On January 1, 2013, the fiscal cliff legislation negotiations passed new laws and regulations, which were a combination of expiration of old law, modification of current law and introduction of new law focused on the wealthiest of American taxpayers.
Increase #1: Rise in maximum marginal rate from 35% to 39.6%.
The U.S. tax system is a progressive one. This means that you don’t pay a flat tax rate on all of your income; rather, as your income increases, so does the rate applied to your last dollar of income earned.
Prior to the expiration of the Bush tax cuts on December 31, 2012, the rate structure was as follows:
10% – 15% -25% – $28 – $33% – 35%
The fiscal cliff negotiations preserved the existing tax brackets, but raised the top marginal rate from 35% to 39.6%. This resulted in the following structure:
10% – 15% -25% – $28 – $33% – 35% – 39.6%
Beginning in 2013, a new maximum rate of 39.6% will be applied on each dollar of taxable income earned in excess of $450,000 (married filing jointly) or $400,000 (single).
Increase #2: Increase in Top Rate on Long-Term Capital Gains and Qualified Dividends from 15% to 20%.
Prior to 2013, you paid tax on your long-term capital gains and qualified dividends at a maximum 15%, regardless of how much income you earned. As part of the fiscal cliff deal, this top rate was raised to 20%, only for taxpayers with taxable income in excess of $450,000 (married filing jointly) or $400,000 (single).
Tax Increase #3: New 3.8% Tax on Net Investment Income
On January 1, 2013, taxpayers will pay an extra 3.8% tax on the lesser of :
(1) Net investment income (interest, dividends, capital gains and passive activity income), Or
(2) The excess of the taxpayer’s modified adjusted gross income (generally the same as adjusted gross income) over the following applicable thresholds: $250,000 (married filing jointly) or $200,000 for single.
Tax Increase #4: New 0.9% Tax on Earned Income
Starting in 2013, you have to pay an additional 0.9% tax on earned income (wages and self-employment income) in excess of $250,000 (married filing jointly) or $200,000 (single).
Tax Increase #5: Return of the Pease Limitation on Itemized Deductions
Previously high-income taxpayers lost the benefit of their itemized deductions (mortgage interest, real estate taxes and charitable contributions) for taxpayers with adjusted gross income in excess of certain thresholds. This tax provision was repealed, but subsequently revived in the fiscal cliff legislation.
As a result, beginning in 2013, taxpayers will lose 3% of your otherwise deductible itemized deductions for each dollar your adjusted gross income exceeds $300,000 (married filing jointly) or $250,000 (single).
Tax Increase #6: Return of the PEP Limitation on Itemized Deductions
Taxpayers are entitled to claim a personal exemption deduction ($3,900 in 2013) for the taxpayer, your spouse, and any dependents. Like the Pease limitation, this tax provision was repealed, but subsequently revived in the fiscal cliff legislation.
Beginning in 2013, taxpayers will lose 2% for each $2,500 adjusted gross income exceeds $300,000 (married filing jointly) or $250,000 (single).