2013 Tax Changes- A Year in Review
1) New Medicare Taxes
2) New Tax Rates and Alternative Minimum Tax
3) Itemized Deduction and Personal Exemption Phase-outs
4) Tax Treatment of Married Same-Sex Couples
5) Estate and Gift Tax Changes
6) Business Related Tax Changes
7) Expiring Provision After 2013
1) New Medicare Taxes
Effective January 1, 2013, the Affordable Care Act imposed two new Medicare taxes on qualified taxpayers: a 3.8 percent net investment income (NII) tax and a 0.9 percent additional Medicare Tax.
Net Investment Income Tax (NII):
The NII tax on taxpayers (individuals and trusts and estates) equals 3.8 percent of the lesser of: (1) net investment income for the tax year, or (2) the excess, if any of: (a) an individual’s modified adjusted gross income (MAGI) for the tax year, over (b) the threshold amount.
The threshold amount is $250,000 in the case of a taxpayer making a joint return or a surviving spouse, $125,000 in the case of a married taxpayer filing a separate return, and $200,000 in any other case (these amounts are not indexed for inflation). The threshold amount for trusts and estates is the start of their 39.6 percent tax bracket, which, for 2013 was $11,950 ($12,150 for 2014).
EXAMPLE #1
Married taxpayers, Ann and Joe, sell their residence in 2013 and the sale qualifies for the Code Sec 121 exclusion of up to $500,000 of net gain. The net gain on the residence sale is $550,000. Their MAGI is $260,000 of salary income before taking the sale of the residence into consideration. Ann and Joe’s net investment income is $50,000 ($550,000 − $500,000 exclusion). The $50,000 net investment income (gain not excluded under Code Sec 121) must be added to their $260,000 salary for a total MAGI of $310,000. Their MAGI in excess of the $250,000 threshold amount is $60,000. Because the net investment income of $50,000 is less than their $60,000 MAGI, they will pay 3.8% of $50,000, or $1,900, on the $550,000 gain on the sale of their residence.
The net investment income tax only applies if the taxpayer has net investment income and the taxpayer’s MAGI exceed the applicable threshold amount.
EXAMPLE #2
Sue and Sam, a married couple who file a joint return, collectively earn $270,000 in wages and have $80,000 of net investment income in 2013. Their MAGI is $350,000. For 2013, the couple will incur a 3.8 percent unearned income Medicare contribution tax on the lesser of their: (1) $80,000 of net investment income, or (2) $100,000 ($350,000 − $250,000) MAGI in excess of the $250,000 threshold for married taxpayers filing jointly. Thus, Sue and Sam will incur a $3,040 (.038 × $80,000) unearned income Medicare contribution tax in 2013.
EXAMPLE #3
In 2013, Rob, a single taxpayer, receives no wages or self-employment income. He does, however, earn $3.2 million in net investment income from a stock and bond portfolio that is not part of a qualified employee benefit plan. This is the total amount of Rob’s MAGI for 2013. Rob will incur a 3.8 percent unearned income Medicare contribution tax on the lesser of his: (1) $3.2 million net investment income or (2) $3 million ($3,200,000 − $200,000) MAGI in excess of the $200,000 threshold amount for a single taxpayer. Thus, Rob will incur an $114,000 (.038 × 3,000,000) unearned income Medicare contribution tax in 2013.
For additional information the IRS has a Q & A page covering NII Tax. You can visit at:
http://www.irs.gov/uac/Newsroom/Net-Investment-Income-Tax-FAQs
Additional Medicare Tax:
In addition to the 1.45 percent employee portion of the Medicare tax imposed on wages and the 2.9 percent Medicare tax on self-employment income, a 0.9 percent Medicare tax is imposed on every taxpayer who receives wages with respect to employment or self-employment income during any tax year beginning after December 31, 2012, in excess of $200,000 ($250,000 in the case of a joint return, $125,000 in the case of a married taxpayer filing separately), as added and amended by the Patient Protection and Affordable Care Act (PPACA) and amended by the Health Care and Education Reconciliation Act of 2010.
The IRS acknowledged that the Additional Medicare Tax requires new recordkeeping and withholding procedures for employers. However, the agency declined to give employers additional time to correct errors, allow corrections for a certain period without penalty, or exempt de-minimis errors from penalties. The IRS also described correction of overpayments and underpayments by employers in the final regulations.
It should be noted that S Corporation income (assuming material participation) is currently not subject to either the NII tax or the Additional Medicare Tax.
For additional information the IRS has a Q & A page covering the Additional Medicare Tax. You can visit at:
2) New Tax Rates and Alternative Minimum Tax
Top Tax Rate: New for 2013 is the top rate of 39.6% applying to taxable income over $400,000 for single filers, $425,000 for head of household filers, and $450,000 for married taxpayers filing jointly ($225,000 for married filing separately).
Capital Gain Rates: A 20% rate applies to individuals’ long-term capital gains and qualified dividends that would otherwise be taxed at the 39.6% rate; the former top rate of 15% applies to long-term capital gains and qualified dividends that would otherwise be taxed at a rate at or above 25% but below 39.6%. The zero rates continue to apply to long-term capital gains and dividends that would otherwise be taxed at the 10% or 15 rates. Short term(S/T) and long term (LT) rates are summarized in the table below.
Income Tax Rate S/T CG Tax Rate L/T CG Tax Rate
10.0% 10.0% 0.0%
15.0% 15.0% 0.0%
25.0% 25.0% 15.0%
28.0% 28.0% 15.0%
33.0% 33.0% 15.0%
35.0% 35.0% 15.0%
39.6% 39.6% 20.0%
Alternative Minimum Tax(AMT) Changes: Beginning in 2013, the American Taxpayer Relief Act of 2012 permanently indexed for inflation the alternative minimum tax (AMT) exemption amount and the thresholds for the 28% AMT rate for individuals and made the AMT offset for nonrefundable credits permanent. The increase for inflation of the AMT exemption amounts for individuals had often been late-enacted relief in years past. For 2013, the exemption amounts are $80,800 for married taxpayers filing jointly, $40,400 for married taxpayers filing separately, and $51,900 for single filers. The inflation-adjusted threshold for the 28% AMT rate is $179,500 for married taxpayers filing jointly and unmarried individuals (other than surviving spouses) and $89,750 for married taxpayers filing separately.
3) Itemized Deductions Limitation and Personal Exemptions Phase-outs
The itemized deductions limitation and personal exemptions phase-outs have been reinstated. The limitation had previously been eliminated for 2010 through 2012. In 2013, if a taxpayer’s adjusted gross income (AGI) exceeds an applicable amount based on his or her filing status, the taxpayer’s allowed itemized deductions will be limited. The applicable amounts for 2013 are $250,000 for single taxpayers, $275,000 for heads of household, $300,000 for married taxpayers filing jointly, and $150,000 for married taxpayers filing separately. The itemized deductions limitation is a 3%/80% formula, under which itemized deductions are reduced by the lesser of 3% of the excess of AGI over the applicable amount above or 80% of the amount of the itemized deductions otherwise allowable for the tax year.
A taxpayer’s personal exemptions are reduced by 2% for every $2,500 (or $1,250 for married taxpayers filing separately) by which AGI exceeds the applicable amounts above. This did not apply for tax years 2010 through 2012.
4) Tax Treatment of Married Same-Sex Couples
The IRS explained that it would treat all legally married same-sex couples as married for all federal tax purposes, including income and gift and estate taxes, regardless of whether a couple resides in a jurisdiction that recognizes same-sex marriage or in a jurisdiction that does not recognize same-sex marriage. The IRS also announced that for tax year 2013 and going forward, same-sex spouses generally must file using a married filing separately or jointly filing status. Additionally, the IRS provided that individuals who were in a same-sex marriage may, but are not required to, file original or amended returns—for federal tax purposes for one or more prior tax years still open under the statute of limitations—choosing to be treated as married.
5) Estate and gift tax changes
The American Taxpayer Relief Act of 2012 also added a new higher estate and gift tax rate of 40% starting in 2013 and made permanent the “portability” election, higher exclusion amount, and other temporary provisions in the Job Creation Act of 2010. Previously, the top rate was 35%. For 2013, the estate, gift, and generation-skipping transfer tax exemption, as indexed for inflation, is $5.25 million, and the annual per-donee gift tax exclusion is $14,000. Under portability, if the executor of the deceased spouse’s estate makes the election, a surviving spouse’s exclusion amount is increased by the unused exclusion amount of the deceased spouse.
6) Business Related Tax Changes
The American Taxpayer Relief Act of 2012 (ATRA) extended most business tax credits and other business related provisions through the end of 2013.
Depreciation:
Section179 expensing. ATRA extended to 2012 and 2013 the higher expensing limit and phase-out threshold for property purchased and placed in service during a tax year ($500,000 and $2 million, respectively).
Bonus depreciation. Similarly, additional first-year depreciation of 50% of the adjusted basis of qualified property (bonus depreciation) was extended by ATRA for 2012 and 2013 but is scheduled to expire again after that. ATRA did not extend 100% bonus depreciation, which expired at the end of 2011.
Built-In-Gains:
Similarly retroactive to 2012 (and scheduled to expire again at the end of 2013) was the shorter five-year built-in gain recognition period for S corporations. ATRA’s technical amendment limiting-carryover of built-in gain over taxable income (Sec. 1374(d)(2)(B)) may have implications for some S-corporation taxpayers in 2013 as well.
Home Office Safe Harbor:
New this year, an optional safe-harbor method of calculating a deduction for expenses for the business use of a taxpayer’s residence. The provision only applies to individuals and is effective for tax years that begin after December 31, 2012. 2013 is the first tax year for which the safe harbor may be elected.
Deduction amount. The maximum safe-harbor deduction is $1,500. The deduction is equal to $5 times the number of square feet in the home office. No more than 300 square feet may be taken into account. The IRS may adjust the $5 rate from time to time.
The primary advantage of the safe harbor is that a taxpayer is not required to substantiate, calculate, and allocate deductible expenses as is the case under the actual expense method. However, there may be situations in which the optional method will result in a significantly lower deduction than the actual expense method. For example, if the office is in excess of 300 square feet or the size of the office is large relative to the total to the space in the home it is more likely that the actual expense method will result in a greater deduction. Also, the actual expense method may produce a better result in the case of more expensive the homes (especially with offices in excess of 300 square feet) because of the relatively large amount of depreciation and insurance that will be allocated to the office under the actual expense method. Since the home office deduction does not vary much from year to year for most taxpayers, a taxpayer can decide whether or not to use the safe harbor method by making a quick comparison between the deductions for prior years and the deduction allowed under the safe-harbor method. However, in making this comparison, the home office deduction for a prior year using the actual expense method should be adjusted by removing the portion of the deduction attributable to taxes and interest since the taxpayer can separately itemize these amounts under the safe harbor method.
Taxpayers who rent are also less likely to benefit from the safe harbor since an allocable portion of rental expenses may be deducted under the actual expense method. Allocable rental expenses will usually be higher than allocable depreciation/tax/insurance deductions that could be claimed by a taxpayer that owns a residence.
7) Expiring Provisions After 2013
There are a total of 57 provisions that expire after 2013 as listed on the Joint Committee on Taxation website. Congress has been giving considerable attention to fundamental tax reform, and the issue will carry over to 2014. The regularly expiring provisions that expire at the end of 2013 got caught up in the tax reform debate, as many of the proposals would eliminate a significant number of targeted tax breaks, including many of the regularly expiring provisions, in exchange for lower rates. We may be well into 2014 before we know the fate of these expiring provisions, either allowed to expire without Congressional action, renewed as in past years, or significantly reduced or modified in the context of tax reform.