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Preparing For The Tax Law Changes In 2013

Updated on March 2, 2013

Tax Changes

The topic of taxes is always one which is greatly debated from both a political as well as an economic perspective. Regardless of one’s political persuasion on such issues, one constant always remains the same. We each do all that we can to avoid paying these taxes, hopefully within the limits of the law. With the end of the 2012 elections it is still a bit difficult to be prepared as there are numerous changes set to take place on an automatic basis, and other still being negotiated.

The tax code has various aspects that affect the individual as well as corporate entities. All changes to the tax code affect every one of us at least indirectly, if not directly. But let’s have a look at the pending changes for 2013 assuming no legislative action so we can be better prepared.

Taxes on Investments & Savings…Starting in 2013 as part of the Health Care and Education Reconciliation Act you must add a new 3.8% Medicare tax on all of your investment income. This includes interest from the bank, dividends, capital gains, rental income & royalties. These are sources of income which the IRS describes as "unearned income" sources. However, the tax is a bit more complicated. This new surtax is 3.8% of the lesser of the taxpayer’s net investment income; or excess of adjusted gross income (AGI) over the "threshold amount." (The threshold amount is $200,000 for single filers; $250,000 for married filing jointly; and $125,000 for married filing separately.) For Example...In the case of a home sale, the captial gain on the sale increases the AGI by the amount of the gain. The gain is added to other income sources and if it totals more than the threshold, you are subject to the tax. As a result of the new taxes on investment income, it is important that going forward you note the term "AGI". This makes maximizing tax shelters like 401k/403b plans and other employer sponsored plans more important. Contributions to these plans bring down the AGI. This may also make 2012 a good year under certain circumstances to realize some capital gains on investments you were considering selling to capture the lower tax rate and accelerate the selling. Additionally, tax loss harvesting strategies will become more important as a result of this new tax on investment income. To understand some more basic strategies on tax loss harvesting read below.

Capital Gains…The current rate on long capital gains tax is a maximum of 15%. For those in lower income ranges it is currently lower than that. The new rate on long term capital gains will be 20%. This includes the long term capital gain distributions commonly paid out to holders of mutual fund positions. This again reinforces the need to focus on tax loss harvesting strategies. The new rate will be 20% plus another 3.8% for the new healthcare tax for those over the threshold for a combined 23.8%. Also keep in mind that those subject to AMT may also pay higher rates on capital gains.

Qualified Dividends…This is a potential big change for many investors. Many investors utilize dividend income as a source to supplement their retirement income. In some cases the yield of a dividend may be what induced the individual to purchase the security even without the need for income. There is certain criteria a company must meet to achieve the definition of “Qualified Dividends”. Such dividend payments impact not only stock holdings but also a portion of payments received by mutual fund holdings. Currently those in lower income brackets below 15% pay ZERO. Those in personal income tax ranges over 15% actually pay 15% on qualified dividends. Beginning in 2013 the rules revert back to pre-2003. This means those individuals in the 15% or lower bracket will pay 10% rather than ZERO on qualified dividends and those above 15% will pay 20% on the same dividends. Keep in mind the Presidents proposed 2013 budget had an increase on dividend income to as high as the maximum marginal income tax rate for 2013 of 39.6%. When you add in the Medicare tax increase mentioned above, that would have brought you to a whopping 43.4%. Keep in mind this additional increase was part of a tax proposal that was NOT passed. However with the 2012 elections now over this is an important one for investors to keep an eye on. Should dividend tax rates reach that high of a level, it would be prudent to rethink your investment strategy and potentially introduce more tax free municipal securities to avoid the impact.

Healthcare Expenses…Currently if you have health care out of pocket expenses, it is not deductible unless it exceeds 7.5% of your AGI. For individuals whom are subject to the Alternative Minimum Tax (AMT) the phase out is 10% of their AGI. Beginning in 2013 the expense must exceed 10% of AGI for all those under age 65.

Flexible Spending Accounts…The maximum contribution to these will be reduced in 2013 to $2,500.00.

Basic income tax Rates…There are numerous aspects to what affects your Federal income marginal tax rate. But as it stands now, the current marginal rates will be increased accordingly. There are 6 tiers to the current marginal income tax rate schedule. Currently they are 10%, 15%, 25%, 28%, 33%, & 35%. Beginning in 2013 they will collapse into a 5 tier system of 15%, 28%, 31%, 36%, & 39.6%. Additionally, employers are required to withhold an additional 0.9% on employee's wages in excess of the threshold amounts referenced earlier.

Estate Taxes…For many investors this is not a concern. The current phaseout is an exclusion of the first $5,120,000.00 of one’s estate. However, beginning in 2013 the phase out drops to just $1,000,000.00 of their remaining estate. While this may seem like a lot of money, consider the totality of your taxable estate is not only you liquid assets. But your home, personal possessions and life insurance proceeds. Any amount in excess of the $1,000,000.00 phaseout is set to be taxed at 55%. It is important to see how congress and the president address these changes and make sure your estate plan is prepared to maneuver around the potential impact.

Gifting…The current estate planning phaseout's mentioned above are identical to the changes in the gift tax rules. The maximum lifetime gift is currently $5,120,000.00 and will be reduced to $1,000,000.00 beginning January 2013. However the gift tax rate is assessed differently.

Generational Skipping Tax (GSTT)...Like the new estate tax rate, the new GSTT rate will increase to 55% with a new lifetime exemption being dropped to $1,000,000.00

Step up in basis...There will be no limit to a step up in cost basis on inherited assets for the purpose of capital gains as there was in 2010. This is set to be unlimited.

There are various other changes set to expire to prior levels such as the AMT patch. These are just a few items to keep an eye on that may affect the individual investor. Tax planning is an important part of the financial planning process that should include your financial advisor, tax advisor and estate attorney working on your behalf. The tax law is in a constant state of change and you the taxpayer are the target. While you should always stay within the guidelines of the law, that doesn’t stop you from becoming a moving target.


Numerous aspects of the 2013 tax code have now been made permanent. For an updated look please view the following hyperlink.


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