Let’s take a look at the key tax law changes for 2013.
Tax rates extended—for most taxpayers. Thanks to repeal of the so-called “sunset” of the Bush-era tax cuts, the new law makes the 10%, 15%, 25%, 28% 33% and 35% tax brackets permanent. However, the new law adds a higher 39.6% bracket, which begins at $400,000 for singles, $425,000 for heads of households, $450,000 for joint filers and surviving spouses, and $225,000 for marrieds filing separately for 2013. [IRC §1(i)]
The new law permanently extends the 0% tax rate on capital gains and qualified dividends for taxpayers below the regular 25% bracket, as well as the 15% rate for other taxpayers. However, the law adds a 20% rate for gains falling in the new 39.6% bracket. [IRC §1(h)]
Double whammy. Another tax law change will further increase the tax bite on capital gains and dividend income for higher income taxpayers. A new Medicare contribution tax on net investment income (including qualified dividends and capital gains), which was enacted by the 2010 health care law, takes effect starting this year. [IRC §1411] The tax is imposed at a rate of 3.8% on the lesser of (a) net investment income or (b) the excess of modified AGI above a threshold amount. The threshold is $250,000 for joint filers ($125,000 for marrieds filing separately) or $200,000 for other filers. So, for example, a single filer with $50,000 dividends and capital gains of income falling in the new 39.6% rate bracket will see the tax on that income rise to 23.8%. For taxpayers with dividends and gains below the 39.6% bracket but above threshold amount, the tax bite will increase from 15% to18.8%.
Marriage penalty relief extended. By repealing the sunset provision, the new law permanently extends “marriage penalty” relief provisions. Thanks to the new law, the size of the 15% rate bracket is permanently set a twice the size of the 15% bracket for single filers. (IRC §1(f) In addition, the standard deduction for marrieds filing jointly is permanently set at twice the amount for single filers. [IRC §63(c)]
PEP and Pease restored—for some. The new law restores the so-called PEP (personal exemption phaseout) and Pease (itemized deduction phaseout, named for the Congressman who authored the legislation) limits, which had been reduced and then suspended by the Bush-era cuts. However, the restored limits apply at higher income levels than under prior law. For 2013, personal exemptions will be reduced by 2% for each $2,500 (or portion thereof) of AGI above $300,000 for joint filers and surviving spouses, $275,000 for heads of households, $250,000 for singles, and $150,000 for marrieds filing separately. [IRC §151(d)(3)] Under the Pease limitation, the total amount of itemized deductions will be reduced by 3% of the amount by which AGI exceeds the same threshold amounts. [IRC §68]
Permanent AMT patch. Over the past several years, Congress has repeatedly “patched” the AMT by temporarily increasing the exemption amount prevent large numbers of taxpayers from becoming subject to the alternative tax. The 2012 Act permanently increases the AMT exemption amount to $50,600 for unmarried taxpayers, $78,750 for joint filers and $39,375 for marrieds filing separately, indexed for inflation after 2012. For 2013, the AMT exemptions are $51,900 for singles, $80,800 for joint filers, and $40,400 for marrieds filing separately. [IRC §55]
The new law also permanently extends the provision allowing nonrefundable personal credits to offset the AMT.
Extenders, extenders, extenders. The 2012 Act extends—in some cases, permanently—a slew of expired or expiring tax provisions for individual taxpayers. Here’s a brief rundown of provisions affecting individual taxpayers.
Child tax credit. The $1000 per-child amount and expanded refundability of the credit are made permanent. [IRC §24(a),(d)] The lower $3,000 threshold for refundability is extended through 2017. [IRC §24(d)(4)]
Child and dependent care credit. The maximum credit is permanently set a $1,050 for one qualifying individual (35% of up to$3,000 of expenses) or $2,100 for two or more qualifying individuals (35% of up to $6,000 of expenses. The 35% credit percentage is reduced, but not below 20%, by one percentage point for each $2,000 (or fraction thereof) above $15,000. [IRC §210
Adoption credit. The expanded adoption credit rules (but not refundability) are made permanent. [IRC §23] The maximum credit is $12,970 for 2013.
Earned income tax credit. The increase in the phaseout threshold for joint filers to $5,000 more than for single taxpayers and the increased EIC amount for families with three or more children are extended through 2017; certain EIC simplification changes are made permanent. [IRC §32]
American Opportunity credit. The American Opportunity education tax credit (in lieu of the Hope Scholarship credit) is extended through 2017. [IRC §25(a)(i)]
Nonbusiness energy property credit. Tax credits for energy efficient home improvements extended through 2013. [IRC §25C0
Exclusion for employer-provided educational assistance. The exclusion, including applicability to graduate courses, is made permanent. [IRC §127]
Exclusion for employer-provided adoption assistance. The exclusion is made permanent. [IRC §137]
Exclusion for employer-provided transit benefits. Parity in exclusions for employer-provided parking and employer-provided transit passes/vanpooling extended through 2013. [IRC §123(f)(2)] For 2013, the maximum exclusions are $245 per month.
Exclusion for discharged home mortgage debt. Exclusion extended through 2013. [IRC §108(a)(1)(E)]
Student loan interest deduction. Expanded student loan interest deduction rules are made permanent. [IRC §221]
Coverdell education savings accounts. Increased $2,000 contribution limit and other changes made permanent. [IRC §530]
Educator expense deduction. Deduction for up to $250 of classroom-related expenses extended through 2013. [IRC §62(a)(2)(d)]
Tuition and fees deduction. Above-the line deduction for qualified tuition and related expenses extended through 2013. [IRC §222]
Deduction for mortgage insurance premiums. Exclusion extended through 2013. [IRC §163(h)(3)(E)]
State and local sales tax deduction. Option to claim itemized deduction for state and local sales taxes in lieu of state and local income taxes extended for 2013. [IRC §164(b)(5)]
IRA distributions to charity. Tax-free distributions from IRAs for charitable purposes extended through 2013. [IRC §408(d)(8)]
Other tax changes for 2013. Taxpayers and their advisers should also note that a number of significant tax changes, which were enacted by the 2010 health reform law, first take effect in 2013. As noted earlier, a new Medicare contribution tax on investment income takes effect in 2013. Other significant changes for your individual clients include.
Health FSA contribution limit. Starting in 2013, health flexible spending arrangements must limit tax-free salary reduction contributions to $2,500 per year. [IRC §125(i)] The $2,500 limit will be indexed for inflation in future years. The contribution limit technically carries a January 1, 2013 effective date; however, the IRS has announced that plans are not required to apply the limit until the first plan year beginning after December 31, 2012. Inflation adjustments to the contribution limit will also apply on a plan year basis. [IRS Notice 2012-40]
Higher medical expense deduction threshold. Starting this year, medical expense deductions for most taxpayers will be subject to a 10% deduction floor—up from 7.5% for prior years. However, for 2013 through 2017, the 7.5% deduction floor will continue to apply if either the taxpayer or the taxpayer’s spouse has reached age 65 before the end of the tax year. [IRC §217]
Additional Medicare tax for high earners. Starting in 2013, an individual is liable for Additional Medicare Tax of 0.9% on wages, other compensation, or self-employment income (together with that of his or her spouse if filing a joint return) exceeding certain thresholds. The thresholds are $250,000 for marrieds filing jointly, $125,000 for marrieds filing separately, or $200,000 for all other taxpayers. [IRC §3101]
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