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Are Dramatic Increases Ahead – For us All?

By Children’s Home Society of Florida Foundation

Following the November election, Congress will return for a “lame-duck” legislative session. Major decisions are needed on both taxes and spending. If Congress does not take action, there will be dramatic tax increases on January 1, 2013.

These potential changes include personal income taxes, long term capital gains tax, dividend tax, a new Medicare tax and the estate tax.

Personal Income Taxes

The major change in personal income taxes is that the rates will return to the 2003 schedule. The tax reductions passed in 2001 and 2003 are no longer applicable after 10 years. Therefore, tax rates are scheduled to increase. The table below shows the rates for 2012 and the new increased rates scheduled for 2013.

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Long-Term Capital Gains

The long-term capital gains rate for 2012 is 15%. Most investment property held more than one year qualifies for the 15% rate. In 2013, long-term capital gains will be taxed at 20%. However, the new 3.8% Medicare tax will apply to capital gains for higher-income persons. Their top rate will be 23.8%.

Dividend Taxes

Dividend taxes in 2012 are at a reduced level for payments from U.S. corporations and some foreign corporations. In 2012, most dividends are taxed at the 15% long-term capital gain rate. If the law is not changed, in 2013 they will be taxed as ordinary income. The top rate for dividends could be 39.6%. In addition, the 3.8% Medicare tax applies to dividends, producing a potential tax on dividends of 43.4% for higher-income taxpayers.

New Medicare Tax

The Patient Protection and Affordable Care Act (PPACA) creates a new Medicare tax in 2013. The tax is 3.8% on the amount of income that exceeds $200,000 for a single person and $250,000 for a married couple. The tax is generally applicable on interest, dividends, passive income from a business, sales of property and other income from financial instruments.

Fortunately, IRA and other pension income are not subject to the increased Medicare tax. However, this retirement income may increase your total income levels. If total income exceeds the $250,000 or $200,000 levels, then your IRA distributions may cause other investment and capital gain income to be subject to the Medicare tax.

Other Personal Tax Changes

There are other changes that will affect individuals. Under PPACA, individuals with incomes over $200,000 (single) or $250,000 (married couples), will pay an additional payroll tax of 0.9% on the excess amount. The personal exemption phase out and limitations on itemized deductions will be reinstated.

Finally, the medical expense deduction floor increases from 7.5% to 10% for most taxpayers. It is retained at 7.5% for persons age 65 and older. Only qualified medical expenses in excess of the floor are deductible.

Estate Tax

In 2012, the applicable exclusion amount for gift and estate taxes is $5.12 million. In addition, a spouse may pass away and transfer his or her available exemption to a surviving spouse. The surviving spouse therefore could have an estate exemption up to double the standard amount.

If there is no tax bill, the exemption reverts to $1 million plus indexed increases over the past decade. In addition, the current 35% estate tax rate will increase to a top rate of 55%, starting at a $3 million estate. Estates from the $1 million plus indexed amount to $3 million will pay tax at a reduced rate. The marital portability, or option to transfer your exemption to a surviving spouse, will not apply unless extended by Congress.

Editor’s Note: It is probable that there will be significant tax changes on January 1, 2013. Because the November legislative session is very short, Congress may change some provisions, but is not likely to change all of these tax rates. It will be important for all Americans to be in contact with their tax advisor to take appropriate action to reduce taxes in December of 2012.

Conclusion

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Filed under: Accounting, Estate Planning, Taxation | Tagged: ACA, divident tax, estate tax, Long-Term Capital Gains, Medicare Tax, Personal Income Taxes, Tax Review for 2013 | 3 Comments »