We try to cover topics that are relevant and interesting to our clients, but sometimes we need to relay information that is very relevant, but not very interesting to people who don’t crunch numbers for a living.  This is one of those articles that covers the upcoming changes to the tax code that is relevant to all of our clients, and basically includes information that you need to be aware of.

Throughout the recent election there was a lot of discussion and information regarding upcoming changes to the tax code.  While we don’t know what new laws will be passed in the coming months that might impact us, we do know that with no action by Congress many changes will take place at the end of this year due to the expiration of ‘temporary’ tax cuts that were put in place several years ago. 

Below is a summary of items that we expect to affect many of our clients.  But, before you get bored reading the details I will give you an example of what people really want to know.  How will this affect my taxes?

A married couple who has $150,000 of income after deductions that affect their AGI (Annual Gross Income) would have paid federal income tax of $25,000 in 2011.  Due to deductions increasing for inflation for 2012 their tax liability would go down to $24,685 so they would see a slight reduction.  However, if there is no bill passed to fix the alternative minimum tax their tax liability for 2012 will go up to $27,300 – a $2,300 increase.  For 2013, if all of the tax cuts are allowed to expire they will see a federal tax increase of $4,500 to $29,500 due to the change in the tax brackets, standard deductions and tax rates discussed below.  If they were deducting student loan interest or have children under the age of 17 their tax increase will be even greater.

Now here is the summary of the upcoming changes after the tax cuts that were put in place 10 years ago expire:

Tax brackets (Code Sec. 1(f), Code Sec. 1(i)). Three fundamental changes occur:

  1. The 10% bracket disappears (the lowest bracket is 15%).
  2. The size of the 15% tax bracket for joint filers & qualified surviving spouses is 167% (rather than 200%) of the 15% tax bracket for individual filers.
  3. The top four brackets rise from 25%, 28%, 33% and 35% to 28%, 31%, 36% and 39.6%.

Taxation of capital gains and qualified dividends (Code Sec. 1(h)). Long-term capital gain is taxed at a maximum rate of 20% (18% for assets held more than five years). For lower-income taxpayers, the maximum rate will be 10% (8% for assets held for more than five years).

Dividends paid to individuals are taxed at the same rates that apply to ordinary income.

Above-the-line student loan interest deduction (Code Sec. 221). The deduction (1) phases out over lower modified adjusted gross income (AGI) ranges and (2) applies only to interest paid during the first 60 months in which interest payments are required.

Standard deduction (Code Sec. 63). The standard deduction for married taxpayers filing jointly (and qualified surviving spouses) is 167% (rather than 200%) of the standard deduction for single taxpayers.

Reduction in itemized deductions (Code Sec. 68). Most itemized deductions of higher-income taxpayers are reduced by 3% of AGI above an inflation-adjusted figure, but the reduction can’t exceed 80%.

Phaseout of personal exemptions (Code Sec. 151(d)). A higher-income taxpayer’s personal exemptions are phased out when AGI exceeds an inflation-adjusted threshold

Credit for household and dependent care expenses (Code Sec. 21). Creditable expenses drop from $3,000 (1 qualifying individual) and $6,000 (2 or more) to $2,400 and $4,800, respectively. The maximum credit percentage drops from 35% to 30%, and the AGI-based percentage reduction begins at $10,000 (instead of $15,000).

Child credit (Code Sec. 24). The maximum credit drops from $1,000 to $500 and the credit is not allowed against AMT. Also, more restrictive rules apply to the refundable child credit.

Accumulated earnings tax rate (Code Sec. 532) and personal holding company tax rate (Code Sec. 541). Both rise from 15% to 39.6%.

Estate tax (Code Sec. 2001 et seq.). The principal changes are as follows: The top rate is 55%. A 5% surtax on the wealthiest of estates phases out the benefit of graduated rates, with (1) a unified credit exemption equivalent of $1 million, (2) a reinstated Code Sec. 2057 deduction for family-owned businesses, and (3) a credit against State death taxes.

Generation skipping transfer (GST) tax (Code Sec. 2631). The GST tax is reinstated, with a top rate of 55%, and the GST exemption amount is set at $1 million (plus inflation adjustment).

Gift tax (Code Sec. 2505). The top rate increases to 55%.

The above changes will affect every US citizen who has taxable income next year.  For the current year the looming uncertainty that we have dealt with every year is the alternative minimum tax.  This tax was meant to keep the wealthy from using too many tax deductions but as tax laws changed the rules for alternative minimum tax have been kept the same.  Every year for a number of years rather than make permanent changes to the law Congress has passed a year end bill that retroactively ‘fixed’ the issues with the law that caused it to apply to couples with income as low as $45,000.  We anticipate that at some time between now and the time for filing tax returns we will once again see a bill passed to change the AMT retroactively for 2012 but this as always makes tax planning a challenge when you are trying to make decisions prior to year end and have to hope that a bill will be passed to change the current law.

If you have questions regarding the above please don’t hesitate to contact us or contact your tax advisor.