The Rest of the Story: Tax Changes that Passed Congress

In the December column, I reviewed several potential tax changes that could affect you. Now that the American Taxpayer Relief Act of 2012 (ATRA) has been passed, I am returning to let you know what passed and what did not.

Smaller Take Home Pay

According to James Larkin, CPA with Thompson, Derrig & Craig, “the payroll tax break was not extended, so withholding will be higher by 2% than in the previous two years.” You probably have already noticed that your paycheck is lighter now than in 2012.

The Dreaded Alternative Minimum Tax (AMT)

Good news! The AMT exemption amount was increased for 2012 and is now indexed for inflation. Larkin tells us that this means most taxpayers will not have to worry about AMT anymore. Had this not been done, the increased tax would have averaged $3,700 for most of you who are reading this article.

Since 1998, we have seen annual patches to this tax. Now this law is permanent and retroactive to January 1, 2012.

Estate Taxes

Let’s review the definition of what an estate is and what it is not. In general, an estate includes all assets owned by the decedent. As with all tax topics, you should consult a CPA to determine how estate taxes relate to your unique situation.

In the December column, we learned that, generally speaking, a taxable estate includes:

Cash
Personal residence
Other real estate
Securities
Family business
Mineral interests
Investments in non-family businesses, partnerships and the like
Undivided interests in partnerships, land, mineral interests and the like
Life insurance policies
Under the prior law, if your estate were to valued at more than $5 million, the amount over $5 million would be taxed at 35% when you pass on. This is called a $5 million exemption. The American Taxpayer Relief Act of 2012 (ATRA) left the $5 million exemption intact but raised the tax rate to 40%.

In the December column, Larkin explained portability, telling us that it “could be a great move if portability carries over in some form into 2013.” More good news: portability survived. As Larkin informs us,

“The existence of portability eliminates the need for a lot of the estate planning we used to do for those with estates well under the $5 million for a single person or $10 million for a married couple. The estate planning is replaced by filing estate tax returns for those who may not have an estate large enough to require filing the return but where filing the return is necessary to elect portability.“

Larkin gives us the following example. A couple has an estate of $7 million. When first spouse dies, his or her share of the estate is $3.5 million, which is under the $5 million exemption. Because the decedent’s estate is below the $5 million exemption amount, an estate tax return is not required to be filed. Assuming all property went to the surviving spouse, he or she would want to file an estate tax return just to be able to claim portability. By filing to claim portability, the surviving spouse would then have a $10 million exemption, which would cover their $7 million estate when they eventually pass on.

Other Items Not Discussed in December

Larkin lists five other tax changes that might affect you:

Medical deductions will be more difficult to claim on your tax return starting with the 2013 tax year. The deduction threshold increases from 7.5% of adjusted gross income to 10% of adjusted gross income. This means you will have to spend more on medical expenses in order to be able to deduct them as an itemized deduction.

The employee portion of Medicare tax has been increased for 2013 by an additional 0.9% on wages that exceed the threshold amounts. The threshold amounts are $250,000 for a joint return or a surviving spouse, $125,000 for a married individual filing a separate return and $200,000 for any other case. This threshold is not indexed for inflation. This means we will have bracket creep on this tax. This means that over time more taxpayers will become subject to this tax because inflation will drive their wages up towards the threshold amount. This additional 0.9% tax is not imposed on employers.

Income tax rates are not changing for 2013 except for taxpayers with taxable income in excess of $450,000 married joint filers and $400,000 single filers. Those rates have increased.

Capital gains rates are not changing for 2013 except for taxpayers with taxable income in excess of $450,000 married joint filers and $400,000 single filers. Their capital gains rate has gone up to 20%.

Mentioned in the December article, but worth repeating is the 3.8% Medicare contribution tax on net investment income effective starting in 2013 for those with taxable income over $250,000 for joint returns and $200,000 for single returns. Most people do not have taxes withheld from investment income. If you think this tax will apply, you may need to adjust your withholding from your wages or increase your quarterly estimated tax payments.

Note: This tax has nothing to do with Medicare. According to the proposed regulations, “no provision is made to transfer this tax from the General Fund of the United State Treasury to any Trust Fund.” This means that none of this money goes to fund Medicare.