face an additional Medicare tax of .9% of the amount by which their salaries or self-employment income exceeds the $200,000/$250,000 thresholds.
Beginning in 2013, single individuals having taxable incomes of more than $400,000, and married couples filing joint returns having taxable income of more than $450,000, will face a tax rate of 39.6% (an increase from the 2012 tax rate of 35%) on their taxable income that exceeds these threshold amounts. In addition, taxpayers in this new bracket will pay a tax of 20% on long-term capital gains and qualified dividends, while taxpayers in the lower brackets will continue to pay a tax of 15%. Taxpayers filing joint returns having taxable income of less than $72,500, and single taxpayers having taxable income of less than $36,250, are in what is referred to as the “zero-bracket” and may not be required to pay any tax on their long-term capital gains and qualified dividends.
Itemized Deductions and Personal Exemptions – Taxpayers filing joint returns having AGI of $300,000, and single taxpayers having AGI of $250,000, will see their itemized deductions and personal exemption begin to phase out. Personal exemptions phase out by 2% for every $2,500 by which their AGI exceeds their applicable threshold amount. Itemized deductions (other than medical expenses, investment interest, casualty and theft losses and gambling losses (the “excluded items”)), are reduced by 3% of the amount by which a taxpayer’s AGI exceeds their applicable threshold, provided that itemized deductions cannot be reduced by more than 80% of the taxpayer’s total of itemized deductions less the excluded items. Taxpayers who are subject to the Alternative Minimum Tax (see below) will not be subject to the phase out of itemized deductions.
The combination of these two phase out provisions can serve to increase the effective tax rate of affected taxpayers by slightly more than 1%
Alternative Minimum Tax – Beginning with the 2012 tax year, the exemption from the Alternative Minimum Tax will be $78,750 for taxpayers filing joint returns, and $50,600 for single filers. These amounts are indexed for inflation. But for this new legislation, the exemptions for 2012 would have been $45,000 and $33,750, respectively. The effective tax rate remains unchanged at 28%.
Gift and Estate Tax – The new law made permanent the changes introduced in 2010. The effective exemption for transfers whether made during one’s life (gift tax), or upon death (estate tax), remains at $5,000,000 and continues to be indexed for inflation making the effective exemption for transfers made during 2013, $5,250,000. In addition, for those who are married, to the extent that the first to die does not use his or her effective exemption, it continues to be available to the survivor. However, it is important to note that the combined exemption may not necessarily be available for gifts made during their lifetimes, unless both spouses consent to treat the gift as being made one-half by each. In addition, it is important to remember that many states, New York being an excellent example, have different rules. For example, the New York exemption is only $1,000,000, and New York does not follow the federal concept of the unused portion of the effective exemption being portable and available to reduce the surviving spouse’s estate tax liability. The annual exclusion for gifts made during 2013 is $14,000 per recipient (an increase from $13,000).
Other Changes – The new legislation has continued certain provisions of the Internal Revenue Code which otherwise would have expired at the end of 2012:
- Employer provided educational assistance exclusion - $5,250.
- Dependent care credit - $600 for one dependent; $1,200 for two or more dependents.
- Child adoption expenses credit.
- Rollover of 401(k) and 403(b) retirement plans to Roth IRA – now permitted for all taxpayers, not just those over 59 ½.
Temporary changes scheduled to expire at the end of 2013:
- Deduction of mortgage insurance premiums as an itemized deduction.
- Deduction of state and local sales taxes in lieu of state and local income taxes.
- Tax free transit and parking benefits – capped at $245 per month.
- College tuition credit/deduction.
- Cancellation of indebtedness income for qualified principal residence indebtedness – up to $2,000,000 may be excluded from income.
- Enhanced Section 179 deduction (retroactive to 2012) – subject to limitations, a business can expense up to $500,000 of fixed asset additions made during a taxable year in the year the asset is placed in service.
- 50% bonus depreciation and 15 year straight line depreciation method for qualified leasehold, restaurant and retail improvement property.
- Work Opportunity Credit – equal to 40% of the wages paid to employees that are members of designated groups during their first year of employment. For veterans the credit can be as high as $9,600; for others, $6,000.
- Enhanced ability by corporations that elected to convert to “S Corporation” status prior to 2008 to sell certain assets without paying tax on the “built-in-gain”.
- Research and development credit.
What has not changed is the fact that our system of taxation is complex and one should not attempt to navigate it without consulting an expert. We stand ready to assist you.
About the author: David N. Milner is a partner at Gallet Dreyer & Berkey LLP. Mr. Milner’s practice focuses on tax law, estate planning, corporate law, and real estate. Mr. Milner, who is also a certified public accountant, helps clients to structure transactions in a manner calculated to reduce adverse tax consequences, and helps families develop estate planning strategies. He is a frequent speaker before community groups and trade organizations on matters relating to estate planning. Mr. Milner can be reached at email@example.com.