My F&M

2013 Changes & Planning Considerations

It’s hard to turn on the news without hearing about the new tax law changes.  This article attempts to summarize some of the major changes and includes some practical planning considerations. 

Tax Rates:  Married couples with taxable income (income after deductions) above $450k ($400k for singles) are now subject to a new tax bracket of 39.6%, up from the prior top bracket of 35%.  For income up to this amount, the previous 10%, 15%, 25%, 28%, 33% and 35% brackets remain in place. 

Long-Term Capital Gain and Qualified Dividends:  Taxpayers in the 10% and 15% brackets will continue to benefit from a 0% federal rate on capital gains and qualified dividends.  Taxpayers in the brackets between 15% and 39.6% will pay 15% on gains and dividends.  These are the same rules as 2012.  There is a NEW 20% gains and dividend rate for taxpayers with taxable income above $450k/$400k and only applies to income over the threshold.  Income below is taxed at the lower rates.  Gains and dividends may also be subject to the new 3.8% Medicare Investment Income Surtax explained below. 

3.8% Medicare Investment Income Surtax:  Starting this year, the surtax applies to married couples with modified adjusted gross income (AGI) above $250k ($200k for singles).  The surtax is calculated at 3.8% on the smaller of your AGI over the limit ($250k/200k) or net investment income.  Investment income includes interest, dividends, capital gains, annuities and passive rental income.  For taxpayers with taxable income above the $450k/$400k threshold, the marginal rate on capital gains and dividends is 23.8%.  Taxpayers whose modified AGI exceeds $250k/$200k will pay 18.8%.   

0.9% Hospital Insurance Medicare Surtax:  Another Medicare surtax starting this year applies to married couples with wages or earned income (including stock option income) above $250k ($200k for singles).  Wages over this threshold will owe an additional 0.9%.  Employers will withhold the surtax from your pay once it exceeds $200k.  This could cause a problem for a dual income couple that together make over $250k but separately make under $200k.  In this case the additional surtax will be due when you file your tax return.  For example, a married couple with wage income of $300k ($50k over the threshold) would owe an additional $450 of tax. 

Payroll Tax:  The 2% reduction in Social Security tax was not extended for 2013.  That means a smaller paycheck this year.  For individuals that make up to the wage base ($113,700 for 2013) this means about $2,300 less in take-home pay. 

Alternative Minimum Tax Exemption:  Congress passed a permanent AMT fix, which increases the exemption to $80,750 for married couples ($51,900 for singles).   Additionally, they indexed it for inflation which will keep many people out of AMT.  This is excellent news for planning. 

Personal Exemption Phaseout (PEP):  Personal exemptions (worth $3,900 per individual) are phased out by 2% for each $2,500 of AGI over $300k for married couples ($250k for singles).  Personal exemptions are phased out entirely once income is $122,500 over the threshold.  This equates to about a 1% increase in the marginal rate per exemption, so about 4% for a family of four.   

Limitations on Itemized Deductions (Pease limitation):  Itemized deductions are phased out by 3% of AGI over the $300k/$250k threshold.  This is $3 for every $100 over the threshold, not to be phased out by more than 80%.  This increases the marginal rate by about 1%.  Deductions exempt from phase out include medical expenses, investment interest and casualty losses. 

Qualified Charitable Distributions (QCDs) from IRAs:  QCDs are back for 2013.  QCDs are available to those over 70 ½ and can be used to satisfy your Required Minimum Distribution.  They are limited to $100k per taxpayer.  These are distributions from an IRA that go directly to charity.  There is no itemized charitable deduction.  It is also not considered an IRA distribution for AGI, which keeps income lower and less likely to trigger phase-outs.  This could also mean lower state taxes.  Although temporary, this could be great for the charitably inclined. 

Estate Planning:  Recent legislation included good news on estate planning including permanent changes to the exemption amount, now $5.25M, and keeping portability.  Portability allows an individual to use a spouse’s unused exemption at the death of the surviving spouse, effectively giving married couples a $10.5M exemption.  The top estate tax rate increased to 40% from 35%, but practically speaking fewer people will be subject to it.  Now may be an excellent time to discuss simplifying your estate with your estate planning attorney or financial professional. 

Planning considerations:  With the new rates and phase-outs, now more than ever, managing your AGI is critical.  While taxes are only one factor in financial decisions it is important to “run the numbers” before recognizing additional discretionary income (i.e. exercising stock options, taking IRA distributions, realizing gains).  Tax-deferred investments are even more appealing as your income rises.  401(k) contribution limits increased to $17,500 ($500 increase) and $23,000 for those age 50 or over.  IRA contribution limits increased to $5,500 ($500 increase) and $6,500 for those over 50.  Tax-sensitive investment management becomes more important.  This includes capital gains management, which is more easily done in portfolios of individual securities where you have more control over gains.  Asset location remains attractive.  This strategy manages taxes by looking at all of your accounts as one portfolio and holding assets with more highly taxed investment income, like taxable bonds, in tax-deferred  accounts, and tax-favored investments, like qualified-dividend-paying stocks, in taxable accounts.