As most of you know by now, as of yesterday a tax deal passed through both the Senate and the House. President Obama is expected to sign the bill into law soon.
The law goes on for 157 pages, so obviously all the details are still being digested, but we decided to shoot out this alert to our clients and friends to highlight what we know at this point.
Income Tax
Generally speaking, for married folks with taxable income below $450,000 ($400k for singles) the impact of the changes will be modest. The marginal tax rates from 2012 will be the same for 2013 for everyone with income below those levels. For those above, a new 39.6% top rate will kick in.
With respect to capital gains and qualified dividends the news is generally favorable. Essentially the 2012 rules will continue to apply for taxpayers below the $450k/$400k levels. Taxpayers in the 10% and 15% brackets will continue to enjoy a zero percent rate on capital gains and dividends. For those above the $450k/$400k threshold, a new 20% top rate will apply to capital gains and dividends.
There are some “stealth” increases that will hit more taxpayers. First, there is the personal exemption phase out. Exemptions are worth up to $3,800 per person but will be phased out for couples with adjusted gross income (AGI) above $300k ($250k for singles). Second, limitations on itemized deductions for taxpayers with AGI above $300k/$250k will go into effect. Essentially, as your AGI exceeds these limits, you will gradually lose the benefit of your itemized deductions; up to a maximum of 80% of deductions will be eliminated. Of course, it is a bit more complex than that but suffice it to say that for folks with AGI above these thresholds their true marginal rate will be a bit higher (1% or so) due to these phase outs.
Alternative Minimum Tax
Congress did pass a “permanent” and long-awaited fix to the AMT, which raises the exemption from $45,000 to $78,750 for 2012 and indexes the exemption for inflation going forward. This will keep millions of people from being subjected to the AMT. Hooray!
Payroll Tax
Many wage earners will feel an immediate tax increase in 2013 due to the expiration of the payroll tax cut. As you may recall, the Social Security tax was temporarily reduced by 2% in 2011 and 2012. This was not extended to 2013 so the rate is once again 6.2%. And of course, there is the new additional Medicare surtax of .9% applied to wages above $250k for married taxpayers ($200k for singles).
Estate Tax
The estate and gift tax exemption will remain at $5,120,000 per individual and adjust for inflation going forward. The top rate on taxable estates above the exemption amount will increase to 40% in 2013. The provision allowing individuals to use their spouse’s unused exemption amount, also known as portability, was also made permanent with the new law. This is very good news.
Other Miscellaneous
The Qualified Charitable Distribution (QCD) that exempts IRA distributions that go directly to charity from income tax is back for both 2012 and 2013. Further, it looks like you can do a QCD in January 2013 and have it treated as a 2012 QCD. Frankly, the hassles may not be worth trying a “retroactive QCD” but it is nice to know it is back in the law. The limit is still $100k.
The provision allowing the deduction for state sales taxes in lieu of state income taxes has been extended and will apply to 2012 and 2013.
The American Opportunity Tax Credit, which is a valuable education credit, is extended for 5 years, as is the Child Tax Credit and the Earned Income Tax credit.
There is a provision in this law which should allow Roth conversions inside retirement plans. Previously this was very limited. This looks like it may apply to just about everyone and provide more flexibility for folks who would like to do a Roth conversion but previously did not have IRA assets. More details on this at a later date.
Not in the new law, but impacting your taxes and your investment decisions, is the new 3.8% Medicare surtax that applies to “net investment income”. This will impact married folks with AGI above $250k (singles above $200k). Put as simply as possible, if your AGI exceeds those limits you may owe an additional tax equal to 3.8% times the lesser of your net investment income or the amount by which your AGI exceeds the limits. Coupled with the capital gain and dividend terms of the new law, what this means is that for folks with taxable income above the $450k/$400k limits, the marginal rate on capital gains and dividends will be at least 23.8% (you also might face phased out deductions, exemptions and other things). For others, whose AGI exceeds the $250k/$200k levels, the marginal rate on capital gains and dividends will be at least 18.8% (15% plus the 3.8% surtax).
We hope this brief summary helps you understand this brand new tax law and helps you think about your own planning. We will of course be working with many of you individually to plan for and deal with these changes as needed.