This year starts with a new set of tax rules. Many important ones were not finalized until Jan 1, 2013 when the fate of the Bush tax cuts was finally decided. This affected many tax returns filings. The agency needs more time to reprogram its computers to reflect late changes made by the Congress.
Despite the relief over a tax deal for 2013, payroll tax increases spoil the party. The payroll tax reduction expired Dec 31, 2012 and the Lawmakers did not renew the 2% point cut in the employees’ share of the Social Security tax. Thus, employees see smaller pay checks as the rate returns to normal unless workers got a raise that offsets the impact. And the higher SECA tax rate means that self-employed individuals should boost their estimated tax payments for 2013.
A 0.9% Medicare surtax on earned income kicks in for higher incomers. This tax hike was passed in 2010 as part of health care reform, but the effective date was delayed to 2013. The levy applies to wages as well as to self-employment income. Singles and heads of household will owe it once total earnings exceed $200,000, Couples over $250,000, and Married filing separately over $125,000. So for earnings over the thresholds, the effective Medicare tax rate will be 3.8% – the usual 2.9% rate plus an extra 0.9%. The surtax applies only to the employee’s share of Medicare tax. Employers don’t owe it. Employees will calculate the actual tax due on their 1040s.
The 3.8% Medicare surtax on net investment income also begins this year, another aspect of health care reform. It applies to unearned income of single filers and head of households who have modified adjusted gross incomes (MAGI) above $200,000. It bites couples with MAGI over $250,000 and $125,000 for separate filers. This surtax is levied on the smaller of the filer’s net investment income or the excess of MAGI over the applicable dollar threshold. Investment income for this purpose includes interest, dividends, capital gains, annuities, royalties, and passive rental income. Tax free interest is exempted, along with payouts from retirement plans such as 401(k)s, IRAs, deferred pay plans, and pension plans.
The expiration date on the Bush income tax cuts has been eliminated. But tax rates on high-incomers increase for the first time since 1993. A 39.6% rate now applies to taxable income over $400,000 for singles, $425,000 for head of households, and $450,000 for married couples filing a joint return. Apart from this raise, the high incomers will also witness the top rate on capital gains and dividends to 20%. For others, a 15% rate still exists and the filers in the 10% and 15% tax bracket can still qualify for the special 0% rate.
Now let’s turn to other tax changes that are taking effect for this year. The estate and gift tax exemption for 2013 increases to $5,250,000. The tax rate jumps to 40% from 35% in 2012. The annual gift tax exclusion rises to $14,000 per done. Congress also revived the portability of the estate tax exemption between spouses.
As noted earlier, there are many other considerations in tax planning that are not addressed here, but my intent is that you use this as a primer for your year-end planning. Starting now can make the process less stressful and leave you with some time to take necessary steps before year-end. However, there might be some significant tax law changes before year-end, be sure to find with me- before year end – any other tax opportunity (ies) that may emerge and would be more beneficial and helpful to your specific tax situation.
Sharing a common goal – to defer or avoid paying taxes as much as possible.
Baljinder (Balli) S. Rakkar, CPA