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.