Our lame duck Congress is set to begin meeting again today, and it is possible that some of the following provisions may change, but as it stands now, there are many significant tax changes ahead for all of us. The first and most pressing of these changes is the repeal of the Bush tax cuts, which are scheduled to automatically expire at the end of December.
Repeal of this provision will cause federal maximum income tax rates to rise from 35 percent to 39.6 percent. In addition to the 13 percent increase in maximum tax rates on ordinary income, the maximum capital gains tax rate increases from 15 percent to 20 percent.
Remember also that the 3.8 percent tax on investment income imposed by Obamacare is also applicable to those who have investment gains, which are taxed at long-term rates. The marginal rate on those gains will increase 8.8 percent above the current 50 percent, which is a 58 percent increase in the capital gain tax rate on investment property disposed of in 2013. If you are planning on disposing of capital gain property early in 2013, you might consider accelerating the sale of those assets into 2012 to avoid the material increase in federal and state income taxes for 2013.
Investors will also be hard hit by the increase in taxes on qualified dividend income. Currently they are taxed at the same rate as long-term capital gains or 15 percent. After Dec. 31, that tax benefit will be repealed and dividend income will be taxed at a maximum rate of 39.6 percent. They will also be subject to a 3.8 percent tax on investment income imposed by Obamacare.
There will also be a 2 percent increase in the FICA tax for those paying into Social Security.
Overall, the tax increases will hit families, charities and small businesses in three great waves on January 1, 2013.
First Wave: Expiration of 2001 and 2003 Tax Relief
In 2001 and 2003, Congress enacted several tax cuts for small business owners, families, and investors (later re-upped by President Obama and the Democratic Congress in 2010). The following tax hikes will occur on January 1, 2013:
• Personal income tax rates will rise on Jan. 1, 2013. The top income tax rate will rise from 35 percent to 39.6 percent. (This is also the rate at which the majority of small business profits are taxed.) The lowest rate will rise from 10 percent to 15 percent.
• All the rates in between will also rise. Itemized deductions and personal exemptions will again phase out, which has the same mathematical effect as higher marginal tax rates. The full list of marginal rate hikes is below:
— The 10 percent bracket rises to a new and expanded 15 percent
— The 25 percent bracket rises to 28 percent
— The 28 percent bracket rises to 31 percent
— The 33 percent bracket rises to 36 percent
— The 35 percent bracket rises to 39.6 percent
• Higher taxes on marriage and family coming on Jan. 1, 2013 include the “marriage penalty,” narrower tax brackets for married couples, which will return from the first dollar of taxable income. The child tax credit will be cut in half, from $1,000 to $500 per child. The standard deduction will no longer be doubled for married couples relative to the single level.
• The Middle Class Death Tax returns on Jan. 1, 2013. The death tax is currently 35 percent, with an exemption of $5 million, or $10 million for married couples. For those dying on or after Jan. 1 2013, there is a 55 percent top death tax rate on estates valued at more than $1 million.
• Higher tax rates on savers and investors on Jan. 1, 2013. The capital gains tax will rise from 15 percent this year to 23.8 percent in 2013. The top dividends tax will rise from 15 percent this year to 43.4 percent in 2013. This is because of scheduled rate hikes, plus Obamacare’s investment surtax.
Second Wave: Healthcare Tax Hikes
There are 20 new or higher taxes in Obamacare. Some have already gone into effect (the tanning tax, the medicine cabinet tax, the HSA withdrawal tax, W-2 health insurance reporting, and the “economic substance doctrine”). Several more will go into effect on Jan. 1, 2013:
• The Obamacare Medical Device Tax begins to be assessed on Jan. 1, 2013. Medical device manufacturers employ 409,000 people in 12,000 plants across the country. This law imposes a new 2.3 percent excise tax on gross sales—even if the company does not earn a profit in a given year. Exempts items retailing for less than $100.
• The Obamacare Medicare Payroll Tax Hike takes effect on Jan. 1, 2013. The Medicare payroll tax is currently 2.9 percent on all wages and self-employment profits. Starting in 2013, wages and profits exceeding $200,000 ($250,000 in the case of married couples) will face a 3.8 percent rate.
• The Obamacare change to Medical Itemized Deductions goes into force on Jan. 1, 2013. Currently, those facing high medical expenses are allowed a deduction for medical expenses to the extent that those expenses exceed 7.5 percent of adjusted gross income (AGI). The new provision imposes a threshold of 10 percent of AGI. Waived for 65+ taxpayers in 2013-2016 only.
• The National Association of Realtors has provided examples of different scenarios for which a 3.8 percent tax on real estate—passed by Congress in 2010 with the intent of generating an estimated $210 billion to help fund President Obama’s health care and Medicare overhaul plans—could be applicable. This tax will not be imposed on all real estate transactions; rather, when the legislation becomes effective in 2013, it may impose a 3.8 percent tax on some (but not all) income from interest, dividends, rents (less expenses) and capital gains (less capital losses). The tax will fall only on individuals with an AGI above $200,000 and couples filing a joint return with more than $250,000 AGI.
Third Wave: The Alternative Minimum Tax and Employer Tax Hikes
These tax increases will be in force for booth 2012 and 2013. The major items include:
• The AMT will affect more than 31 million families, up from 4 million last year. These families will have to calculate their tax burdens twice, and pay taxes at the higher level.
• Full business expensing will disappear. In 2011, businesses can expense half of their purchases of equipment. Starting on 2013 tax returns, all of it will have to be depreciated.
• Tax Benefits for Education and Teaching Reduced. The deduction for tuition and fees will not be available. Tax credits for education will be limited. Teachers will no longer be able to deduct classroom expenses. Coverdell Education Savings Accounts will be cut. Employer-provided educational assistance is curtailed. The student loan interest deduction will be disallowed for hundreds of thousands of families.
• Charitable Contributions from IRAs will no longer be allowed. Under current law, a retired person with an IRA can contribute up to $100,000 per year directly to a charity from their IRA. This contribution also counts toward an annual “required minimum distribution.” This ability will no longer be there.