Q: I’ve heard that tax year 2013 could be much different than 2012 due to the expiration of the Bush tax cuts. Do you all have any perspective on this?
A: Back in 2001, then President Bush passed what was known as the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), more commonly known as the Bush Tax cuts. For the last few years ever since the cuts were extended through 2012, there has been much consternation as to what is going to happen to tax rates in 2013 when they expire. The question on everyone’s mind is if the expiration of the cuts in 2013 will really be all that painful? Some also wonder if Congress will extend the tax cuts as they did in 2010 when the expiration was originally scheduled to occur. Not knowing the final outcome, it’s important to have a plan in place to prepare for whatever Congress decides.
In addition to the above, the Patient Protection and Affordable Care Act (PPACA), also referred to as Obamacare, will also have provisions that begin in 2013.
If we take a look at the provisions that President Obama has included in his fiscal year 2013 budget, we can get an idea if we need to worry much about what may potentially happen.
Increase in ordinary tax brackets. The most significant changes from the expiration of the 2001 tax cuts would be the increase of the Ordinary Income Tax Brackets. For most earners, the Income Tax would not increase, but individuals who are in the top two brackets would see changes. For example, if you earn over $390,050 a year, expect an increase of 4.6% in the top most bracket.
Increase in long-term capital gains rates. Ever since 2003 long term capital gains tax for assets held greater than 1 year has been 15% for those in the 15% bracket and higher and 10% for those in the 10% bracket. The change would affect single taxpayers with taxable income below $200,000, head of households below $225,000 and joint couples below $250,000. These individuals long term rate would remain at 15% while filers above these amounts would have a have a 20% rate.
Qualified dividend tax rate. Since 2003 the maximum qualified dividend tax rate has been 15%. President Obama’s budget proposal looks to keep the current dividend rate of 15% for everyone not considered an upper income taxpayer. For these individuals, dividends would be taxed at their ordinary income tax rate of either 36% or 39.6%.
Change in benefit of itemized deductions. Itemized deductions allow one to reduce taxable income be deducting amounts greater than the standard deduction. This includes things such as charitable deductions, mortgage interest, state income taxes, medical expenses, etc. The value of itemized deductions for those upper income taxpayers would be capped at 28%, so someone in the 35% that currently receives $3,500 of benefit for $10,000 of itemized deductions, would only receive $2,800 of tax savings.
Change in the health care deduction limit. Through December 31st 2012 you can deduct health care expenses that exceed 7.5% of your adjusted gross income (AGI). However, beginning January 1st 2013 that threshold will rise to 10%. For some, that essentially results in a tax increase, since you have to spend more on health care before seeing the deduction. A way to get around this is to use a FSA or HSA so that all of your expenses are basically tax deductible.
Medicare wage surtax. Starting in 2013, if you make more than $200,000 as a single person ($250,000 if married filing jointly) you will pay a 0.9% tax on the income above that level.
Medicare unearned income surtax. Another tax will be applied to Modified AGI (in this case AGI + tax-free income) for those with income levels that are the same as above. There is an additional 3.8% surtax applied to the lesser of your net investment income OR the excess Modified AGI beyond the limits.
Excise tax on medical devices. Medical devices such as prosthetics and wheelchairs will be assessed an excise tax of 2.3%, although items like hearing aids and eyewear that are sold in retail settings won’t be subject to the tax.
While the impact of most of these items won’t be felt until you file your 2013 return in 2014, it’s good to give some thought as to how you will plan out next year in light of what may be on the horizon. But then again, this is an election year so there is always the probability that no increases will happen. Who wants to increases taxes when you’re trying to get elected?