You know the old saying, “If it wasn’t for the last minute, nothing would ever get done.”
Well, Congress passed the American Taxpayer Relief Act of 2012 (ATRA) in the nick of time on New Year’s Day, and President Obama signed it into law on January 2.
ATRA leaves income-tax rates where they were for 99 percent of households, while raising them sharply on the top 1 percent. Unfortunately, these new tax laws are the biggest income-tax increases in over 20 years for higher wage earners. At first glance, ATRA appears simple. In terms of income tax, for example, only the highest tax rate in 2012 — the 35 percent tax bracket — increased in 2013, to 39.6 percent, and that applies only to taxable income starting at $400,000 for singles and $450,000 for married couples.
However, don’t get comfortable too soon. Your 2013 marginal tax rate may be much higher than you expect. Phase-outs of tax benefits are one cause. They actually are stealth rate increases, pushing your marginal tax rate above the 39.6 percent bracket in the new law.
The first change is a phase-out of itemized deductions. The next change is the loss of personal exemptions, which adds on as much as 1.05 percent per exemption to your true tax rate. ATRA lowers deductions and trims personal exemptions for those with AGI over the $250,000/$300,000 thresholds.
Two other brand-new taxes for 2013 can also increase your marginal rate. The first is the additional 0.9 percent Medicare surtax on earned income over $200,000 for singles or $250,000 for couples. The next new tax is the additional Medicare surtax of 3.8 percent on taxable interest, dividends (both qualified and nonqualified), rents, royalties and capital gains. This affects those at the same AGI thresholds.
What to do? Reduce your AGI, which reduces exposure to these surtaxes or stealth tax increases, by focusing on finding as many above-the-line deductions as possible. Some of these include taking only the required RMD from IRA accounts, using certain tax-advantaged investments like municipal bonds and life insurance, which avoid or defer taxation, realize capital losses and sell real estate or business property that have unrealized losses, and maximize 401k and IRA contributions. Remember, you can always marry someone who has large capital loss carry-forwards, or has large net-operating losses. Sometimes we have to choose laughter over tears when the taxman comes around.
— Brian Gibbs is a 34-year veteran retirement and tax planning specialist, and CEO of Heritage Retirement Advisors in Rancho Bernardo. He can be reached at (858) 487-1111 or at firstname.lastname@example.org.