The American Taxpayer Relief Act of 2012, signed into law on Jan. 2, 2013 to avert the fiscal cliff, will have a profound and permanent effect on our taxes.
Most wage earners will see their payroll taxes increase in 2013. Most retirees will not be affected by the new tax law.
Unmarried taxpayers who have $250,000 or more of income who itemize, and married taxpayers filing jointly with $300,000 or more of income who itemize will see an income tax increase as the personal exemption and itemized deductions are phased out.
The maximum income tax rate will increase from 35 percent to 39.6 percent for incomes above $400,000 (single) and $450,000 (joint filers). However, for taxpayers who have less than $250,000 of income (single) and $300,000 (joint filers), incomes tax rates remain unchanged, as the Bush tax cuts continue for them.
Payroll Taxes. The payroll tax holiday of last year will not be extended. Therefore, the payroll tax rate will revert to the pre-2011 level of 6.2 percent for all wage earners. In addition, the new .9 percent health care tax on wages starts on Jan. 1 for single taxpayers earning $200,000 or more and joint filers earning $250,000 or more.
Tax Incentives Extended. Many tax incentives that were to sunset on Dec. 31 were extended under the new tax law, such as the marriage penalty relief, IRA transfer to charity exemption, the AMT exemption, child tax credit, earned income credit, college spending incentives, and others.
Estate Taxes. As a compromise to the Republicans, President Obama agreed to a larger-than-expected estate and gift tax exemption of $5.25 million, which will continue without a sunset and be indexed for inflation.
This means that a single person can pass on after death $5.25 million to children or other loved ones estate-tax free, and for married couples the estate-tax free amount is twice that amount, or $10.5 million. Portability under the 2012 estate tax law is continued under the new law and made permanent.
Under portability, the unused portion of a deceased spouse's estate tax exemption can be used by the surviving spouse against gifts and testamentary transfers.
As a result of these changes, few of us will need to worry about estate taxes, meaning that planning will concentrate on income tax strategies for high earners.
Gift Taxes. The gift tax lifetime exemption is also $5.25 million in addition to the new $14,000 annual exclusion from gift tax for 2013. As a result of the $5.25 million estate tax exemption, tax-motivated annual gifts to loved ones of $14,000 or less, and gifts to charity will be less attractive.
The stepped-up tax basis rules for capital assets, such as land and stocks, received upon death were unaffected by the new tax law.
This means that with the estate tax exemption at $5.25 million, lifetime gifts of capital assets with a low carry-over tax basis will be less attractive.
Impact on Estate Planning. For married clients who have A/B trusts and assets under $5.25 million, they can either redo their estate plan as a single joint marital trust or change each spouse's A/B trust into a separate all-to-surviving spouse trust. The second option is simpler than the first option because it does not involve retitling of assets.
For persons with assets exceeding $5.25 million, the A/B Trust and other estate tax reduction strategies should still be considered.
However, for these wealthier taxpayers, portability of the unused portion of the deceased spouse's exemption will reduce the usefulness of A/B trust planning.
Capital Gains and Dividend Rates. Higher income taxpayers will also see an increase in capital gains and dividend rates from 15 percent to 20 percent.
The thresholds are $400,000 of taxable income for single and $450,000 of taxable income for joint filing taxpayers.
Moreover, the taxpayers above these thresholds will also have to pay the new 3.8 percent health care surtax on net investment income, which includes capital gains and dividends, meaning that their capital gains and dividends rate will actually be 23.8 percent (20 percent plus 3.8 percent).
However, for the taxpayers below these thresholds, capital gains and dividend rates remain at a low 15 percent.
The game is not over; more tax law changes are expected later this year.
Editor's note: Robert C. Anderson is an attorney who is based in Marquette.