Without Congressional action before the end of the year, just about everyone, rich and poor alike, will be hit by tax increases. These increases are the result of temporary tax benefits that will expire at the end of 2012.
Just about everyone will be affected in one way or another. The following is a list of the expiring benefits and how taxpayers will be affected. Check the list for items that will apply to you to get an idea of how your taxes will be impacted.
- Exemption Phase-Out – Each taxpayer is entitled to a $3,800 (2012) tax exemption (deduction) for him or herself, his or her spouse, and each dependent. Beginning in 2013, a phase-out (reduction) of the exemptions will return for higher income taxpayers. The otherwise allowable exemption amounts will be reduced by 2% for each $2,500 or part of $2,500 ($1,250 for married filing separately) that the taxpayer’s AGI exceeds the AGI threshold for the year based on the taxpayer’s filing status. The threshold amounts for 2013 have not been announced yet but will be inflation-adjusted amounts from 2009 (the last year when this rule applied). These amounts were $372,700 for married taxpayers filing jointly, $186,350 for married taxpayers filing separately, $331,000 for head of household filers, and $289,300 for single filers. Impact: Higher income families.
- Itemized Deduction Phase-Out - Beginning in 2013, higher income taxpayers will again be subject to the phase-out of itemized deductions. Not all itemized deductions are subject to phase-out. The following are the ones subject to phase-out: taxes, interest (except investment interest), charitable contributions, employee job expenses and other miscellaneous itemized deductions (excluding gambling and casualty or theft losses).If the itemized deductions are subject to the limit, the total of all itemized deductions is reduced by the smaller of: 1) 3% of the amount by which the AGI exceeds the annual limit, or 2) 80% of the itemized deductions that are affected by the limit. The threshold amounts for 2013 have not been announced yet but will be inflation-adjusted amounts from 2009, which were $83,400 for married taxpayers filing separately and $166,800 for all others. Impact: Higher income families who itemize their deductions.
- Payroll Tax & Self-Employment Tax – Both the payroll withholding tax and self-employment tax rates have been reduced by 2 percentage points for two years. Payroll FICA withholding will return to 6.2% (up from 4.2%) and self-employment tax will return to 12.4% (up from 10.4%) beginning in 2013. Impact: All working taxpayers.
Long-Term Capital Gains Rates Increase – Taxpayers have enjoyed reduced long-term capital gains rates for several years as a result of the Bush-era tax cuts. However, those reduced rates will return to the higher rates in effect prior to 2003. The table below compares the current long-term capital gains rates to the anticipated rates for 2013 and subsequent years. Taxpayers with unrealized gains in investment property they’ve held for over one year may want to consider selling some or all of those assets in 2012 to lock in the lower long-term capital gains rate on their gains. Impact: All taxpayers with long-term capital gains.
- Regular Tax Rates – In addition to lower long-term capital gains rates, the regular marginal tax rates have been declining since 2001. However, without Congressional action, those reduced rates will return to the higher rates that were in effect prior to 2001. The table below compares the current marginal individual tax rates to the anticipated rates for 2013 and subsequent years.
- These increased rates will apply to all varieties of ordinary income, including interest, dividends, short-term capital gains, employment income, etc. Marginal tax rates increase as a taxpayer’s overall income increases, taxing the first block of income received at the lowest rate and each subsequent block at ever-increasing rates until the maximum rate is reached. As with assets eligible for the long-term capital gains rates, it may be appropriate for some taxpayers to accelerate ordinary income into 2012 to take advantage of the lower rates. Impact: All taxpayers.
- Bonus Depreciation Expires – For several years, businesses have been able to take advantage of bonus depreciation that essentially allows a 50% (100% during some periods) depreciation deduction of the cost of qualified business equipment and machinery in the first year it is placed in service. The big business write-off expires after 2012. Impact: Larger businesses.
- Coverdell Education Accounts – Some years back, the tax benefits related to Coverdell Education Accounts were liberalized and made more beneficial to taxpayers. Those liberalized benefits will no longer apply after 2012. The most notable of these changes are: the dollar limit on contributions for any one beneficiary is reduced to $500 from $2,000, contributions can be made only by individuals, the modified AGI phase-out range for the annual contribution limit will be $150,000 – $160,000 for joint filers instead of twice the amounts for single filers ($95,000 – $110,000), contributions for special needs students age 18 or over will no longer be allowed, contributions for the tax year must be made by December 31 (was April 15 in the following year), qualifying expenses will no longer include those related to elementary or secondary school expenses, contributions to a Coverdell account and a Sec 529 Qualified Tuition Program will no longer be allowed in the same year, and education credits cannot be taken in a year in which a Coverdell withdrawal is made. Impact: Lower to moderate income families.
- American Opportunity Tax Credit Expires – The American Opportunity Tax Credit (AOTC), which took the place of the Hope Education credit beginning in 2009, will expire after 2012. This liberalized credit provided a credit of up to $2,500 (the Hope credit provided only $1,800), and where the Hope credit could be used only to offset a taxpayer’s tax liability, up to 40% of the AOTC is refundable in many instances. In addition, the ATOC provided 4 years of credit, while the Hope credit only applies for two years. The AOTC expires after 2012. Impact: Lower income families.
- Higher Education Loan Interest – A deduction of up to $2,500 is allowed for interest paid on loans for higher education. This deduction was originally limited to the first 60 months for which the interest payments were required. Congress subsequently temporarily eliminated the 60-month limitation and increased the AGI phase-out. Beginning in 2013, the 60-month rule returns and the AGI phase-out ranges (before adjustment for inflation) will be reduced to $60,000 – $75,000 for joint filers and $40,000 – $55,000 for other filers (except married couples filing separately who are barred from claiming this deduction). Impact: Lower to moderate income taxpayers.
- Alternative Minimum Tax (AMT) – Congress originally implemented the AMT to impose a minimum taxon higher-income taxpayers who were avoiding taxes through tax shelters and other legal means. However, years of inflation without corresponding adjustment to the AMT components have, each successive year, caused an increasing number of taxpayers to be subject to the AMT.Much as the regular income tax allows personal exemptions, the AMT calculation allows an exemption, but based upon filing status. For the past several years, Congress has, on a year-to-year basis, increased that exemption for inflation. However, should they fail to provide an increase for 2012 and 2013, the exemption amounts would revert to levels not seen since the early 2000s, which, depending upon filing status, would result in an approximate 30% to 40% decrease in the exemption amount. For example, the exemption amount for joint filers would drop from 2011’s $74,450 to $45,000. The reduction of the exemption amount would snare a significantly greater number of taxpayers for 2012 – estimated to be around 31 million versus 4 million for 2011. Impact: Generally, middle income taxpayers.
- Child Tax Credit – Since 2003, the child tax credit has been $1,000 for each qualified child of a taxpayer who is under the age of 17 at the end of the year. However, this was a temporary provision that expires at the end of 2012, and, beginning in 2013, the credit will revert to $500 per child. In addition, the refundable portion of the credit will be reduced. Impact: Lower income taxpayers with children.
- Child & Dependent Care Credit – As part of the Bush-era tax cuts, the maximum expenses qualifying for dependent care credit were raised from $2,400 ($4,800 for two or more qualifiers) to $3,000 ($6,000 for two or more qualifiers) and the income-based maximum credit percentage was raised from 30% to 35%. However, these increases are scheduled to revert to the lower amounts in 2013. Impact: Lower income working taxpayers with children.
- Earned Income Tax Credit – In 2009, a credit category for three or more children was added, providing an increased credit for taxpayers with three or more qualifying children. However, that was a temporary measure which will expire at the end of 2012. This will reduce the maximum credit for individuals with three or more children by $650 in 2013. Other changes that enhanced and simplified the credit computation are also set to expire. Impact: Lower income taxpayers with large families.
In addition to the expiring benefits listed above, depending upon what the Supreme Court ultimately decides about the Health Care Law, the following provisions of the Heath Care law will take effect in 2013:
- Increased Hospital Insurance Tax – The Hospital Insurance (HI) tax rate (currently at 1.45%) will be increased by 0.9 percentage points on individual taxpayer earnings (wages and self-employment income) in excess of compensation thresholds for the taxpayer’s filing status. Thus, the wage withholding HI rate will be 1.45% up to the income threshold and 2.35% (1.45 + 0.9) on amounts in excess of the income thresholds. The hospital insurance portion of the SE tax rate will be 2.9% up to the income threshold and 3.8% (2.9 + 0.9) on amounts in excess of the threshold. The income thresholds where this increase begins is $250,000 for married taxpayers fling jointly, $125,000 for married taxpayers filing separately, and $200,000 for all other taxpayers. Impact: Higher income working families.
- Surtax on Unearned Income – A new surtax called the Unearned Income Medicare Contribution Tax is imposed on the unearned income of individuals, estates, and trusts. For individuals, the surtax is 3.8% of the lesserof:
- 1. The taxpayer’s net investment income or
- 2. The excess of modified adjusted gross income over the threshold amount ($250,000 for a joint return or surviving spouse, $125,000 for a married individual filing a separate return, and $200,000 for all others)
“Net” investment income is investment income reduced by allowable investment expenses. Investment income includes: Income from interest, dividends, annuities, royalties, rents (other than those derived from a trade or business), capital gains (other than those derived from a trade or business), trade or business income that is a passive activity with respect to the taxpayer, and trade or business income with respect to the trading of financial instruments or commodities. For surtax purposes, modified adjusted gross income doesn’t include excluded items such as interest on tax-exempt bonds, veterans’ benefits, and excluded gains from the sale of a principal residence. Impact: Higher income families.
- Employer Health FLEX-Spending Plan Contributions Limited – In order for a health FSA to be a qualified benefit under a cafeteria plan, the maximum amount available for the reimbursement of incurred medical expenses of an employee, the employee’s dependents, and any other eligible beneficiaries with respect to the employee under the health FSA for a plan year (or other 12-month coverage period) cannot exceed $2,500. Impact: All taxpayers participating in health FSAs.
- Medical Itemized Deductions Limited – The AGI threshold percentage for claiming medical expenses on a taxpayer’s Schedule A will be increased from 7.5% to 10%, which is the same as the current threshold percentage for alternative minimum tax (AMT) purposes. Individuals (and their spouses) age 65 (before close of year) and older will continue to use the 7.5% rate through 2016. Impact: Higher income taxpayers.
Keep in mind that Congress could and probably will extend some of the provisions. In addition, the Supreme Court is considering the validity of the health care provisions. Even so, it may be appropriate to review your tax situation and plan for all eventualities.
Please give our office a call if you would like to schedule a planning session for steps you can take now to mitigate the changes coming in 2013.