With the Healthcare Act and The American Taxpayer Relief Act of 2012, most business owners are confused about what the current tax law actually is. Keeping track of the constantly changing tax code and how to apply the new rules is difficult for many tax preparers, so the confusion of business owners is quite understandable. Today, I will summarize the top tax rule changes for 2013.......so let's dive in.....
Everybody's Taxes Increase
The social security portion of the payroll tax increased back to 6.2% from 4.2%. The tax was dropped temporarily to spur the economy in 2010, but the tax cut has expired and it has returned to its original rate. This increase will be felt in the economy as money available for spending is reduced. In my view, reducing the money going into social security is not good policy, but it was one way to get money into peoples hands so they could spend it and help boost the economy. Whether it worked or not will be debated by Republicans and Democrats alike, but the reduction in funds to Social Security will have to be made up eventually with some kind of tax hike or benefit reduction.
Tax Increases on the Wealthy
New Top Marginal Rate
There is a new top marginal rate. For married filers who have adjusted gross income over $450,000 and single filers with over $400,000 in adjusted gross income, the rate increased from 35% to 39.6%. This does not impact the majority of the US tax payers, but it certainly impacts the successful small business owner. They will make it up by increasing prices or decreasing the amount they spend. I see this as the beginning of more tax increases.
Phase out of Itemized Deductions
The phase out of itemized deductions was a result of the expiration of the Bush Tax cuts. The American Taxpayer "Relief" Act of 2012 only increased the threshold at which the phase out begins. The phase out for itemized deductions reduces total itemized deductions by 3% of excess income over a threshold. The threshold amounts are now an Adjusted Gross Income of $300,000 for married filers, and $250,000 for individuals. This is just an additional tax increase on the "wealthy".
Phase Out of Personal Exemptions
The phase out of personal exemptions, was also a result of the expiration of the Bush Tax cuts. The threshold for the phase outs is the same as that for itemized deductions. According to my calculations, the net impact of the itemized limitations and the personal exemptions can increase the marginal tax rate by 2%.
Increase in Long Term Capital Gains and Qualified Dividends
There are four tax brackets for Long Term Capital Gains and Qualified Dividends and the rates aren't what most think they are. For married filers who have adjusted gross income over $450,000 and single filers with over $400,000 in adjusted gross income, the rate will be 23.8%. For married filers who have adjusted gross income over $250,000 and single filers with over $200,000 in adjusted gross income, the rate will be 18.8%. For married filers who have adjusted gross income under $72,500 and single filers with under $36,250 in adjusted gross income, the capital gains rate will be 0%. For everyone else, the rate will be 15%.
Common media headlines just remind us that capital gains tax rates went up to 20% but the reality is they have gone up and additional 3.8% as a result of the Medicare tax on investment income that went into effect as a result of the Healthcare Act.
The Forgotten Payroll Tax Increase
The Healthcare Act increases the Medicare portion of the payroll tax on married filers who have wages over $250,000 and single filers with wages over $200,000 by .9%. For example, if a single employee has wage income of $300,000, the employer would withhold from the employees wages a 1.45% Medicare tax up to the $200,000 threshold and 2.35% after that. Another tax increase on the "wealthy".
Tax on Net Investment Income
As I mentioned above in the discussion of tax increase on Long Term Capital Gains and Qualified Dividends, there is a 3.8% increase on net investment income. According to the IRS, net investment income includes, but is not limited to: interest, dividends, capital gains, rental and royalty income, non-qualified annuities, income from businesses involved in trading of financial instruments or commodities, and businesses that are passive activities to the taxpayer. To calculate your net investment income, your investment income is reduced by certain expenses properly allocable to the income. This 3.8% tax will impact many of our clients with rental real estate.
Tax Breaks for Small and Medium Size Businesses
Section 179 Depreciation and Bonus Depreciation
Section 179, which provides for the immediate expensing of qualifying assets, was scheduled to decrease to $25,000 in 2013. The fiscal cliff deal changed all of that, increasing the limit to $500,000 for 2013. Also, the amount of qualifying assets that can be placed in service before a reduction in the limitation is required is $2,000,000 in both years. This is a significant tax break for startup businesses and expanding businesses.
Bonus depreciation was scheduled to come to an abrupt end in 2012, but it has been extended for one more year. The 50% bonus depreciation rule is back for one more year. New equipment qualifies for bonus depreciation but with the expanded Section 179 election, the bonus depreciation will only be used for those businesses that purchase over $500,000 in equipment or have items such as tenant improvements that do not qualify for Section 179 but qualify for bonus depreciation.
So What is Next?
Everyone is seeing an increase in taxes in 2013. Those who make over $200,000/$250,000 are seeing a larger share of their taxes increase. The next two months will have a lot of political fighting over increasing the debt limit for our nation. This fight will be about spending and taxes. President Obama has pledged no cuts to spending without a corresponding increase in taxes. So more potential changes are coming.