Taxes in 2013: 10 Important Changes from Recent Legislation

The recently passed deal to avoid the fiscal cliff (the American Taxpayer Relief Act of 2012) comes with good news, but also some unpleasant facts if you are a high income taxpayer. It brings some welcome permanence to the tax code after over 10 years of dealing with provisions that “sunset” or lapse after a certain period of time – making it more practical to update or develop multi-year tax and estate plans.

While little changes for the majority of people, high income taxpayers will find the impact of the new law much less appealing. Also, provisions from the 2010 Affordable Care Act (“Obama Care”) go into effect this year as well – further raising applicable taxes. Finally, California’s Proposition 30 increases income tax rates on high income not only in 2013, but retroactively to January 1st, 2012!

Here is a summary of the 10 most important changes:

1. The Payroll Tax Cut Lapsed – Social Security taxes will go back to 6.2% (versus 4.2% in 2011 and 2012); this will reduce the take home pay of about 77% of American households.
2. A New 39.6% Tax Rate – Taxpayers with income over $400,000 Single / $450,000 Married Filing Joint (MFJ) will be subject to a new 39.6% marginal tax rate. The lower “Bush-era” tax rates will now be permanent.
3. A Higher Capital Gains and Dividend Rate – A 20% long-term capital gains and dividends tax rate for those with income over $400,000 Single / $450,000 MFJ. Lower income taxpayers get to keep the old 0% and 15% tax rates.
4. The 3.8% Medicare Tax Applies – Those with net income over $200,000 Single / $250,000 MFJ will pay an additional 3.8% tax on their investment income. Now dividends or capital gains could be taxed at 18.8% (15% + 3.8%) or 23.8% (20% + 3.8%).
5. The AMT Patch is Now Permanent –The Alternative Minimum Tax (AMT) is a parallel tax system that was enacted in 1969 to ensure a minimum tax is paid by those who benefit from various tax exclusions, credits, or other allowances; but it was not indexed for inflation. After several years of temporary patches, the AMT has been fixed so that it doesn’t affect “middle income” households.
6. IRA Distributions to Charity can get Special Treatment – If an IRA owner is over age 70½, they can give from their IRA directly to a public charity. The gift will satisfy the IRS required minimum distribution (RMD) requirements, and will not be counted as taxable income. This provision has been enacted and allowed to lapse repeatedly over the years, and currently it will only continue through 2013.
7. Permanent Gift/Estate Exemption, but New Tax Rate – The $5M (indexed) estate tax exemption is now permanent but the top rate rises to 40%.
8. New Phase-out of Itemized Deductions – High income taxpayers will lose some of their previously allowed tax deductions. This effectively increases the tax rates about 1% for those with income over $250,000 Single / $300,000 MFJ.
9. New Phase-out of Personal Exemptions – High income families ($250,000 Single / $300,000 MFJ) will lose the deduction for personal exemptions. This adds about a 1% tax for each person – so a family of 5 would see a net marginal tax increase of about 5%.
10. New CA Tax Rates – New higher income tax brackets of 10.3%, 11.3%, and 12.3% (versus 9.3% previously) apply starting with income over $250,000 Single / $500,000 MFJ.