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The American Taxpayer Relief Act (“ATRA”) was the fiscal cliff deal legislation passed in the wee hours of January 1, 2013. It is making itself felt by taxpayers as they prepare to file their 2013 taxes. The legislation extended many provisions of the tax code that were set to expire at the end of 2012. It also added some new rates for income and dividends and new surcharges on investment income. It also brought back less-than-popular phase-outs on itemized deductions and personal exemptions that will affect some taxpayers.
How will the new rules affect you and what you owe Uncle Sam?
Rates on Ordinary Income
For most individuals, the federal income tax rates for 2013 will be the same as last year: 10%, 15%, 25%, 28%, 33% and 35%. The top tax rate will increase to 39.6% for singles with taxable income above $400,000, married filing jointly couples with income above $450,000, those filing “head of household” with income above $425,000 and married individuals who file separately with income above $225,000. Tax brackets are based upon taxable income after all deductions, not on adjusted gross income (AGI).
Long-Term Gains and Dividends
Taxes on capital gains and qualified dividends for most investors will also remain the same – 15%. Qualified dividend treatment, which was due to expire in 2012, was also made permanent. However, like the tax rates on ordinary income, the maximum rate on capital gains and dividends will increase to 20% for the top tax bracket (the new 39.6% bracket with the $400,000/$450,000/$425,000 thresholds noted above).
In addition, to foot the bill for Obamacare, those making more than $250,000/$200,000 will also pay an additional 3.8% Medicare surtax on investment income, including both dividends and capital gains. For individual taxpayers, the surtax is based on the lesser of (1) net investment income, or (2) the amount by which modified adjusted gross income (MAGI) exceeds the threshold amount.
For these higher earners, the result is a 23.8% federal tax rate on long-term gains and dividends. However, immense as that may sound, many experts think that these investors dodged a major bullet. If a fiscal cliff deal had not been reached, dividends were slated to be taxed at ordinary income rates, resulting in a top rate of more than 43%, including the health care surcharge.
The Pease limitation and Personal Exemption Phase-out (PEP) – They’re Baaaaack!
Are you impacted? The answer is “maybe”. The Pease Limitation, the phase-out of itemized deductions, returned for 2013. It reduces total itemized deductions by 3% of excess income over a certain AGI threshold. Taxpayers who will be affected are those with adjusted gross incomes of $250,000 for individuals, $300,000 for married couples and $275,000 for those filing head of household.
The personal exemption phase-out (PEP), which impacts the much beloved personal exemption, also has returned. Most taxpayers are entitled to claim a personal exemption for themselves and any dependents they support, thereby reducing their taxable income and the taxes they pay. The personal exemption amount is indexed annually for inflation and is $3,900 for 2013. The PEP, however, reduces personal exemptions by 2% of the total exemption amount for each $2,500 of income over the AGI thresholds mentioned above. These amounts are also indexed for inflation.
The net impact of the PEP and Pease limitations is that each “rule” increases an individual’s marginal tax rate by about 1%. However, the reduction cannot exceed 80% of the total affected deductions.
Home Office Deduction Simplified
The IRS has changed the requirements on the home office deduction for the 2013 tax year. Under the new rule, taxpayers have the option to take a “standard” home office deduction of $5 for every square foot of office space up to 300 square feet as opposed to the old way of trying to figure out what percentage of your home was used as home office space.
Forgiven Principal Residence Mortgage Debt
For federal income tax purposes, a forgiven debt generally is considered taxable income. In 2007, in response to the mortgage crisis, Congress exempted up to $2 million per couple of COD (cancellation of debt) income from mortgage debt on a principal residence. From 2007 through 2012, this COD was treated as tax-free. This generous exemption was extended through 2013.
State and Local Sales Tax Deduction
ATRA also restores the option of claiming an itemized deduction for state and local sales taxes instead of state income taxes on your Schedule A. Like many other deductions, it expired at the end of 2011 but has been extended through 2013.
K-12 Educators’ Expenses
The $250 deduction for school-related expenses paid by teachers and other K-12 educators has been extended through 2013.
Energy-Efficient Home Improvement Credit
The tax credit of up to $500 for certain energy-saving improvements to a principal residence has been extended through 2013.
Higher Education Tuition Deduction Extended
The ability to deduct tuition and fees for higher education has also been extended through 2013.
Gift and Estate Tax Exemptions
For 2013 and beyond, ATRA permanently installed a unified federal estate and gift tax exemption of $5 million (adjusted annually for inflation) and a 40% maximum tax rate (up from 35%). Exemption portability, the right to leave your unused estate and gift tax exemption to your surviving spouse, was also made permanent.
The gift exemption, known as the annual exclusion, was also indexed for inflation. It is $14,000 for 2013, up from $13,000 in 2012, and is set to increase in $1,000 increments every few years. Couples that “gift split” can now give $28,000 per recipient annually.
Before We Go
In summary, the tax picture for 2013 returns is not too drastically different for many people. Next year looks to have all the increases and less deductions but as the tax landscape is constantly changing, 2014 is still anyone’s guess.
The deadline to file individual tax returns for the year 2013 or to request an automatic extension (Form 4868) is Tuesday, April 15, 2014. State tax deadlines vary, so check with your state’s Department of Taxation for that information.
At this time of year, we hope that you have found this paper to be helpful but it should not be construed or interpreted to be advice for your specific tax situation. Please check with your tax advisor or accountant to ensure any advice works for your particular circumstances.