New Tax Compromise: What It Means To You

Now that the dust has settled a bit over the much-hyped ‘fiscal cliff’ with regards to the tax portion of the issue, I thought it would be helpful to put some thoughts together regarding what this all means for you. I have decided to break this post into categories based on whether or not one is working/retired and level of income. What follows is not meant to be exhaustive and is certainly not meant to be specific to any one individual. But based on how this is put together, I think you will have a pretty good idea of how you will be impacted by the new tax changes in 2013.

Retired & Income under $250,000 (married) or $200,000 (individual): it seems that if you are retired and your adjusted gross income is less than $250,000, then there should be no impact for you. Your income tax rates, capital gain and dividend rates all stay the same. Since you are no longer working you are also not impacted by the sunset of the payroll tax cut.

Retired & Income over $250,000 (married) or $200,000 (individual): there is a new 3.8% Medicare surtax on unearned income that will impact everyone with adjusted gross income over these income limits. Furthermore, if your taxable income is over $450,000 (married) or $400,000 (individual) you would be subject to the highest new tax bracket of 39.6% but only on the amount over these thresholds. You would still enjoy a continuation of the Bush-era income tax rates on all income under these thresholds. (It is important to note that taxable income is calculated after all deductions and credits are subtracted from adjusted gross income.)

Working & Income under $250,000 (married) or $200,000 (individual): For the past two years working Americans have benefited from a 2% cut in payroll taxes. That has expired for 2013 so if you work, you will pay an additional 2% in taxes this year. Other than this though, income tax rates along with capital gains and dividend rates stay the same for 2013.

Working & Income over $250,000 (married) or $200,000 (individual): In addition to the higher 2% in payroll taxes, you are subject to the 3.8% Medicare surtax on unearned income. Also, there are limitations on personal exemptions and itemized deductions that are coming back into play if your income is above $300,000 (married) or $250,000 (individual). On average, the net of these limitations will be an increase in federal tax burden of 1%. As noted, this will be slightly different for everyone.

Working & Taxable Income over $450,000 (married) or $400,000 (individual): in addition to the extra taxes mentioned above, you have been selected for a higher rate on income above these thresholds. A new 39.6% tax bracket will apply above these thresholds. In addition, you will also pay higher taxes on capital gains and qualified dividends. The rate is going from 15% to 20%. If you couple in the new Medicare surtax of 3.8%, in effect, your rate is going from 15% to 23.8% for long-term capital gains and dividends. It should be noted that short-term capital gains have always been taxed at ordinary income tax rates.

Other issues: many other credits were extended that are targeted towards the middle class. This includes education incentives as well as the child tax credit and dependent care credit. There was also the issue of the estate tax. For the most part, the system that was in place in 2012 has been extended for 2013. The individual exemption is over $5m per person or $10m per couple. The only thing that changed is that the tax rate on those lucky enough to pay these federal estate taxes is going up from 35% to 40%.

Good news on the AMT: the alternative minimum tax is a term that many of our clients have become familiar with over the years. While this system was not repealed, it was ‘patched’ for 2012 and then the new exemption made permanent and indexed for inflation. What does this all mean? It means that the sword of the AMT will not be hanging over heads each year waiting for Congress to come up with a permanent solution. We can at least do a bit of planning!

Talking about permanence and planning- the tax rates for income, capital gains, dividends, and the estate tax were all made permanent. Unless Congress is able to achieve tax reform this year (or any year), the constant uncertainty of tax rates should go away for at least four years. For those of us who help others plan, this in itself is great news.

One last thing: while the permanence of these tax rates is a very good thing in my opinion, the complexity of our tax code just got a whole lot worse. (If that was even possible!) While we can hope for tax reform and simplification, my guess is that the children in Washington are not capable of that just yet.

About the author

Ken Weingarten, MBA, CFP®

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