On January 1, 2013, the country faces what Federal Reserve Chairman Ben Bernanke has called a “fiscal cliff”, which includes expiring Bush-era tax cuts, cuts in government spending, uncertainty over the alternative minimum tax, tax breaks known as “tax extenders”, and the Medicare surtax on higher income earners. Taxes are going to be a major issue for the rest of 2012 and potentially for much of 2013 and beyond.
Some of these tax increases are very likely to be enacted after the first of the year while others are being negotiated by President Obama and members of Congress. There is no way to predict what Congress will do about these issues or when they will act. This uncertainty makes doing effective tax planning very challenging; however doing nothing could leave you paying significantly more in taxes after 2012. Here are the more significant projected tax changes that may impact your tax liability next year:
Medicare Tax on Investment Income
For tax years 2013 and later, a 3.8% “net investment income tax” will apply to unearned income of taxpayers whose total income exceeds the thresholds of $250,000 for a married couple and $200,000 for an individual taxpayer. This Medicare tax applies to individuals as well as trusts and estates.
Medicare Tax on Wages
The Medicare tax rate for individuals with gross wages or earnings from Self Employment in excess of $200,000 will increase by 0.9%.
Payroll Tax “Holiday”
The 2% payroll tax cut is set to expire, reducing take-home pay for wage earners and increasing self-employment tax.
Increase in Income Tax Brackets
The current federal income tax brackets of 10%, 15%, 25%, 28%, 33%, and 35% are set to revert back to rates of 15%, 28%, 31%, 36%, and 39.6%. Those in the highest tax bracket will also likely be impacted by the Medicare surtax of 3.8%, increasing the highest marginal tax rate on income to 43.4% for federal tax.
Increase in California Tax Rates – Retroactive to January 1, 2012
For taxpayers with income in excess of $500,000(Married Filing Joint) and $250,000(Single), Proposition 30 increased your California tax rates by up to 3%. This is retroactive to January 1, 2012, so you will owe it in April 2013 if you are in this group.
Capital Gains and Qualified Dividend Rates
Capital gains tax rates are set to increase from 15% to 20%. Qualified Dividends that have been taxed at favorable Capital Gains rates of 15% are set to revert to ordinary income tax rates of 15% to 39.6%. Income from these sources may also be subject to the Medicare surtax depending on income.
The Alternative Minimum Tax (AMT) patch has expired. The patch has traditionally provided higher AMT exemption amounts and other relief. If the 2011 ‘patch’ is not extended, up to 60 million taxpayers may be subject to a tax they have not paid before. This could have significant impact on California taxpayers and could also delay the tax filing for those taxpayers affected.
Personal Exemptions Phase-Out (PEP) and Itemized Deduction Reductions (PEASE)
Gradual elimination of exemptions and itemized deductions will result in higher taxable income for taxpayers over the $200,000/$250,000 income ranges.
Other tax credits set to reduce or expire include the Child Tax Credit, the Dependent Care Credit, and certain education credits. For higher income earners, these credits have likely been phased out and will not be missed.
Section 179 and Bonus Depreciation
For small businesses and rental property owners, limits for Section 179 expensing of assets will reduce to $25,000. In addition, Bonus Depreciation of 50% on new assets is set to expire.
Estate and Gift Taxes
Currently, the estate and gift exemption amount is $5.12M. At the end of 2012, the exemption will revert to $1M. In addition, the estate tax rate will go from a maximum of 35% to a maximum of 55%. Now may be the time to do some gifting.
Some of these changes may be repealed, delayed, or altered for taxpayers at certain income levels, but it is impossible to know what these changes will be. We are watching for any developments and anxiously await action from Congress and the President. We are also updating our website www.negranti-higgins.com as changes happen. By staying informed and being prepared to act as events unfold, you can minimize your 2012 and 2013 tax liability. We encourage you to make 2012 yearend tax planning a priority and are committed in helping you analyze the tax-cutting strategies best suited to your individual circumstances. If you have questions or would like to arrange a year-end tax review, please contact us directly at (805) 543-1987.