New year brings new tax changes; are you ready?

What are the key points of the new tax law that was enacted?
Nervousness over the potential of falling off the oft-publicized “fiscal cliff” was averted when the American Taxpayer Relief Act of 2012 (ATRA) was approved by the House and Senate and signed into law by President Obama. The legislation addressed and resolved most of the tax uncertainty that made year-end tax planning for 2012 so difficult for many people. Unfortunately, however, the final resolution of issues related to spending cuts and the debt ceiling was delayed.

ATRA allows the Bush-era tax rates to rise after 2012 for individuals with incomes over $400,000 and joint filers with incomes over $450,000. Taxable income above these levels will be subject to an income tax rate of 39.6%, up from the 2012 maximum rate of 35%. For example, a married couple with taxable income of $600,000 will pay an additional $6,900 of federal income tax due to the change. In addition, those high-income taxpayers will also be subject to an increase in capital gains and dividend taxation. ATRA uses the same income threshold to apply a new, higher rate of 20% on capital gains and dividends, as opposed to last year’s maximum of 15%. A taxpayer with $10,000 in capital gains and $10,000 in dividend income will pay an additional $1,000 in federal income taxes.

Other key individual tax provisions in the legislation that are generally effective for 2013 include:

• Itemized deductions will be reduced by 3% of the excess of adjusted gross income (AGI) over $300,000 (joint), or $250,000 (single). In addition, itemized deductions cannot be reduced by more than 80%. Here, a couple with $40,000 in itemized deductions and AGI over $450,000 could pay an additional tax of $6,200.

• Personal exemptions will also be reduced for those with AGI in excess of $300,000 (joint) and $250,000 (single). The reduction is 2% for each $2,500 of AGI in excess of these threshold amounts. This means that exemptions are reduced to zero if AGI exceeds $425,000 (joint) or $375,000 (single). A couple with two dependent children and AGI above $450,000 could end up paying additional taxes of $6,200.

• The employee portion of Social Security withholding tax increases from 4.2% to 6.2%. This increase also applies to those subject to the self-employment tax.

• The estate tax exemption remains at the 2011 level of $5 million, adjusted for inflation, bringing the 2013 exemption rate up to $5.25 million. However, the top estate tax rate increases from 35% to 40%.

• The alternative minimum tax (AMT) exemption was increased to $50,600 for single taxpayers and $78,750 for joint filers, with an annual inflation adjustment to the exemption amounts for years beginning after 2012. The 2013 AMT exemption amounts are projected to be $51,900 (single) and $80,750 (joint).

Additionally, the legislation includes a permanent extension of an expanded adoption credit, permanent extension of an expanded dependent child care credit, a 2-year extension of the state sales tax deduction in lieu of deducting state income taxes, and a 2-year extension of the ability for taxpayers over age 70½ years to make charitable donations of up to $100,000 of assets from an individual retirement account.

The legislation did not affect the Medicare tax surcharge on earned income or the 3.8% net investment income tax that applies to those with modified adjusted gross income in excess of $250,000 (joint) or $200,000 (single). These taxes were added by the Affordable Care Act and apply beginning in 2013.

While ATRA is intended to bring some certainty to the tax code, it also at the same time sets the stage for comprehensive tax reform, possibly later in 2013. Be sure to consult with your tax adviser to determine ATRA’s impact on your own specific situation.

Are there any new limits for retirement plan contributions for 2013?
Some limits were changed and others were not. Here are the highlights:

• The elective deferral (contribution) limit for employees who participate in 401(k), 403(b), and most 457 plans increases to $17,500 from $17,000.

• The catch-up contribution limit for those age 50 years and older remains unchanged at $5,500. The overall limit for defined contribution plan deferrals from all sources (employer and employee combined) increases to $51,000 per participant from $50,000.

• The amount of employee compensation limit that can be considered in calculating contributions to defined contribution plans increases to $255,000 from $250,000.

• The limit used in the definition of a key employee in a top-heavy plan remains unchanged at $165,000.

• The limit used in the definition of a highly compensated employee for 401(k) non-discrimination testing purposes remains unchanged at $115,000.

Joel M. Blau, CFP, is president and Ronald J. Paprocki, JD, CFP, CHBC, is chief executive officer of MEDIQUS Asset Advisors, Inc. in Chicago. They can be reached at 800-883-8555 or blau@mediqus.com or paprocki@mediqus.com.