We’re almost midway through January, and I’m still trying to get a handle on all of the provisions of the American Taxpayer Relief Act of 2012 (ATRA). This bill was signed into to law by President Obama on January 2nd but made some laws retroactive back to January 2012 (yes, January 1, 2012). This broad sweeping bill creates a wide swath of changes that will impact us all. Most changes come down to taxation. Here are a few highlights that I feel may impact you (my clients, family, and friends) most heavily.
Income tax rates
Most income tax rates will remain the same and become “permanent,” at least until congresses decides to change them again. A new upper tax bracket is created for those with taxable income above $450,000 (married filing jointly- MFJ), $425,000 (head of household- HOH), and $400,000 (single- S). These brackets will be indexed for inflation, which means they will creep up little by little each year.
Payroll tax holiday goes away
In tax years 2010 and 2011, congress reduced the amount of payroll tax due by 2%. I wrote about this several times, which you can read here and here. Congress did NOT extend this reduction in payroll taxes, which means we will all pay 2% more on our individual earnings up to $113,700. So, for many folks, their take home pay will receive a 2% haircut. While we are simply putting a tax back into place, it will still impact your bottom line and will be felt.
Dividends and capital gains
Qualified dividends and long term capital gains will permanently enjoy preferential rates. Even those in the upper tax bracket (39.6%) will be taxed at a reduced rate of 20% (up from 15%) on this income. While preferential rates on dividend and capital gains have been in place for years, dividends and capital gains may also be subject to an additional new tax of 3.8%, which will be discussed later.
Phase out of itemized deductions and personal exemptions
Both itemized deductions and personal exemptions will be reduced when adjusted gross income rises above $300k (MFJ), $275k (HOH), and $250k (S). Itemized deductions will be reduced by 3% of the excess above the threshold. Personal exemptions vanish by 2% of each $2500 above the threshold.
Alternative minimum tax (AMT)
A real bright spot of the Act surrounds AMT. AMT is now permanently indexed for inflation. Indexing AMT instead of a yearly fix by congress will alleviate a huge headache felt by those of us who proactively plan for taxes…..and those of you who wait for the AMT patch every year.
The American Taxpayer Relief Act also makes permanent estate tax exemptions that have been in place for the last couple of years. Thankfully, the permanence of this provision does include indexing for these exemptions. For 2013, the exemption for estate tax is $5.25M. So, most all estates with $5.25M or less will not be subject to estate tax. However, the top rate for estate, GST, and gift tax was increased to 40% (up from 35%).
What you may not know
While most of what we have heard from the media revolves around the increased tax rate for the highest income earners, new provisions will impact those making less as well. If you fall under the $450,000 taxable income limit, don’t relax just yet. There are several provisions that may impact your taxable bottom line. The Patient Protection and Affordable Care Act (PPACA), also known as Obama Care, slips additional taxes into the tax code that is not unified with our new tax brackets.
Medicare surtax – A tax of .9% (9/10 of 1%) will be accessed on wage income above $250k (MFJ), $200k (HOH), and $125k (S). Again, this tax is accessed on wage income (what you earn), as compared to taxable income (used in income tax calculation), which is all income minus adjustments, exemptions, and deductions. If you earn more than the above thresholds, your employer will be required to withhold the additional .9% tax.
Additional Medicare tax on unearned income– This tax is imposed on unearned income (investment income, such as capital gains and dividends, as well as rental income). The threshold for the net investment income subject to this additional tax is modified adjusted gross income (MAGI) above $250K(MFJ), $200 (HH), and $125(S). Modified adjusted gross income is determined differently than wage income used for the .9% Medicare surtax threshold, which makes calculating these new taxes rather complicated.
Obviously, there are many other provisions included in ATRA. Some of these additional provisions are permanently fixed, while some are extended for a finite amount of time.
This bill adds another layer of complexity to our already confusing tax code. Those making in the $250k-$450k range could move between tax brackets, lose deductions and exemptions, pay additional taxes on investment income, and pay a Medicare surtax, so the importance of tax planning is very obvious. I don’t mean to exclude those making less or those making more because tax planning will be of great benefit, as it has in the past.