Tax Rate Update

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For the past several years, year-end tax planning has been a challenge for so many people.  Trying to anticipate whether Congress will act to extend some or all of the Bush tax cuts has been the cause of many a sleepless night for tax advisors.  The HIRE Act had small business in an uproar over the possibility of expanded reporting requirements on Form 1099.  Not only would businesses have to report payments to service providers and a few other limited transaction types, they would have been required to report on product purchases, as well.  Then came the Patient Protection and Affordable Care Act (Obamacare).   In this mammoth piece of legislation, we are seeing a series of new taxes that are to be implemented over several years.  As with the ultimate repeal of the expanded Form 1099 reporting in the HIRE Act, there is afoot an effort to repeal some of the new taxes from Obamacare.  Success in repeal will more than likely be far less successful.

THE RUNDOWN:

Bush Tax Cuts – The inevitability of the Bush tax cuts has to be that taxes will go up, whether 1) it is across the board, because Congress again will not come to an agreement or 2) They do agree and extend the cuts for taxpayers in all but the highest bracket.  Following is a comparison of the tax brackets, with and without the Bush cuts:

  Current After Lapse
Wages 10% 15%
  25% 28%
  28% 31%
  33% 36%
  35% 39.6%
     
Qualified Dividends 15% Taxpayer’s Highest Marginal Wage Rate
     
Capital Gains 0 or 15% Maximum 20%

In addition, the Child Tax Credit will drop from $1000 to $500 per child, and the Personal Exemption phase out will be reinstated on income above $122,500.

Obamacare – Following are the tax increases slated for implementation under this legislation for tax year 2013:

Medical Device Manufacturers – This one is similar to the infamous tanning bed tax.  It is a 2.3% excise tax that will be imposed on sales by manufacturers of medical devices.  This, in effect, acts like a national sales tax, because it is imposed on the gross receipts of a transaction regardless of the profitability of the company.

Medical Expense Deduction – The longstanding deduction for unreimbursed medical expenses that exceed 7.5% of your adjusted gross income will now be limited to amounts that exceed 10% of adjusted gross income.   The increase does not apply to taxpayers over the age of 65, until the year 2016.

Flexible Spending Accounts (FSA) – If your company has an FSA, through which you can contribute pre-tax dollars for otherwise unreimbursed medical expenses, those contributions will be limited to $2500.

Investment Income Surtax – For households earning greater than $250,000 per year ($200,000 for single taxpayers), there will be a 3.8% surtax on the lower of investment income or income that exceeds the aforementioned earnings.  Generally speaking, investment income consists of interest, dividends and capital gains.  Keep in mind the above discussion regarding the lapse of the Bush tax cuts.  If the Bush tax cuts lapse, high income taxpayers’ tax rates on dividends and capital gains could be 43.4% and 23.8% respectively.

Medicare Payroll Tax – Currently, wage earners and self-employed taxpayers are subject to the Medicare tax, alongside the Social Security tax.  Beginning in 2013, those with wage or self-employment earnings greater than – you guessed it – $250,000 married ($200,000 single) will see the overall Medicare tax increase from 2.9% to 3.8%.

Other – The Payroll tax holiday is over, as well.  For the past two years, everyone subject to the Social Security tax has seen their share of Social Security contributions decreased from 6.2% to 4.2%.  Beginning in 2013, the 6.2% rate will be reinstated.

One good thing is that the 401K contribution limitations will increase from $17,000 to $17,500 and the catchup provision for taxpayers age 50 and over will increase from $5,000 to $5,500.  I presume this is of little consolation, given the rest.

TAKEAWAY:
This year could finally be the time to accelerate earnings at year end, the antithetical plan from what tax practitioners have advised for many years.