Tax Law Changes for 2013

Taxes are going up and spending cuts are on hold until March.  As predicted, our elected representatives in Washington D.C. are unwilling to deal with the reality of our budget deficits.  We have a financial crisis that no amount of tax increases will solve unless we make serious spending cuts.  This assumes our elected officials have the intestinal fortitude to put the country above their own self-interests i.e., re-election.  So our government has done the one thing it is great at – kick the can down the road and let someone other elected representative deal with the problem while this country buries itself further in debt.  I digress.  Having received numerous emails and calls today regarding what transpired this morning here is an explanation of some of the most significant of H.R.8, the "American Taxpayer Relief Act" (the "Act"):

Personal Income Tax Rates. For tax year 2013 and thereafter, any income in excess of $450,000 for joint filers, $425,000 for heads of household, $400,000 for single filers and $225,000 for married taxpayers filing separately the tax rate will increase to 39.6% for any income in excess of this rate.

Capital Gains/Dividends. Long-term capital gains and "qualified dividends" will increase to 20% for taxpayers with incomes exceeding $400,000 ($450,000 for married taxpayers).  When combining the Obama Care 3.8% surtax on investment-type income and gains for tax years beginning after 2012, the overall will be 23.8%.  

For taxpayers whose ordinary income is generally taxed at a rate below 25%, capital gains and dividends will permanently be subject to a 0% rate. Taxpayers who are subject to a 25%-or-greater rate on ordinary income, but whose income levels fall below the $400,000/$450,000 thresholds, will continue to be subject to a 15% rate on capital gains and dividends. (Note that your capital gains tax rate is determined by adding your capital gains into income to determine your ordinary income tax rate then applying the appropriate capital gains rate.)

Estate and Gift Taxes. The Act retains the 2012 estate and gift tax exemption amount of $5 million (adjusted for inflation) but increases the federal estate and gift tax rates on transfers in excess of this amount from 35 to 40 percent. For 2013, the inflation-adjusted exemption amount is expected to be $5.25 million. The Act also continues the portability feature of the estate tax law, which allows a surviving spouse to utilize his or her deceased spouse's unused exemption amount.

PEP limitations to Apply to "High-Earners”.  The Personal Exemption Phaseout (PEP), which previously had been suspended, is reinstated with a starting threshold of adjusted gross income (AGI) above $300,000 for joint filers and surviving spouses, $275,000 for heads of household, $250,000 for single filers and $150,000 for married taxpayers filing separately. Under the phaseout, the total amount of exemptions that may be claimed by a taxpayer who is subject to the limitation is reduced by 2 percent for each $2,500 (or a portion thereof) by which the taxpayer's AGI exceeds the relevant threshold. These dollar amounts will be inflation-adjusted for tax years after 2013.

Pease limitations to Apply to "High-Earners”. The “Pease“ limitation on itemized deductions, which had previously been suspended, with a starting threshold of AGI above $300,000 for joint filers and surviving spouses, $275,000 for heads of household, $250,000 for single filers and $150,000 for married taxpayers filing separately. Thus, for taxpayers subject to the “Pease” limitation, the total amount of their itemized deductions is reduced by 3 percent of the amount by which the taxpayer's AGI exceeds the threshold amount, with the reduction not to exceed 80 percent of the otherwise allowable itemized deductions. The Pease limitation affects all deductions, including the charitable donation deduction and the deduction for home mortgage interest.  

Example

Single filer with no dependents and AGI = $300,000: AGI exceeds the phaseout threshold by $50,000 (= $300,000 - $250,000); 3 percent of $50,000 is $1,500. Itemized deductions may be reduced by $1,500, up to a maximum of 80% of itemized deductions.

Alternative Minimum Tax (AMT). The Act provides some permanent AMT relief for tax years 2012 and later by retroactively increasing the applicable exemption amounts to $50,600 for unmarried taxpayers, $78,750 for joint filers and $39,375 for married persons filing separately.  Also, prior to the Act, nonrefundable personal credits, other than the adoption credit, the child credit, the savers' credit, the residential energy efficient property credit, the non-depreciable property portions of the alternative motor vehicle credit, the qualified plug-in electric vehicle credit and the new qualified plug-in electric drive motor vehicle credit, were allowed only to the extent that the individual's regular income tax liability exceeded his tentative minimum tax, determined without regard to the minimum tax foreign tax credit. Retroactively effective for tax years beginning after 2011, the Act permanently allows an individual to offset his entire regular tax liability and AMT liability by the nonrefundable personal credits.

Exclusion of Small Business Capital Gains. Generally, non-corporate taxpayers may exclude 50 percent of the gain from the sale of certain small business stock acquired at original issue and held for more than five years. For stock acquired after February 17, 2009 and on or before September 27, 2010, the exclusion is increased to 75 percent. For stock acquired after September 27, 2010 and before January 1, 2011, the exclusion is 100 percent and the AMT preference item attributable for the sale is eliminated. The Act extends for one year the 100 percent exclusion of the gain from the sale of qualifying small business stock through 2013.

Other Miscellaneous Deductions and Credits. 

The Act also extends for five years the American Opportunity Tax Credit. For many taxpayers this dollar-for-dollar credit is worth up to $2,500. 

The Act also would extend for five years the current versions of the Child Tax Credit and Earned Income Tax Credit, which are claimed by many lower-income workers making up to approximately $50,000.

The Act includes a one-year extension of current "bonus" depreciation rules, which allow businesses to deduct up to 50 percent of the cost of a wide variety of property and equipment, excluding real estate.

Additionally, the Act extends through 2013 the exclusion of certain income from the discharge of qualified principal residence indebtedness. 

The Act also extends several energy-related tax credits for an additional year, including a wind tax credit and a credit for certain plug-in electrical vehicles.

Increase in Employee-Paid Payroll Taxes. The two percent payroll tax holiday that taxpayers have enjoyed for the past two tax years is allowed to expire under the Act (the reduction had decreased the rate from 6.2 to 4.2 percent). For an individual earning the maximum 2013 cap of $113,700 or more, this increase will amount to $2,274 in 2013.

Unemployment Benefits. The Act includes a one-year extension of unemployment insurance benefits.

Spending Cuts. Under the Act, the $1.2 trillion in automatic spending cuts that were scheduled to take effect and would have affected the Pentagon and many other domestic programs are delayed for two months, paid for by a reduction in the discretionary spending cap for 2013 and 2014.