Table of Contents
- Income Tax Changes in 2013
- Tax Rates
- Tax Brackets
- Payroll Tax Rates
- Net Investment Income Tax
- Long-Term Capital Gains
- Qualified Dividends
- Above-the-Line Deduction
- Standard Deduction
- Itemized Deductions
- Personal Exemption
- Tax Credits
- AMT
- Transfer Tax Changes in 2013
- Tax Rates
- Exemption Amount
- Credit for State Estate Taxes Paid
- Return of Qualified Family-Owned Business Interest Deduction
- Spousal Portability
- Charitable Giving Changes in 2013
- Expiring Incentives
- Return of the IRA Charitable Rollover?
The upcoming changes in the federal tax law effective January 1, 2013, are extensive and will increase taxes across the board (especially for high-income taxpayers). There are several reasons why:
- The expiration of the Bush-era tax cuts
- The new surtaxes and a limit on medical expense deductions that are part of the 2010 healthcare law
- The continued non-renewal of the “tax extenders”
However, late in 2012 or early in 2013, Congress might move to suspend some or all of the anticipated tax increases. It is important to be aware of the impending changes to our tax code, if only to understand how Congress may act in the next few months.
Income Tax Changes in 2013
Income Tax Rates
The federal income tax system is progressive; as income increases, it is taxed at a higher rate. Since 2001, there have been six income tax rates applicable to non-corporate taxpayers: 10% – 15% – 25% – 28% – 33% – 35%.[i]
On January 1, 2013, there will only be five income tax rates. The lowest rate of 10% will be dropped and four of the remaining tax rates will increase: 15% – 28% – 31% – 36% – 39.6%.[ii]
Income Tax Brackets
The range of income taxed at each rate (known as a “tax bracket”) depends on the status the taxpayer claims: single, head of household, married filing jointly, married filing separately, trust/estate.
Since 2001, the amount of income subject to the 15% tax bracket for married persons filing jointly has been double the amount for single taxpayers in the same tax bracket. This provision alleviates the “marriage penalty,” which is the disadvantage for married persons filing jointly as compared to a single taxpayer.[iii]
On January 1, 2013, the amount of income subject to tax in the 15% tax bracket for married persons filing jointly will decrease from double (200%) to only 167% of the amount for single taxpayers. This will increase the tax burden on married couples relative to single taxpayers.[iv]
Payroll Taxes
“Payroll taxes” is a common term for the FICA taxes imposed on both the employee and employer based on wages. These taxes are directed to social insurance programs funded by the federal government. The Social Security tax is imposed on a limited taxable wage base that is indexed to inflation ($110,100 for 2012). The Medicare tax is imposed on all of the worker’s wages.
Since 2011, the Social Security tax rate on the employee’s taxable wages has been 4.2% (the employer continues to pay at a 6.2% rate).[v] Since 1990, the Medicare tax has remained constant at 1.45% for both the employee and employer.[vi]
On January 1, 2013, payroll tax rates change in two significant ways:
- The temporary cut on the employee’s Social Security tax rate will end and the rate will jump back up to 6.2%.[vii]
- The tax rate for the employee’s Medicare contribution will increase for high-income earners. A taxpayer will pay an additional tax of 0.9% on wages in excess of $200,000 ($250,000 for married persons filing jointly).[viii]
Net Investment Income Tax
New Tax on Unearned Income
On January 1, 2013, a new tax on net investment income will be imposed as a result of the Patient Protection and Affordable Care Act.[ix] Individuals with more than $200,000 in income ($250,000 for a married couple filing jointly) who have net investment income will pay an additional tax of 3.8% on the lesser of net investment income or the excess of modified adjusted gross income over the threshold amount.
Investment income is defined as the sum of gross income from interest, dividends, annuities, royalties, and rents and net gain attributable to the disposition of property (i.e., capital gains). Obviously, this does include passive income. However, net investment income does not include retirement plan distributions, nor does it include income from a Subchapter S corporation or partnership subject to self-employment tax.
In the case of an estate or trust, the tax is 3.8% on the lesser of undistributed net investment income or the excess of adjusted gross income over the amount at which the highest tax bracket begins (for 2012, that highest tax bracket is $11,650). Net investment income for estates and trusts is defined under IRC Sec. 67(e). Note that the following trusts are not subject to tax: charitable remainder trusts, trusts exempt under IRC Sec. 501, and trusts for which all unexpired interests are devoted to charitable purposes.
Long-Term Capital Gains
Long-term capital gains are defined as gains from the sale or exchange of capital assets held in excess of one year. Since 2007, the tax rate on long-term capital gains has been 0% for persons in the bottom two tax brackets and 15% for all other taxpayers.[x]
On January 1, 2013, the taxation of long-term capital gains will change in two significant ways:
- The tax rates on long-term capital gains will jump to 10% for those taxpayers in the lowest tax bracket and 20% for all other taxpayers.[xi] Note that lower rates on capital gains attributed to assets held for longer than five years will now be available (8% and 18% respectively).[xii]
- The new tax on net investment income will apply to capital gains.
Qualified Dividends
Qualified dividends are defined as those received during the taxable year from domestic corporations and qualified foreign corporations.[xiii] Since 2007, the tax rate on dividends has been 0% for persons in the bottom two tax brackets and 15% for all other taxpayers.[xiv]
On January 1, 2013, the taxation of dividends will change in two significant ways:
- The tax rates on dividends will correspond to ordinary income instead of long-term capital gains.
- The new tax on net investment income will apply to dividend income.
Above-the-Line Deductions
An “above-the-line” deduction is an expense or amount deducted from gross income before reaching the adjusted gross income (AGI). A taxpayer need not itemize in order to take an above-the-line deduction. Notable examples include IRA contributions,[xv] Health Savings Account contributions,[xvi] student loan interest,[xvii] and tuition expenses.[xviii]
On January 1, 2013, the Bush-era expansion of the availability of the student loan interest deduction will end. The deduction will be available only for interest payments made within the first 60 months of repayment on the loans.[xix] In addition, the AGI range for phasing out the deduction will begin much lower than previous years.
The above-the-line deduction for qualified tuition and related expenses expired at the end of 2011.[xx]
Standard Deduction
A taxpayer who decides not to itemize deductions can subtract from AGI a standard deduction amount determined by filing status. Since 2001, the standard deduction for married persons filing jointly has been double the amount available to single taxpayers.[xxi] This provision alleviates the “marriage penalty”—the disadvantage of married persons filing jointly as compared to each spouse filing as a single taxpayer.
On January 1, 2013, the standard deduction for married persons filing jointly will decrease from double (200%) to only 167% of the amount for single taxpayers. This increases the tax burden on married couples relative to single taxpayers.[xxii]
Itemized Deductions
An itemized deduction is an expense that can be deducted from adjusted gross income (AGI). From 2006 to 2009, the Pease limitation on itemized deductions for high-income taxpayers was gradually rescinded.[xxiii] From 2010 to 2012, there was no reduction for itemized deductions based on modified AGI.
As of January 1, 2013, itemized deductions will be limited in several ways:
- The Pease limitations will reduce the amount of certain itemized deductions high-income taxpayers can claim: either 3% of the taxpayer’s income over the modified adjusted gross income limit, or up to 80% of certain deductions (whichever amount is less).[xxiv]
- The taxpayer threshold for claiming medical expenses as an itemized deduction will be increased from 7.5% of AGI to 10% (though individuals age 65 and older will continue to use the 7.5% threshold from 2013 to 2016).[xxv]
- As was the case in 2012, the option to deduct state and local sales taxes rather than income taxes will not be available.[xxvi]
Personal Exemptions
A taxpayer can deduct a personal exemption, an exemption for a spouse and for eligible dependents. The amount of the deduction is referred to as the exemption amount. In 2012, the personal exemption amount is $5,950. From 2006 to 2009, the reduction in personal exemption amounts for high-income taxpayers was gradually rescinded.[xxvii] From 2010 to 2012, there was no reduction for personal exemption amounts based on modified AGI.
As of January 1, 2013, personal exemption amounts will once again be phased out for high-income taxpayers.[xxviii] For every $2,500 (or fraction thereof) over the modified AGI threshold, the exemption will be reduced by 2%. Note that married persons filing separately will phase out the exemption for every $1,250 over the modified AGI.
Credits
A tax credit is an amount subtracted from the taxpayer’s tax liability (which makes a $100 credit much more valuable than a $100 deduction). Notable tax credit enhancements made between 2001 and 2012 include:
- Child Credit: Increased to $1,000 per child.[xxix]
- Child and Dependent Care Credit: The applicable percentage of care expenses covered increased to 35% ($3,000 for one, $6,000 for two or more), and the floor of the AGI limit to reduce the credit increased to $15,000.[xxx]
- American Opportunity Credit: The Hope Scholarship Credit renamed and enhanced to permit a maximum credit of $2,500.[xxxi] The AGI limit for reducing the eligibility increased, and availability expanded to the first four years of post-secondary education.
- Adoption Credit: The exclusion from income of employer payment of adoption expense, and the increase in the adoption credit to $12,000.[xxxii]
On January 1, 2013, both the amounts and the range of eligibility for these credits will be lowered.
- Child Credit: Drops to $500 per child.[xxxiii]
- Child and Dependent Care Credit: The applicable percentage of care expenses covered drops to 30% ($2,400 for one, $4,800 for two or more), and the floor of the AGI limit to reduce the credit returns to $10,000.[xxxiv]
- Hope Scholarship Credit: Credit drops to a maximum of $2,000, the AGI limit for reducing the eligibility returns to previous levels, and coverage drops back to two years of post-secondary education.[xxxv]
- Adoption Credit: The exclusion from income of employer payment of adoption expense returns to prior levels, the available credit returns to $5,000 ($6,000 for a special needs child), and the credit becomes a nonrefundable personal credit (which can only be used to reduce tax liability).[xxxvi]
AMT Exemption
The alternative minimum tax, or AMT, is a parallel tax system originally created to prevent excessive tax avoidance by stripping out certain tax breaks for high-income taxpayers. Individuals and corporations are subject to the AMT if it produces a higher tax than the regular income tax calculation.[xxxvii] For the past decade or more, Congress has increased the statutory AMT exemption amount for non-corporate taxpayers on a year-to-year basis.[xxxviii] And, under the Bush-era tax cuts, the child tax credit was not subject to reduction under the AMT regime.[xxxix]
On January 1, 2013, the favorable tax treatment of certain credits will end. For example, the child tax credit will be reduced for high-income taxpayers under the AMT.[xl] Also, a greater percentage of the excluded gain on the sale of qualified small business stock will be treated as an AMT preference item.[xli]
Congress has not (yet) renewed an increased AMT exemption for either 2012 or 2013. The exemption amounts remain at statutory levels:[xlii]
Single – $33,750
Married Filing Jointly – $45,000
Married Filing Separately – $22,500
Transfer Tax Changes in 2013
Transfer Tax Rates
Tax rates for federal estate, gift and generation-skipping transfer (GST) taxes often changed, sometimes from year to year, according to a schedule outlined under EGTRRA. The top rate of 55% gradually lowered to 45% for transfer taxes between 2002 and 2009.[xliii] In 2010, there was no estate tax, the GST tax rate was 0% and the gift tax rate dropped to 35%.[xliv] The Tax Act of 2010 re-unified the estate and gift tax rate capped at 35%, and installed a flat 35% rate for the GST tax.[xlv]
On January 1, 2013, the gift and estate tax rate will remain unified but the top tax rate will rise to 55%.[xlvi] In addition, there will be a surtax of 5% imposed on the taxable estate between $10,000,000 and $17,144,000. The GST tax will have a flat rate of 55%.[xlvii]
Transfer Tax Exemption Amounts
Similar to tax rates, the exemption amounts for federal estate, gift and generation-skipping transfer taxes often changed, sometimes from year to year, according to a schedule outlined under EGTRRA. The estate and gift tax exemption amounts were “de-coupled”—the estate tax exemption rose to $3.5 million in 2009 before disappearing altogether in 2010, and the gift tax exemption rose to $1 million and stayed pat.[xlviii]
On January 1, 2013, the unified gift and estate tax exemption will drop to $1 million.[xlix] The GST tax exemption will be approximately $1.4 million because it is indexed for inflation.[l]
Estate Tax Credit for State Estate Taxes Paid
Prior to 2005, an estate could take a credit against the federal estate tax for “the amount of any estate, inheritance, legacy, or succession taxes actually paid to any State or the District of Columbia, in respect of any property included in the [fusion_builder_container hundred_percent=”yes” overflow=”visible”][fusion_builder_row][fusion_builder_column type=”1_1″ background_position=”left top” background_color=”” border_size=”” border_color=”” border_style=”solid” spacing=”yes” background_image=”” background_repeat=”no-repeat” padding=”” margin_top=”0px” margin_bottom=”0px” class=”” id=”” animation_type=”” animation_speed=”0.3″ animation_direction=”left” hide_on_mobile=”no” center_content=”no” min_height=”none”][decedent’s] gross estate.”[li] However, the credit was replaced by a deduction for state estate taxes paid.[lii]
On January 1, 2013, the federal estate tax credit for state estate taxes paid will return. The maximum credit will be $1,082,800 plus 16% of the excess over $10,040,000.[liii]
Return of the Qualified Family-Owned Business Interest Deduction
From 1998 to 2003, an estate could elect to deduct up to $675,000 of the adjusted value of the qualified family-owned business interest (QFOBI) from a decedent’s gross estate.[liv] To have been eligible for this tax break, the estate must have owned a qualifying farm or business interest that consisted of more than 50% of the value of the adjusted gross estate.[lv] There were several other technical requirements for eligibility concerning which family members would inherit, how involved the decedent was in the business, and how the business was owned.
Congress removed the QFOBI deduction due to the increases in the estate tax exemption under EGTRRA.[lvi]
On January 1, 2013, the QFOBI deduction will be restored.
Option of Spousal Portability of Unused Exemption No Longer Available
The Tax Relief Act introduced the new concept of the portability of a deceased spouse’s unused applicable exclusion amount to a surviving spouse. If someone died in 2011 or 2012, the decedent’s estate may use some, all or none of the estate tax applicable exclusion amount.[lvii] For instance, if the decedent’s estate used only some or none of the $5 million applicable exclusion amount available in 2011, the decedent’s spouse could add the unused amount to his or her own applicable exclusion amount upon their death.[lviii]
On January 1, 2013, portability will no longer be available as an option for the executor of the decedent’s estate. Married couples will again be required to plan in advance in order to avoid losing a portion of the estate tax exemption upon the death of a spouse.
Charitable Giving Changes in 2013
Charitable Giving Tax Incentives Set To Expire
Many enhanced deduction options for charitable contributions have been added to federal tax law over the last decade in an effort to encourage certain kinds of philanthropic gifts.
- Enhanced charitable deduction for contributions of capital gain real property made for conservation purposes—up to 50% of AGI (rather than the standard 30%) in the year the gift is made[lix]
- Enhanced charitable deduction for contributions of capital gain real property made for conservation purposes by farmers and ranchers—up to 100% of AGI[lx]
- Enhanced charitable deduction for food inventory[lxi]
- Enhanced charitable deduction for book inventory to public schools[lxii]
- Enhanced charitable deduction for corporate contributions of computer technology and equipment for educational purposes[lxiii]
As of January 1, 2013, none of these enhanced deduction options will be available.
IRA Charitable Rollover
As part of the Pension Protection Act of 2006, the IRA charitable rollover, the popular term for a qualified charitable distribution from an IRA, was a temporary (two-year) provision permitting donors age 70½ and older to direct a distribution from an IRA to a qualified charity without realizing the amount as taxable income.[lxiv] Congress renewed the provision in 2008, and again in 2010, but the provision expired after December 31, 2011.
There are reasons why an IRA charitable rollover is a good option for donors:
- Many unfavorable provisions in federal tax law apply once the taxpayer reaches a certain level of AGI (e.g., the Pease limitations or PEP). However, if the taxpayer utilizes the IRA charitable rollover, that amount counts toward the required minimum distribution but is not realized as income.[lxv]
- Taxpayers who do not itemize deductions do not gain a tax benefit from a charitable contribution, but do benefit from the exclusion of the qualified charitable distribution from their income.[lxvi]
Congress still has not renewed the provision for 2012 (or 2013).
Endnotes
- EGTRRA: Economic Growth and Tax Relief Reconciliation Act of 2001 (P.L.107-16)
- JGTRRA: Jobs and Growth Tax Relief Reconciliation Act of 2003 (P.L. 108-27)
- WFTRA: Working Families Tax Relief Act of 2004 (P.L. 108-311)
- TIPRA: Tax Increase Prevention and Reconciliation Act of 2005 (P.L. 109-222)
- PPA: Pension Protection Act of 2006 (P.L. 109-280)
- PPACA: Patient Protection and Affordable Care Act (P.L. 111-148)
- HCERA: Health Care and Education Reconciliation Act of 2010 (P.L. 111-152)
- TRUIRJCA: Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (P.L. 111-312)
[i] IRC. Sec. 1(f); EGTRRA Sec. 101(a). Later, the provision was amended by JGTRRA Sec. 104, and WFTRA Sec. 101 to accelerate the phase-in of the lowest 10% tax bracket.[↵]
[iii] IRC Sec. 1(f)(8); EGTRRA Sec. 302(a). Later, the provision was amended by JGTRRA Sec. 102, and WFTRA Sec. 101(c).[↵]
[v] IRC Sec. 3101(a); TRUIRJCA Sec. 601(a), extended by Sec. 101 of the Temporary Payroll Tax Cut Continuation Act of 2011 (P.L. 112-78) and Sec. 1001 of the Middle Class Tax Relief and Job Creation Act of 2012 (P.L. 112-96).[↵]
[viii] IRC Sec. 3101(b)(2); PPACA Sec. 9015.[↵]
[x] IRC Sec. 1(h)(1)(B) and (C); JGTRRA Sec. 301. Later, the provision was extended by TIPRA Sec. 102.[↵]
[xi] IRC Sec. 1(h)(1)(B) and (C).[↵]
[xii] IRC Sec. 1(h)(9); temporarily repealed by JGTRRA Sec. 301.[↵]
[xiii] IRC Sec. 1(h)(11)(B); JGTRRA Sec. 302.[↵]
[xiv] IRC Sec. 1(h)(11)(A); JGTRRA Sec. 302. Later, the provision was extended by TIPRA Sec. 102.[↵]
[xvii] IRC Sec. 221; EGTRRA Sec. 412.[↵]
[xviii] IRC Sec. 222; EGTRRA Sec. 431.[↵]
[xix] IRC Sec. 221(f)(2) and (3).[↵]
[xxi] IRC Sec. 63(c)(2) and (7); EGTRRA Sec. 301(a). Later, the provision was amended by JGTRRA Sec. 103 and WFTRA Sec. 101(b) to accelerate the phase-in under IRC Sec. 63(c)(7).[↵]
[xxiii] IRC Sec. 68(f); EGTRRA Sec. 103.[↵]
[xxv] IRC Sec. 213(a); PPACA Sec. 913.[↵]
[xxvi] IRC Sec. 164(b)(5)(I).[↵]
[xxvii] IRC Sec. 151(d)(3)(E); EGTRRA Sec. 102.[↵]
[xxviii] IRC Sec. 151(d)(3).[↵]
[xxix] IRC Sec. 24(a); EGTRRA Sec. 201.[↵]
[xxx] IRC Sec. 21(a)(2); EGTRRA Sec. 204.[↵]
[xxxi] IRC Sec. 25A(a)(i); Sec. 1004 of the American Recovery and Reinvestment Act of 2009 (P.L. 111-05).[↵]
[xxxii] IRC Sec. 23 (re-designated IRC Sec. 36C); EGTRRA Sec. 202; PPACA Sec. 10909.[↵]
[xxxiii] IRC Sec. 24(a) and (b).[↵]
[xxxviii] IRC Sec. 55(d)(1); TRUIRJCA Sec. 201.[↵]
[xxxix] IRC Sec. 24(b)(3); EGTRRA Sec. 201(b).[↵]
[xliii] IRC Sec. 2001(c); IRC Sec. 2502(a); IRC Sec. 2602; EGTRRA Sec. 511.[↵]
[xliv] IRC Sec. 2210(a); IRC Sec. 2664; EGTRRA Sec. 501.[↵]
[xlvi] IRC Sec. 2001(c); IRC Sec. 2502(a); IRC Sec. 2602.[↵]
[xlvii] IRC Sec. 2001(c)(2).[↵]
[xlviii] IRC Sec. 2010(c); IRC Sec. 2505(a); IRC Sec. 2631(a); EGTRRA Sec. 521.[↵]
[xlix] IRC Sec. 2010(c); IRC Sec. 2505(a).[↵]
[l] IRC Sec. 2631(c)(1)(B).[↵]
[lii] IRC Sec. 2011(b)(2); EGTRRA Secs. 531 and 532.[↵]
[liii] IRC Sec. 2011(b)(1).[↵]
[lvi] IRC Sec. 2057(j); EGTRRA Sec. 521(d).[↵]
[lvii] IRC Sec. 2010(c)(4); TRUIRJCA Sec. 303.[↵]
[lviii] See also Temp. Regs. 20.2001-2T(b), 20.2010-1T(e), 20.2010-2T(e), 20.2010-3T(f), 25.2505-1T(e), and 25.2505-2T(g).[↵]
[lix] IRC Sec. 170(b)(1)(E)(i); PPA Sec. 1206(a).[↵]
[lx] IRC Sec. 170(b)(1)(E)(iv).[↵]
[lxi] IRC Sec. 170(e)(3)(C).[↵]
[lxii] IRC Sec. 170(e)(3)(D).[↵]
[lxiii] IRC Sec. 170(e)(6).[↵]
[lxiv] IRC Sec. 408(d)(8); PPA Sec. 1201. Later, the provision was extended by Sec. 205 of the tax-extenders section of the Emergency Economic Stabilization Act of 2008 (P.L. 110-343), and TRUIRJCA Sec. 725.[↵]