Thursday, January 3, 2013

What Are The New Individual Income Taxes?

Congress has given us a new tax bill – the American Taxpayer Relief Act of 2012. It was passed by the Senate at approximately 2 a.m. on January 1 and ….. Actually, that fact alone tells you about the quality of this tax bill.

Let’s take a look at some individual tax measures.

(1)   The 2% social security tax reduction is gone. Everybody with a paycheck will immediately see their take-home pay go down.

(2)   The previous tax rates of 10/15/25/28/33/35 percent still exist, but ….

a.      There is a new 39.6% tax rate.

NOTE: The new rate starts at $400,000 for singles and $450,000 for marrieds.

(3)   The qualified dividends and capital gains rates do not change UNLESS…

a.      … you make more than $400,000 for singles and $450,000 for marrieds.

b.      If this is you, your NEW qualified dividends and capital gains tax rate will be 20%.

OBSERVATION:  Let’s be fair: 20% is not a bad tax rate.

You may have noticed that the above three changes pivot on $400,000/$450,000.

QUESTION: Can we rely on this throughout the new law?  

ANSWER: Silly you. Of course not.

(4)   Phaseout of your personal exemptions

Tax pros call this the “PEP,” and it is the brilliant idea to reduce (if not eliminate) your exemptions for yourself, your spouse, your kids and anyone else – once you go past a certain income.

QUESTION: What is that income level?

ANSWER: $250,000 for singles and $300,000 for marrieds.

(5)   Phaseout of your itemized deductions

You have the same reasoning as (4), but this time we are talking about reducing your itemized deductions. These are your mortgage, real estate taxes, contributions and so on.

QUESTION: What is that income level?

ANSWER:  $250,000 for singles and $300,000 for marrieds.

(6)   Alternative Minimum tax

Congress reset the exemption amounts to $50,600 for singles and $78,750 for marrieds – about in line with 2011.

This is good news because – if Congress did nothing – the exemption amounts were scheduled to decrease drastically. This would have pulled millions more people into the AMT, even with the same income as 2011 and would have made for some stressful client conversations.

Congress has also linked the AMT exemption and phaseout levels to an inflation factor. Finally and thank goodness.

Frankly, in my opinion the AMT may be the most important thing Congress did with individual taxes in this legislation.

(7)   Coverdell IRAs

a.      Remain at $2,000 rather than reverting to $500

b.      As an FYI, these are the “education” IRAs

(8)   Employer provided education

a.      The exclusion from income is renewed at $5,250.

NOTE: This will make a Tax Guy’s wife happy as she returns for her Master’s.

(9)   Student loan interest

a.      Remains deductible up to $2,500

(10)  The American Opportunity tax credit     

a.      Is renewed up to $2,500

NOTE: Good news for a Tax Guy with a daughter in college

(11)    The $250 supplies deduction for elementary and secondary school teachers

a.      Is renewed

(12)    Mortgage debt exclusion from income

a.      Up to $2 million is renewed but for 2013 ONLY

(13)    The sales tax deduction in lieu of income tax deduction

a.      Is renewed

b.      Good news if you live in Florida, which does not have an income tax

(14)    Above-the-line deduction for higher education

a.      Up to $4,000 – if you can meet the income limits

(15)    Child credit

a.      Stays at $1,000 per child rather than dropping to $500

Let’s go back a moment to the 39.6% tax rate (income of $400,000/450,000) and the PEP/Pease (income of $250,000/300,000).  In addition to this spaghetti, there are two NEW taxes in 2013. They are NOT in this bill because they already existed and were waiting to hatch, like something in the movie Aliens. They are ADDITIONAL taxes on top of the above. They are:

(1)   If your income goes above $200,000 for singles and $250,000 for marrieds, there will be a new 3.8% tax rate on your interest, dividends, capital gains and investment income of that type. This was courtesy of ObamaCare.

(2)   If your income goes above $200,000 for singles and $250,000 for marrieds, there will be a new 0.9% tax on your salary for additional Medicare. This too is courtesy of ObamaCare.

Did you see what Congress did here? Look at the income thresholds on some of these taxes:




Try remembering all that and doing the math in your head whenever you get a client phone call.

Notice what the “true” top federal tax rate is: 39.6% plus 3.8% plus 0.9% plus 1.2% (approximate PEP/Pease effect) equaling 45.5%. This is Congress' thing now: sneaking taxes on you through the back door.

We will go over the business tax provisions with another blog.

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