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President Signs American Taxpayer Relief Act of 2012
President Obama on January 2 signed the American Taxpayer Relief Act of 2012. The new law makes permanent Bush-era tax rates for individuals and couples with annual income of $400,000 and $450,000, respectively. The law also permanently indexes the alternative minimum tax for inflation, extends unemployment insurance benefits for one year and extends numerous business benefits. The law does not continue the 2012 reduction in employment tax rates from 6.2 percent to 4.2 percent.
For two years, employees have enjoyed a 2% reduction in the FICA payroll tax. That will all come to an abrupt end beginning with their first payroll check in 2013 when the FICA rate returns to 6.2% (up from 4.2% in 2011 and 2012). Self-employed individuals will have a corresponding increase in their SE tax.
The maximum wage subject to the FICA tax in 2013 is $113,700 (up from $110,100 in 2012). Thus, if you make $113,700 or more during the year, the result will be a $2,274 increase in payroll tax for the entire year, and each paycheck will be reduced by 2% of your pay until the maximum amount has been withheld. If you make less than the maximum, simply multiply your pay for the year by 2% to determine your tax increase.
Employees who made more than $110,100 in 2012 enjoyed a period of time with no FICA withheld, but FICA withholding will return at the full 6.2% rate with the first paycheck in 2013.
To make matters worse, as part of the Obamacare legislation, higher income taxpayers are faced with an additional 0.9% health insurance (HI) tax. Starting in 2013, this surtax is imposed upon wage earners and self-employed taxpayers whose wage and self-employment income exceeds $250,000 for married taxpayers filing jointly ($125,000 if filing separately) and $200,000 for all others.
Although each employer will withhold the additional tax, the employer is not required to account for other employment or both spouses working. Thus, in these situations when the total earned income exceeds the threshold amounts, the unpaid tax will have to be included on the 2013 tax return.
Example: John is a single individual who had two jobs in 2013. He earns $150,000 from one employer and $100,000 from the other. For the purposes of determining his liability for the extra 0.9% HI tax, his wages from both are added together, and to the extent that they exceed $200,000, he is subject to the additional 0.9% tax. Because he earned less than $200,000 from each employer, neither of them withheld any of the additional 0.9% tax. Because his total wages for the year were $250,000, John is liable for an additional $450 (0.009 x $50,000) in taxes when he files his 2013 tax return.
Example: A married couple, one earning $300,000 and the other $100,000, is subject to an additional tax of 0.9% of their combined incomes in excess of $250,000. In this case, that’s an additional 0.9% on $150,000 ($400,000 less $250,000). However, the spouse earning the $300,000 will already have had the additional tax withheld, so the amount of additional tax on their 2013 return will be $900 (0.009 x $100,000).
Employees in these situations may want to adjust their 2013 income tax withholding amounts or make estimated income tax payments to account for the additional tax. Self-employed taxpayers subject to the tax will need to increase their 2013 estimated tax payments to cover the additional amount.
Please give this office a call if you have additional questions.
For several years now, Congress has left the taxpaying public hanging to the last minute with tax changes and extensions. And each year, the political gridlock seems to get worse, leaving taxpayers pondering how to plan their finances and businesses undecided about capital investments and hiring new employees, not knowing what the tax laws will bring in the next year.
This year is even worse: It seems that our politicians are preoccupied with the elections and have put on the back burner a whole host of tax issues that have expired or are going to expire in the near future, once again leaving taxpayers in the dark and at risk of some substantial tax increases. There are more tax provisions expiring this year than ever before. In fact, if Congress does nothing, there will be a huge tax increase across the board affecting just about every taxpayer, rich and poor alike. Federal Reserve Chairman Bernanke referred to this problem as a “fiscal cliff.”
To understand the enormity of the problem, here is a rundown of a number of the more significant expiring provisions:
- Capital Gains Rates Increase - Beginning in 2013, the maximum capital gains rates will increase from the current 15% (0% for lower-income taxpayers; 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).
- Tax Rates (Brackets) Increase - Three fundamental changes will occur in 2013. (1) The 10% bracket will disappear (the lowest bracket will be 15%). (2) The size of the 15% tax bracket for joint filers and qualified surviving spouses will be 167% (rather than 200%) of the size of the 15% tax bracket for individual filers. (3) The top four brackets will rise from 25%, 28%, 33% and 35% to 28%, 31%, 36% and 39.6% respectively. This represents an across-the-board tax increase for all taxpayers.
- The 2011–2012 Payroll Tax Cuts Expire - This means that for 2013, the payroll and self-employment taxes will increase by 2% on all earned income up to $113,700. This will result in increases of up to $2,274 for working Americans.
- Education Benefits Take A Hit - After 2012, several education benefits will expire or be reduced, primarily impacting middle- and lower-income Americans.
o American Opportunity Education Credit – A tax credit that provides up to $2,500 for the first four years of post-secondary education, a portion of which is refundable. The Hope Education Credit will take the place of this credit, but it will be limited to the first two years of post-secondary education, providing a reduced maximum credit of $1,950, none of which is refundable.
o Coverdell Education Accounts – These will have their annual contribution cap reduced to $500 from the current $2,000 limit.
o Employer Education Assistance – This $5,250 tax-free employer-provided educational benefit expires after 2012.
o Student Loan Interest – This will only be allowed for the first 60 months in which interest is due and the deduction is phased out for most middle-income Americans. Previously there was no time limit for this deduction.
- Lower-Income Taxpayers Lose Benefits - The most significant changes taking place after 2012 include: The Child Tax Credit will be chopped in half to $500; the Earned Income Tax Credit bracket for taxpayers with three or more children will be eliminated; and the creditable expenses for the Child Care Credit will drop to $2,400 (formerly $3,000) for one child and $4,800 (formerly $6,000) for two or more children.
- "Obamacare" Taxes Kick In - Two taxes to fund Obamacare apply to higher-income individuals beginning in 2013.
o Surtax on Net Investment Income – The official name of this new tax is the “Unearned Income Medicare Contribution Tax.” It imposes a 3.8% surtax on the net investment income (interest, capital gains, rents, royalties and annuities) of individuals with incomes of $200,000 ($250,000 for joint filers) or more.
o Increased Hospital Insurance Tax – Currently a 1.45% payroll deduction, this will increase to 2.35% on wages in excess of $200,000 for unmarried individuals and $250,000 for married individuals filing jointly. The same increase applies self-employed individuals.
It is anticipated that some of the provisions discussed in this article will be extended when Congress finally gets around to it, but no one knows for sure which. However, it is important that you be ready for any eventuality, given that everything is in limbo at this time.
This office is closely following tax changes and is here to help you avoid any tax “fiscal cliffs” created by the ever-changing tax laws. Please call if you have questions or wish to do some year-end planning for yourself, or if family members or friends need assistance.
Uncertainty dominates year-end tax planning this year. Unless Congress acts, the Bush-era tax cuts will expire and bring higher tax rates and the loss of many deductions and credits starting in 2013. More individuals will be snared by the alternative minimum tax, which has not been patched for 2012 as it has for many years in the past.
Even with the uncertainty, there are actions you can still take before the end of the year that can save a considerable amount of tax. Not all actions recommended in this article will apply to your particular situation, but you will likely benefit from many of them. Maximize Education Tax Credits
- If you qualify for either the American Opportunity or Lifetime Learning education credits, check to see how much you will have paid in qualified tuition and related expenses in 2012. If it is not the maximum allowed for computing the credits, you can prepay 2013 tuition as long as it is for an academic period beginning in the first three months of 2013. That will allow you to increase the credit for 2012. Employer Health Flexible Spending Accounts
- If you contributed too little to cover expenses this year, you may wish to increase the amount you set aside for next year. As a reminder, you can no longer set aside amounts to get tax-free reimbursements for over-the-counter drugs, and the maximum contribution for 2013 is $2,500. Maximize Health Savings Account Contributions
- If you become eligible to make health savings account (HSA) contributions late this year, you can make a full year’s worth of deductible HSA contributions even if you were not eligible to make HSA contributions for the entire year. This opportunity applies even if you first become eligible in December. In brief, if you qualify for an HSA, contributions to the account are deductible (within IRS-prescribed limits), earnings on the account are tax-deferred, and distributions are tax-free if made for qualifying medical expenses. Roth IRA Conversions
- If your income is unusually low this year, you may wish to consider converting your traditional IRA into a Roth IRA. The lower income results in a lower tax rate, which provides you an opportunity to convert to a Roth IRA at a lower tax amount. State Income Taxes
- State income taxes paid during the year are deductible as an itemized deduction on your federal return. As long as pre-paying the state taxes does not create an AMT problem and you expect to owe state and local income taxes when you file your 2012 return next year, it may be appropriate to increase your withholding at your place of employment or make an estimated tax payment before the close of 2012, thereby advancing the deduction into this year. Advance Charitable Deductions
- If you regularly tithe at a house of worship, you might consider pre-paying part or all of your 2013 tithing, thus advancing the deduction into 2012. This can be especially helpful to individuals who marginally itemize their deductions, allowing them to itemize in one year and then take the standard deduction in the next. Pay Tax-deductible Medical Expenses
- For example, if you have outstanding medical or dental bills, paying the balance before year-end may be beneficial, but only if you already meet the 7.5% of the AGI floor for deducting medical expenses, or if adding the payments would put you over the 7.5% threshold. You can even use a credit card to pay the expenses, but you would only want to do so if the interest expense you’d incur is less than the tax savings. You might also wish to consider scheduling and paying for medical expenses, such as glasses, dental work, etc., before the end of 2012, since the medical floor is slated to increase to 10% of the AGI in 2013 for taxpayers under the age of 65. Don’t Forget Your Minimum Required Distribution
- If you have reached age 70-1/2, you are required to make minimum distributions (RMDs) from your IRA, 401(k) plan, and other employer-sponsored retirement plans. Failure to take a required withdrawal can result in a penalty of 50% of the amount of the RMD not withdrawn. If you turned age 70-1/2 in 2012, you can delay the first required distribution to the first quarter of 2013, but if you do, you will have to take a double distribution in 2013. Consider carefully the tax impact of a double distribution in 2013 versus a distribution in both this year and next. Take Advantage of the Annual Gift Tax Exemption
- You can give $13,000 in 2012 (increases to $14,000 in 2013) to each of an unlimited number of individuals, but you can't carry over unused exclusions from one year to the next. The transfers also may save family income taxes when income-earning property is given to family members in lower income tax brackets who are not subject to the kiddie tax. Avoid Underpayment Penalties
- If you are going to owe taxes for 2012, you can take steps before year-end to avoid or minimize the underpayment penalty. The penalty is applied quarterly, so making a fourth-quarter estimated payment only reduces the fourth-quarter penalty. However, withholding is treated as paid ratably throughout the year, so increasing withholding at the end of the year can reduce the penalties for the earlier quarters. This can be accomplished with cooperative employers or by taking a non-qualified distribution from a pension plan, which will be subject to a 20% withholding, and then returning the gross amount of the distribution to the plan within the 60-day statutory limit. Please consult this office to determine if you will be subject to underpayment penalties (there are exceptions), and if so, the best strategy to avoid or minimize them. Be Aware of Two New Health Care Taxes in 2013
- Both can have unexpected consequences. If you expect your 2013 income to exceed the thresholds at which one or both of the new taxes applies, and you are able to accelerate some of the income you anticipate for 2013 into 2012, it may be beneficial to do so.
- Additional Hospital Insurance Tax – This additional 0.9% tax is imposed upon wage earners and self-employed taxpayers starting in 2013 whose wages and self-employment income exceeds a threshold amount. The threshold is $250,000 for married taxpayers filing jointly ($125,000 if filing separately) and $200,000 for all others. Although each employer will withhold the additional tax, the employer is not required to account for other employment or both spouses working. Thus, in these situations where the total earned income exceeds the threshold amounts, the unpaid tax will have to be included on the 2013 tax return. Employees may want to adjust their 2013 withholding amounts or make estimated tax payments to account for the additional tax. Self-employed taxpayers subject to the tax will need to increase their 2013 estimated tax payments to cover the additional amount.
- Unearned Income Medicare Contribution Tax – Obviously, our politicians came up with the name. This is not a “contribution”; this is actually a 3.8% surtax on the lessor of a taxpayer’s net investment income or the excess of the taxpayer’s modified adjusted gross income in excess of the threshold amount, which is the same amount as for the additional hospital insurance tax explained above. This surtax would apply to home sale gain where the long-term gain substantially exceeds the $250,000 home-sale exclusion amount ($500,000 for joint filers). Withholding and estimated taxes should be increased as necessary to cover this “contribution.”
– There are additional factors to consider for a number of the strategies suggested above, and you are encouraged to contact this office prior to acting on any of the advice to ensure that your specific tax circumstances will benefit.
As the end of the year approaches, many are looking for ways to reduce their business profits before year’s end. Here are some possible moves that might apply to your situation. Self-employed Retirement Plans
- If you are self-employed and haven't done so yet, you may wish to establish a self-employed retirement plan. Certain types of plans must be established before the end of the year to make you eligible to deduct contributions made to the plan for 2012, even if the contributions aren’t made until 2013. You may also qualify for the pension start-up credit.Increase Basis
- If you own an interest in a partnership or S corporation that is going to show a loss in 2012, you may need to increase your basis in the entity so you can deduct the loss, which is limited to your basis in the entity. Hire Veterans
- If you are considering hiring some new employees between now and the end of the year, you might consider hiring a qualifying veteran so that you can qualify for the work opportunity tax credit (WOTC). The WOTC for hiring veterans in 2012 ranges from $2,400 to $9,600, depending on a variety of factors (such as the veteran’s period of unemployment and whether he or she has a service-connected disability). Purchase Equipment
- If you are in the market for new business equipment and machinery and you place them in service before year-end, you will qualify for the 50% bonus first-year depreciation allowance. Or, you can elect to expense up to $139,000 of the newly acquired items using the Sec 179 expensing allowance. The $139,000 expense limit is reduced by one dollar for every dollar in excess of the $560,000 annual investment limit. Purchase an SUV for Business
- If you are in the market for a business car, and your taste runs to large, heavy SUVs (those built on a truck chassis and rated at more than 6,000 pounds gross [loaded] vehicle weight), consider buying in 2012. Due to a combination of favorable depreciation and expensing rules, and depending on the percentage of business use, you may be able to write off most of the cost of the heavy SUV this year.
These are just some of the year-end steps that can be taken to save taxes. Please contact this office so we can tailor a plan to your particular needs.
Unless Congress extends it, the American Opportunity Tax Credit (AOTC) expires at the end of 2012, leaving only the Hope and Lifetime Learning credit for 2013 and subsequent years.
Where the AOTC provides a credit of up to $2,500 for qualified tuition and other related expenses for each qualifying student, the Hope credit maxes out at $1,950 (2013) and is only available for the first two years of post-secondary education. Up to 40% for the AOTC is refundable, while the Hope credit can only be used to offset tax liability, and any excess is lost. Both credits are phased out for higher-income taxpayers, although the Hope credit is completely phased out at $63,000 for single individuals ($127,000 for joint filers) in 2013, where the AOTC is phased out at much higher incomes ($90,000 for unmarried individuals and $180,000 for joint filers).
If the AOTC is not extended and the student(s) do not qualify for the Hope Credit, their tuition can still qualify for the Lifetime Learning credit, which is equal to 20% of up to $10,000 of qualified tuition and related expenses paid during the tax year. Unlike the Hope or AOTC, the Lifetime credit is calculated on a per-family basis, with a maximum annual credit of $2,000.
As a hedge against the loss of the AOTC, taxpayers can pre-pay qualified tuition and related expenses for an academic period that begins during the first three months of 2013 and claim them as expenses paid for purposes of calculating the AOTC in 2012. Care should be taken only to pre-pay enough of the expenses to maximize the credit in 2012 and preserve the remainder for 2013 in case the AOTC is extended or for computing the Hope or Lifetime Learning Credit in 2013.
If you would like discuss prepaying expenses to maximize the AOTC for 2012 or if you have questions related to education credits and deductions, please give this office a call.