The New Income, Capital Gains, and Estate Tax Environment – Winter 2013

After many years of living with temporary tax brackets, we now have a more settled scheme due to the recently passed but inaccurately named American Taxpayer Relief Act of 2012. Let’s outline the new realities:

Income Taxes:

For most taxpayers, the federal income tax rates for 2013 will be the same as in 2012: 10%, 15%, 25%, 28%, 33%, and 35%. However, married filers with taxable of more than $450,000 ($400,000 single) will have a new, higher maximum rate of 39.6%.

Payroll Taxes:

The rate on Social Security tax withholding increases from the current 4.2% to 6.2%.   Amounts earned over $113,700 are not taxed for Social Security. For married filing jointly taxpayers earning more than $250,000 ($200,000 single) an additional 0.9% Medicare tax applies to earnings above the threshold.

Capital Gains and Dividend Taxes:

Long term capital gains and qualified dividends will remain the same for most taxpayers. However, for “high income earners” (married filers earnings with taxable income over $450,000; singles over $400,000) there is a new higher rate of 20%. There is also a new 3.8% Medicare surtax on investment income for married filers with MAGI (modified adjusted gross income) over $250,000 and singles over $200,000.

Personal and Depended Exemption Deduction Phase-Out:

Your personal exemptions will now be phased out by 2% for each $2,500 of income over the $300,000 AGI (adjusted gross income) threshold if you are married filing jointly and over $250,000 AGI if you are single.

Itemized Deduction Phase-Out:

If you are married and have an AGI over a threshold of $300,000, or single with AGI over $250,000, you can potentially lose up to 80% of your write-offs for mortgage interest, state property taxes, and charitable contributions. Specifically, the total amount of your affected itemized deductions is reduced by 3% of the amount by which your AGI exceeds the aforementioned thresholds.

Alternative Minimum Tax (AMT):

The “patch” which congress has passed every year to prevent millions of households from becoming ensnared by the AMT has been made permanent, and it has been indexed for inflation.

Estate and Gift Tax:

The federal estate and gift tax exemption is now at $5.25 million, and it is indexed for inflation. However, the new maximum estate tax bracket has been increased from 35% to 40%. The Washington State estate tax exemption remains at $2 million, and is not indexed for inflation.

Note: All of the above changes are permanent. There are many other provisions dealing with various credits, education plans, charitable gifts from IRAs, and others.

You will observe that the “marriage penalty” is back with a vengeance for high earners. For example, an unmarried couple may not pay the new top bracket on household income until their collective earnings exceed $800,000; whereas a married couple will pay the top rate on income over $450,000. Married couples will also begin to lose their exemptions at a much lower income level.

This tax law does give some certainty to future tax liability, which is a good thing. However, it does virtually nothing to solve our basic problem of overspending, which is sure to be a major topic for Congress when our current debt limit is reached within a few weeks.

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