Be ready to deal with the brave new world of 2013 tax increases.
The tax landscape has shifted precipitously for taxpayers who find themselves on the wrong side of the new divide between “middle class” and “higher earners.” Effective in 2013, there is a new 0.9% payroll tax on wages and self-employment income, and a new 3.8% surtax on the net investment income of higher-income individuals. There also are higher top income tax rates on ordinary income, capital gains and dividends, while limitations are imposed on the availability of the personal exemption and itemized deductions. All of these changes increase the importance of tax awareness and tax planning for 2013. Here are the details.
Increased payroll tax for high-earning employees and self-employed. An additional 0.9% hospital insurance tax (i.e., a component of the FICA payroll tax) applies to wages above: $250,000 for joint returns; $125,000 for marrieds filing separately; and $200,000 for others. The additional tax also applies to self-employment income in excess of the above dollar amounts.
Surtax on investment income of higher-income individuals. Individuals, estates and trusts are subject to a new “Medicare contribution tax.” For individuals, the tax is 3.8% of the lesser of either (1) net investment income, or (2) the amount of modified AGI above $250,000 for a joint return or surviving spouse, $125,000 for a married individual filing separately, or $200,000 for all others.
And increased top income tax rate. A new rate 39.6% rate applies for 2013 for income above $450,000 for joint filers and surviving spouses; $425,000 for heads of household; $400,000 for single filers; and $225,000 for marrieds filing separately.
Top capital gain and dividend rates rise. The top rate for capital gains and dividends rises from 15% to 20% in 2013 for taxpayers with incomes subject to the new 39.6% rate. The increased rate applies both for regular tax and AMT purposes.
Personal exemption is limited for high earners. Personal exemptions and dependency deductions phase out for 2013 starting at AGI of $300,000 for joint filers and surviving spouses; $275,000 for heads of household; $250,000 for single filers; and $150,000 for marrieds filing separately. The amount of exemptions that can be claimed is reduced by 2% for each $2,500 (or portion thereof) by which the taxpayer’s adjusted gross income exceeds the above thresholds.
Itemized deductions are limited for high earners. Itemized deductions for 2013 are reduced for taxpayers with AGI over $300,000 for joint filers and surviving spouses; $275,000 for heads of household; $250,000 for single filers; and $150,000 for marrieds filing separately. Their itemized deductions are reduced by 3% of AGI above those thresholds; however the reduction can’t exceed 80% of the otherwise allowable itemized deductions.
Some of these taxes will be very difficult to avoid, but planning can help lessen the damage from some – especially the 3.8% surtax on net investment income. For surtax purposes, gross income excludes a number of items, such as interest on tax-exempt bonds and excluded gain from the sale of a principal residence. Qualified retirement plan and IRA distributions are excluded. So, generally, is non-passive business income. And some loss carryovers can offset investment income otherwise subject to the tax. Finally the timing of various types of income will be very important. Tax advisors of high-income individuals will want to use our research products to help clients plan their business and investment affairs to minimize the tax increases wherever possible.