There are a number of tax changes lurking right around the corner. These changes are set to take effect on January 1, 2013. Here are the three essentials you need to know about taxes in 2013.
Income taxes are increasing. Currently there are a number of income tax increases next year. First, the lowest income tax bracket will increase from 10% to 15% and the highest income tax bracket will increase from 35% to 39.6%. All the other brackets in-between will likewise be adjusted.
The capital gains rate will return to 20% from its current 15% level and dividends will once again be taxed as ordinary income. Thus, if you are in the highest income tax bracket your dividend rate will increase from 15% to 39.6%.
For California residents, taxes have already increased. The recent passage of Proposition 30 made tax increase retroactive to January 1, 2012. The top California income tax rate for ordinary and capital gain income is now 13.3%.
Not only are income tax rates increasing, but also both the Pease limitation and the personal exemption phase out are returning. The Pease limitation reduces itemized deductions for adjusted gross income above approximately $175,000. The deductions most affected by the Pease limitation are the mortgage interest deduction, state income tax deduction, property tax deduction and charitable deductions. The personal exemption phase out also affects higher income taxpayers by reducing the amount of the personal exemption they can claim on their income tax returns. The result of both the Pease limitation and the personal exemption phase out is higher income taxes.
The Patient Protection and Affordable Care Act, most commonly known as Obamacare, brings new taxes for 2013. Not only will there be a 0.9% Medicare surtax for earned income over $200,000 for single taxpayers and over $250,000 for married taxpayers, but there is also a Medicare surtax on unearned income. Unearned income is defined as dividends, interest, capital gain, annuity income, royalties and rental income. The tax is the lesser of 3.8% of your unearned income or the amount in which your adjusted gross income exceeds $200,000 if you are single or $250,000 if you are married. For example, if you and your spouse sell a parcel of real estate generating a $200,000 capital gain and also have $100,000 of income for working, your income is $300,000. Of your $300,000 income, $200,000 is considered unearned income. Your tax is the lesser of 3.8% multiplied by $200,000 ($7,600) or 3.8% multiplied by $50,000, the amount in which your income exceeds the $250,000 threshold ($1,900). The lesser of the two amounts is $1,900, thus you would have an additional tax of $1,900 in addition to the traditional capital gains tax you would have on the sale of appreciated property.
The Patient Protection and Affordable Care Act also sets the maximum amount you can put into flexible spending account at $2,500. Formerly the maximum was $5,000. Also, starting in 2013, you will only be able to deduct out-of-pocket medical expenses for amounts greater than 10% of your adjusted gross income. Currently you can deduct out-of-pocket medical expenses for amounts greater than 7.5% of your adjusted gross income.
The estate tax exemption is scheduled to go down to $1 million. A transfer tax is a tax on your ability to give away your accumulated wealth. With a transfer tax the tax liability is on the giver rather than the receiver. Transfers made during your lifetime are subject to the gift tax while transfers made after your lifetime are subject to the estate tax. Currently everyone enjoys a gift or estate tax exemption of $5,120,000. If you are married, you and your spouse have a total exemption of $10,240,000. If you give an amount greater than your exemption, the excess is subject to a 35% tax. Starting in 2013, that exemption amount will fall to an amount just over $1M. For a married couple the amount is just over $2M. When you consider the assets that comprise your estate, such as any real estate you own, your retirement account, life insurance held under your name, investment accounts and bank accounts, many people will likely exceed the $1M exemption amount. If you do exceed the exemption amount, there will be a 55% tax on the amount exceeding $1M.
What can you do? It is very important to be informed and to plan. Given that we are almost at the end of 2012, it is critical to meet with your advisors if you will be affected by any of the above tax changes. Many people are taking advantage of the current gift and estate tax exemption amount by making transfers to family now.
If you are considering selling an appreciated asset you may want to sell this year rather than next year to avoid the higher capital gains rate and the new 3.8% Medicare surtax on unearned income. If you have the ability to appropriately trigger some of your other income this year rather than in 2013, you may wish to accelerate that income into 2012 to take advantage of lower income tax rates.
Currently the charitable deduction remains untouched. Gifts to charity this year will ensure you receive the full tax benefits of those gifts. If you are making charitable gifts, consider giving stock rather than cash. Giving stock that you have held for more than one year allows you to take a deduction for the stock's fair market value on the day it is received by the charity. Thus, you receive a charitable deduction on what you paid for the stock plus the amount of the appreciation without having to pay taxes on the appreciated amount. Giving stock is one of the most tax-effective gifts.
If you do not have an estate plan in place it is extremely important to have an estate plan done. With next year's low exemption amount, not having a plan in place can cost your loved ones several hundred thousands of dollars or more. Overall, it is important to plan and be prepared, even in this busy holiday season.
If you have any questions on the three essentials you need to know about taxes in 2013 or any other related income, gift or estate tax questions please call the Center for Estate and Gift Planning at (310) 506-4893 or email us at Stephanie.Buckley@pepperdine.edu. We are here to assist our Pepperdine alumni, family and friends.