Personal Finance Update: Tax Changes 2013

Now that we’ve made it though the “cliff” and the “Mayan end of the world” scares, let’s take a look at what’s happened to taxes – and it’s been a lot. The payroll tax reduction hataxess ended, new Medicare surtaxes have kicked in, and some of the Bush income tax cuts have been eliminated. Let’s begin by looking at the one that will impact almost everyone, the payroll tax increase, then move to Medicare, then to personal taxes.

Payroll Taxes:

For the past two years the employees’ share of payroll taxes were reduced by two percent, this lowered level of payroll taxes has ended with the new tax law. This change has a broad impact, affecting 125 million households – so almost everyone is hit by it. On average this two percent payroll tax increase amounts to $16.37 a week from take home pay, which is just about equivalent to the average gain in weekly wages experienced by workers over the past year.

Medicare Tax on Earned Income:

0.9% Surtax. The changes in Medicare stem from (1) a new 0.9% surtax on earned income for high earners and (2) a new 3.8% surtax on net investment income for high income filers. As a result of the Patient Protection and Affordable Care Act (PPACA) commonly called Obamacare, high-earners must pay an additional 0.9% Medicare payroll tax on wages above $200,000 for individuals and $250,000 for couples. This means for earners above that threshold, the current 2.9% Medicare payroll tax will be increased to a total of 3.8%. This surtax only applies to the employee’s portion of the Medicare tax, not to the employer’s portion. Employers will withhold the additional tax once an employee’s wages reach the threshold. For more on the Medicare tax on earned income go to the IRS website on the Additional Medicare Tax.

3.8% Surtax on Net Investment Income. There is also a new 3.8% surtax on net investment income impacting higher income individuals. This tax affects only individuals with more than $200,000 in modified adjusted gross income (MAGI), married couples filing jointly with more than $250,000 of MAGI, and separate filers with more than $125,000 of MAGI.   For example, let’s look at a taxpayer filing as a single individual who makes $180,000 in wage income plus $90,000 from investment income. The individual’s modified adjusted gross income is $270,000. The 3.8 percent tax applies to the $70,000, which is the amount above the $200,000 threshold, and the individual would pay $2,660 in surtaxes.

Personal Taxes:

Tax Rates. The Bush income tax cuts had been scheduled to be eliminated, but have instead been renewed for all but high-income earners. A 39.6% rate will now apply to taxable income over $400,000 for singles, $425,000 for heads of household and 450,000 for married couples filing a joint return.

The tax rates for 2013 are:

Marrieds:

If taxable income is                                             The tax is
Not more than $17,850                                          10% of taxable income
Over $17,850 but not more than $72,500          $1,785.00 + 15% of excess over $17,850
Over $72,500 but not more than $146,400       $9,982.50 + 25% of excess over $72,500
Over $146,400 but not more than $223,050     $28,457.50 + 28% of excess over $146,400
Over $223,050 but not more than $398,350    $49,919.50 + 33% of excess over $223,050
Over $398,350 but not more than $450,000  $107,768.50 + 35% of excess over $398,350
Over $450,000                                                  $125,846.00 + 39.6% of excess over $450,000

Singles:

If taxable income is                                       The tax is
Not more than $8,925                                         10% of taxable income
Over $8,925 but not more than $36,250         $892.50 + 15% of excess over $8,925
Over $36,250 but not more than $87,850      $4,991.25 + 25% of excess over $36,250
Over $87,850 but not more than $183,250    $17,891.25 + 28% of excess over $87,850
Over $183,250 but not more than $398,350 $44,603.25 + 33% of excess over $183,250
Over $398,350 but not more than $400,000 $115,586.25 + 35% of excess over $398,350
Over $400,000                                                  $116,163.75 + 39.6% of excess over $400,000

Household heads:

If taxable income is                                         The tax is
Not more than $12,750                                        10% of taxable income
Over $12,750 but not more than $48,600       $1,275.00 +15% of excess over $12,750
Over $48,600 but not more than $125,450     $6,652.50 + 25% of excess over $48,600
Over $125,450 but not more than $203,150    $25,865.00 + 28% of excess over $125,450
Over $203,150 but not more than $398,350   $47,621.00 + 33% of excess over $203,150
Over $398,350 but not more than $425,000   $112,037.00 + 35% of excess over $398,350
Over $425,000                                                   $121,364.50 + 39.6% of excess over $425,000

Standard Deduction.  Other changes include a slight increase in the standard deduction, with marrieds getting $12,200, if one spouse is age 65 or older this climbs to $13,400, and if both are 65 or older $14,600. For singles the standard deduction is $6,100, and $7,600 if they’re 65 or older. For household heads it is $8,950 plus $1,500 more once they reach age 65.  Finally, the blind receive $1,200 more ($1,500 if unmarried and not a surviving spouse).

Phaseout in Itemized Deductions. High-incomer earners not only face a higher tax rate, but also lose some of their itemized deductions for 2013. This is referred to as the Please limitation, named after former Congressman Donald Please. The limitation for 2013 will kick in on AGI levels that exceed $300,000 for joint filers and $250,000 for individuals, indexed for inflation. Income over the applicable amount will trigger an itemized deduction limit of the lesser of (a) 3% of the adjusted gross income above the applicable amount, or (b) 80% of the amount of the itemized deductions otherwise allowable for the taxable year. (It should be noted that the Pease limitation doesn’t apply to medical expense deductions, the investment interest deduction, casualty, theft, or gambling loss deductions.)

Personal Exemptions. Other changes include an increase in the personal exemption to $3,900 for filers and their dependents. Once again, this write-off is phased out for high-incomers, being cut by 2% for each $2,500 of AGI over the same thresholds for the itemized deduction phaseout.

Investments:

While the tax rate on capital gains and dividends remains the same for most taxpayers, it jumps to 20% for high-income taxpayers, with high income taxpayers defined as singles with taxable income above $400,000 and couples over $450,000. When you look at this increase coupled with the new Medicare surtax, this rate jumps to 23.8% for high income taxpayers. For others, the old 15% rate still applies, and filers in the 10% or 15% tax bracket still qualify for the special 0% rate.

Alternative Minimum Tax:

While the Alternative Minimum Tax or AMT did not go away, exemptions went up for 2013. For 2013 they jump to $80,750 for couples and $51,900 for both singles and household heads, up from 2012 by $2,050 and $1,300, respectively. It will also automatically adjusted for inflation in the future. In addition, personal tax credits, such as those for tuition and dependent care, will continue to offset alternative minimum tax liability.

Social Security:

As is the case every year, the Social Security wage base rises this year to $113,700, which is a $3,600 boost. As noted earlier, because of the expiration of the 2% cut in the employee Social Security rate and the 0.9% Medicare surtax on high-earners, Social Security taxes are on the rise.

In terms of benefits, Social Security benefits go up 1.7% in 2013, this is less than half of 2012’s hike. The earnings limits also change, going up this year. Taxpayers who turn 66 this year do not lose any benefits if they make $40,080 or less a year. Taxpayers who are at least 62 but are not 66 by the end of 2013 can make up to $15,120 before they lose any benefits. There is no earnings cap once a beneficiary turns 66. The amount needed to earn Social Security credits also changes, going up to $1,160 a quarter. Thus, if you earn $4,640 anytime during 2013 you will capture the full four quarters of coverage.

Medicare:

For 2013, the basic Medicare Part B premium increases to $104.90 per month. For higher income taxpayers (modified adjusted gross incomes for 2011 exceeded $170,000 for couples or $85,000 for single people), the Part B and D premiums are much higher, with the total surcharges on upper-incomers running as high as $297.40 a month.

Medical Deductions:

Deducting Medical Expenses. For 2013, the threshold for deducting medical expenses jumps to 10% of AGI for singles under age 65 and married couples who file a joint return, unless at least one of the filers is age 65 or older in which case the 7.5%-of-AGI cap applies.

Ceiling on Deductible Payins. For 2013, the annual ceilings on deductible payins to health savings accounts rose to $6,450 for account owners with family medical coverage and $3,250 for single coverage. HSA owners born before 1959 can put in $1,000 more. The limitations on out-of-pocket expenses (for example, deductibles and copayments) increased to $12,500 for those with family coverage and $6,250 for single coverage, and the minimum policy deductibles increase to $2,500 for families and $1,250 for individuals.

Long-Term Care Premiums. Taxpayers 71 or older can write off up to $4,550 per person and those 61 to 70 can write-off up to $3,640. For those 51 to 60 the maximum is $1,360, for those age 41 to 50 $680, and 40 and younger $360. In addition, the limit for tax free payouts under such policies increases to $320 a day.

Savings Plans:

401(k), 403(b), 457 Plans and SIMPLES. The maximum contribution is $17,500 for 2013, and for taxpayers born before 1964 it is up to $23,000. The catch-up contribution limit for employees aged 50 and over who participate in 401(k), 403(b), most 457 plans, and the federal government’s Thrift Savings Plan remains unchanged at $5,500. The limit on SIMPLEs is $12,000, and taxpayers 50 or older in 2013 can contribute an additional $2,500. For more on 401(k) plans, check out the 401khelpcenter.com.

Contribution and income limits for IRAs and Roth IRAs. For 2013 the contribution limits for IRAs and Roth IRAs is raised to $5,500, $500 more than for 2012. Anyone who was born in 1963 or earlier can put in an extra $1,000. In addition, the income ceiling on Roth IRA contributions goes up. For 2013, contributions phase out for Roth IRAs at AGIs of $178,000 to $188,000 for couples and $112,000 to $127,000 for singles.

For 2013 the phaseout range for deducting an IRA contribution when you are covered by a retirement plan at work ranges from $95,000 of AGI to $115,000 for couples and from $59,000 to $69,000 for singles.

Education:

For 2013 the lifetime learning credit starts now phase out over the range from $53,000 to $63,000 of AGI for singles and $107,000 to $127,000 for couples. In addition, for 2013, the income caps for EE bonds tax free for education are higher, with the exclusion starts phasing out above $112,050 of AGI for married couples and $74,700 for singles and ends when AGI hits $142,050 and $89,700, respectively.

Adoption:

Adoption Credit.  For 2013, the adoption tax credit can cover up to $12,770 of costs, a $120 boost.   If the credit is more than a filer’s tax liability, the excess is not refundable.

When the adoption is for a special needs child, the full $12,770 credit is available, even if it cost less.

Continued Tax Breaks:

American Opportunity Tax Credit.  The American Opportunity Tax Credit was continued.

Mortgage debt tax relief.  Mortgage debt tax relief was extended.  As a result, home owners facing short sales, reduced loan principals, or foreclosures avoid paying taxes on any debt still owed to the bank.  If this tax feature had not been extended, the debt would have been taxed by the IRS as income.

State and local sales tax.  Another tax feature that was continued was the election to write off state and local sales taxes in lieu of state income taxes.

Teacher’s supplies. Also, the ability for teachers to deduct class supplies was extended.

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