On January 1, 2013, the American Taxpayer Relief Act (ATRA) of 2012 was passed by the United States Congress, and was signed into law by President Barack Obama the next day.
Highlights of the Act include but not limited to the following:
Income tax rates. Individual income tax rates will remain at 10%, 15%, 25%, 28%, 33% and 35% with only individuals earning more than $400,000 ($450,000 for joint filers) subjected to the higher rate at 39.6% for income above that threshold.
Capital gain and qualified dividend rates. Taxpayers in the 35% and lower tax bracket continue the 15% rate. Lower income earners in the 10% and 15% tax brackets will have a 0% rate. Individuals earning more than $400,000 ($450,000 for joint filers) will pay a 20% tax on capital gains and qualified dividends. With the new 3.8% Medicare surtax on net investment income, the maximum rate will effectively increase to 23.8% for many higher-income payers. More on the 3.8% Medicare surtax later in this update.
Itemized deduction (Pease) and personal exemption phase (PEP) outs. The “Pease” (named after Senator Pease) limitation on itemized deductions was reinstated, affecting individuals making $250,000 ($300,000 for joint filers). This provision reduces the total amount of itemized deductions by 3% of the amount that adjusted gross income (AGI) exceeds the threshold amount. The reduction cannot exceed 80% of the otherwise allowable deductions. Personal exemptions are reduced by 2% for each $2,500 of AGI over the $250,000 for single filers and $300,000 for joint filers. Exemptions are totally phased out when AGI exceeds $372,500 for single filers and $422,500 for joint filers.
Permanent alternative minimum tax (AMT) relief. ATRA permanently increased the AMT exemption amounts to $51,900 for single filers, $80,750 for joint filers, and $40,375 for married filing separately. The exemption amounts will automatically increase in future years based on the rate of inflation.
Payroll tax holiday ends. The two-year old payroll tax holiday was not extended. This now returns the employee’s portion of FICA tax to 6.2% from the reduced 4.2%.
Estate and gift tax rates. Estate tax exemptions were increased to $5,250,000 per person and indexed for inflation using 2011 as the base. Prior to passing ATRA, the exemption amount was set to decrease to $1 million, with the top tax rate increasing to 55%. By passing the Act, Congress permanently increased the estate tax exemption and unified the exemptions from gift tax and generation-skipping transfer tax (“GST Tax) at the same amount with a top tax rate of 40%. The annual gift tax exclusion increases to $14,000 per donee. Portability of the estate tax exemption between spouses was renewed.
Social Security and Medicare. The wage base increased to $113,700 for 2013 ($110,100 in 2012). Also, benefits increased by 1.7% in 2013. The basic Medicare Part B premium increased to $104.90 per month. The Part B and D premiums are higher for upper income individuals if their modified adjusted gross income (MAGI) for 2011 exceeded $170,000 for couples or $85,000 for single individuals. MAGI is AGI plus tax exempt interest, EE bond interest used for education, and excluded foreign earned income. The total surcharges on upper income recipients can be as large as $297.40 a month per person.
Additional changes in tax rules for 2013 that were not finalized until January 1, 2013, included the following:
The Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act of 2010 imposed the following new taxes effective for years beginning on January 1, 2013:
Effective January 1, 2013 is the 3.8% Medicare surtax on net investment income. It applies to unearned income for single filers and heads of household who have MAGI above $200,000. For joint filers the tax applies to unearned income if MAGI is over $250,000. Investment income includes interest, dividends, capital gains, annuities, royalties and passive rental income. Tax free municipal bond interest and retirement plan distributions are not included in the definition of investment income.
Effective January 1, 2013 is a 0.9% Medicare surtax on earned income. The surtax applies to wages and self-employment income. It applies to single filers and heads of household when total earnings exceed $200,000 and $250,000 for joint filers. For earnings over the threshold, the effective Medicare tax will be 3.8%, the usual 2.9% tax rate, plus an extra 0.9%. The surtax only applies to the employee’s share of tax. Employers do not owe it. Employers will withhold the surtax once an employee’s wages exceed the threshold amounts. Employees will then calculate the actual tax due on their Form 1040.