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2012/2013 Tax Planning

The Bush tax cuts will automatically expire atthe stroke of midnight on December 31, 2012 -- unless Congress takes action. Inaddition, the 2 percent Social Security tax rate reduction, often called thepayroll tax holiday, is also scheduled to expire at December 31, 2012. Finallythe 2010 healthcare legislation includes two other unfavorable changes thatwill affect many individuals, starting in 2013:

1. An additional 0.9 percent Medicare taxon salaries and self-employment income earned by higher-income individuals.

2. A 3.8 percentMedicare surtax on investment income earned by higher-income folks.

Impact of the ScheduledBush-ERA Tax Cut Expirations

INCREASED TAX RATES

Unless Congress takes action, taxes rates willrise for everyone.

  • The existing 10 percent bracket will go away, and the lowest "new" bracket will be 15 percent.
  • The existing 25 percent bracket will be replaced by a 28 percent bracket.
  • The existing 28 percent bracket will be replaced by a 31 percent bracket.
  • The existing 33 percent bracket will be replaced by a 36 percent bracket.
  • The existing 35 percent bracket will be replaced by a 39.6 percent bracket.

HIGHER CAPITAL GAINS AND DIVIDEND TAXES

The maximum federal rateon long-term capital gains and dividends is only 15 percent. Effective1/1/2013, the maximum rate on long-term gains is scheduled to increase to 20percent (or 18 percent on gains from assets acquired after December 31, 2000and held for more than five years), and the maximum rate on dividends willskyrocket to a whopping 39.6 percent.

Currently, themaximum federal rate on short-term capital gains is 35 percent. Effective1/1/2013, it is scheduled to increase to 39.6 percent.

In addition,there is currently a 0 percent rate that applies to long-term gains anddividends collected by individuals in the lowest two rate brackets (the 10percent and 15 percent brackets). Effective 1/1/2013, taxpayers in the lowesttwo brackets (the 15 and 28 percent brackets) will pay

·        A 10 percent rate on long-term gains.

·        A 15 percent and 28 percent rate on dividends.

·        A 15 percent and 28 percent rate on short-term gains.

PHASE-OUT RULE FOR ITEMIZED DEDUCTIONS

Before the Bush taxcuts, the itemized deduction phase-out rule could eliminate up to 80 percent ofa higher-income individual's itemized deductions for mortgage interest, stateand local taxes, and charitable donations. The rule was gradually eased andfinally eliminated in 2010. Next year, however, the phase-out will be back withfull force. If you itemize and your 2013 adjusted gross income above about$179,000, the phase-out will affect your deductions.

PHASE-OUT RULE FOR PERSONAL EXEMPTIONS

Before the Bush taxcuts, personal exemption phase-out rule could eliminate up to 100 percent of ahigher-income individual's personal exemption deductions. The rule wasgradually cut back and finally eliminated in 2010. Your personal exemptiondeductions will be eliminated if you are a married joint-filer with 2013adjusted gross income above about $269,000, single adjusted gross income above about$179,000, head of household adjusted gross income exceeds about $224,000 andmarried filing separate status adjusted gross income above about $134,000.

MARRIAGE PENALTY

The marriage penalty can cause a married coupleto pay more in taxes than when they were single.

  • The bottom two tax brackets for married joint-filing couples are exactly twice as wide as for singles. This helps keep the marriage penalty from biting lower and middle-income couples. Starting next year, the joint-filer tax brackets will contract, causing higher tax bills.
  • The standard deduction for married joint-filing couples is double (200%) the amount for singles. Starting next year, the joint-filer standard deduction will fall back to about 167 percent of the amount for singles.

Scheduled Expiration ofPayroll Tax Holiday

For 2012, the so-called payroll tax holiday cut the SocialSecurity tax rate on salaries and net self-employment income by 2 percent. Themaximum tax-saving benefit for one person is $2,202 (2 percent times the $110,100ceiling on salary and self-employment income for Social Security tax purposesfor 2012). A married couple can potentially save twice as much (up to $4,404)if they both work. The payroll tax holiday is scheduled to end on December 31,2012.

HEALTHCARELEGISLATION TAXES

New 0.9 percent Medicare Tax on Higher-Income Individuals

Currently, the Medicaretax on salary and/or net self-employment (SE) income is 2.9 percent. If you'rean employee, 1.45 percent is withheld from your paychecks, and the other 1.45percent is paid by your employer. If you're self-employed, you pay the whole2.9 percent yourself. Starting in 2013, an extra 0.9 percent Medicare tax willbe charged on:

1. Salary and/or net SE income above $200,000 for an unmarriedindividual;

2. Combined salary and/ornet SE income above $250,000 for a married joint-filing couple; and

3. Salary and/or net SEincome above $125,000 for those who use married filing separate status.

For self-employed individuals, the additional 0.9 percent Medicaretax hit will come in the form of a higher SE bill, but it will not qualify forthe deduction for 50 percent of your SE tax bill. If you owe the extra 0.9percent Medicare tax, it should be taken into account in determining if youneed to make quarterly estimated tax payments.

New 3.8 Percent Medicare Surtax on Investment Income

Currently, the maximumfederal income tax rate on long-term capital gains and dividends is only 15percent. Starting in 2013, the maximum rate on long-term gains is scheduled togo up to 20 percent and the maximum rate on dividends is scheduled to increaseto 39.6 percent as the Bush tax cuts expire. Also starting in 2013, all or partof the net investment income, including long-term capital gains and dividends,collected by higher-income individuals are taxed with an additional 3.8 percent"Medicare contribution tax."

You are subject to the new 3.8 percent Medicare surtax if  your modified adjusted gross income (MAGI)exceeds:

  • $200,000 if you are unmarried,
  • $250,000 if you are a married joint-filer, or
  • $125,000 if you use married filing separate status.

For this purpose, MAGI means regular AGI from the last line onpage 1 of your Form 1040 plus certain tax-free income from foreign sources. Formost people, MAGI will be the same as regular AGI

The surtax will apply to the lesser of your net investmentincome or the amount of your MAGI in excess of the applicable threshold. Netinvestment income includes gains from assets held for investment (like stock,other securities, and real estate), interest, dividends, royalties, annuities,rents, income from passive business activities, and income from trading infinancial instruments or commodities. Net investment income also includestaxable gains from personal residence sales. (Gains from assets held forbusiness purposes are not subject to the surtax.)

Higher Threshold for ItemizedMedical Expense Deductions

Right now, youcan claim an itemized deduction for medical expenses paid for you, your spouse,and your dependents, to the extent the expenses exceed 7.5 percent of AGI.Starting 2013, the threshold is raised to 10 percent of AGI.