Seven significant new income tax law changes went into effect at the beginning of the year as a result of two pieces of legislation: The 2010 Health Care Reform Act and the American Taxpayer Relief Act of 2012.
Although the new laws are primarily designed to increase taxes for those with higher levels of income, everyone with earned income is affected. With the first seven months of 2013 behind us, have you begun planning for these changes?
Increased Social Security tax
At a basic level, anyone with earned income has seen a reduction in take-home pay this year as a result of the first tax law change. The employee Social Security tax rate, which was reduced from 6.2% to 4.2% in 2011 and 2012, is back to 6.2%.
Combined with the increase in the maximum Social Security wage base from $110,100 in 2012 to $113,700 in 2013, maximum Social Security tax withholding has increased from $4,624.20 in 2012 to $7,049.40 in 2013. This has resulted in a total paycheck reduction of $2,425.20 for individuals reaching the maximum wage base.
Six changes for high income levels
There are a total of six changes to be aware of once your income exceeds the $200,000 single or $250,000 married filing joint (MFJ) levels. Two of the changes begin at these levels, two at $250,000 (single) or $300,000 (MFJ), and two at $400,000 (single) or $450,000 (MFJ), with different definitions of income associated with each change.
A summary of the six changes, which are also included on the 2013 Individual Federal Income-Based Tax Law Changes spreadsheet, including the income types and applicable income threshold amounts, follows:
1. Medicare earned income tax increase
The Medicare tax on earned income increased from 1.45% in 2012 to 2.35% in 2013 on earned income exceeding $200,000 (single) or $250,000 (MFJ) if modified adjusted gross income (MAGI) also exceeds these threshold amounts. While the percentage increase of 0.9% is about half of the Social Security tax rate increase of 2%, unlike the calculation of Social Security tax which is capped at a maximum wage base, there’s no limit on the amount of wages that are subject to the Medicare tax.
2. New Medicare investment income tax
The Medicare investment income tax is a brand new tax that penalizes individuals with MAGI exceeding $200,000 (single) or $250,000 (MFJ) with taxable interest, dividends, and capital gains, as well as rental, royalty, and nonqualified annuity income, otherwise known as “investment income.” A surcharge of 3.8% is assessed on the lesser of net investment income or MAGI in excess of the applicable threshold amounts.
3. Itemized deductions limitation
Repealed in 2010, the itemized deductions limitation was reintroduced this year to the dismay of individuals with adjusted gross income (AGI) exceeding $250,000 (single) or $300,000 (MFJ). It reduces otherwise allowable itemized deductions by 3% of the amount by which AGI exceeds the threshold amounts with some exceptions.
4. Personal exemption phase out
Also repealed in 2010, the personal exemption phase out reduces the personal exemption amount of $3,900 per individual in 2013. The amount of the reduction is 2% for each $2,500 in excess of AGI threshold amounts of $250,000 (single) or $300,000 (MFJ).
5. Income tax bracket increase
Individuals with taxable income (TI) of $400,000 (single) or $450,000 (MFJ) will see an increase of 4.6% in their top tax bracket, with the 2012 top bracket of 35% increasing to 39.6% in 2013 on income exceeding these thresholds.
6. Long-term capital gains and qualified dividends tax rate increase
The federal income-tax rate on long-term (assets held longer than one year) capital gains and qualified dividends increased from 15% to 20% for individuals with TI exceeding $400,000 (single) or $450,000 (MFJ).
When applicable, any one, let alone a combination, of the foregoing seven income tax law changes can result in a sizable increase in your 2013 federal income tax liability compared with 2012.
If you haven’t had a 2013 income tax projection prepared to determine the potential impact of the various changes on your tax situation, now’s the time to get it done. Trust me; you don’t want to wait until your 2013 tax returns have been prepared to unveil the damage.