H&R Block experts answer top tax questions
2013: Year of tax hikes?
With the Bush-era tax cuts set to expire at year end, some individuals and businesses could face major increases and a new level of tax complexity.
Unless Congress takes action, 2013 will bring the highest tax rates that Americans have faced in more than a decade. Tax rates on many types of income — from work earnings to dividends and long-term capital gains — are scheduled to rise. And the value of some deductions and tax credits available to individuals and businesses are going to be reduced or even disappear, in some cases.
H&R Block tax experts Jackie Perlman, CPA, and Lindsey Buchholz, JD and LLM, recently answered questions about possible changes for 2013, the election’s impact and moves to consider with your financial and tax advisors.
Q: How likely are taxes to rise next year?
A: Unless Congress passes legislation to extend the current tax breaks, or enacts a new law, tax rates will go up for most Americans in 2013. Clearly, the outcome of the November election — which party is in the White House and controls each chamber of Congress — will play a key role in deciding what taxes will look like in 2013 and beyond. In any case, we may see a short-term extension of the current law during the "lame-duck" Congressional session.
Q: What are the possible tax changes that consumers need to be ready for in 2013?
A: If Congress doesn’t act, tax year 2013 will see the sunset of the Bush-era tax cuts. This would entail:
- Higher income tax rates: The lowest bracket (10%) being eliminated; the highest two brackets increasing from 33% and 35% to 36% and 39.6%, respectively.
- Higher capital gains rates: The top net long-term rate generally increasing from 15% to 20%.
- Dividends being taxed at ordinary rates instead of qualifying for the lower capital gain rates.
- Personal exemptions and itemized deductions being phased out for higher-income taxpayers.
- The "marriage penalty" returning: Married working couples paying higher taxes than two single working individuals with the same income.
Q: How much of a tax increase could investors see?
A: Here’s an example: Let’s say a married couple, filing jointly, has income — whether from work, retirement plan distributions, or other ordinary income sources — of $275,000, plus $10,000 in qualified dividends and $15,000 in long-term capital gains. In 2012, their federal tax would be just under $65,000. In 2013, they would pay more than $76,000 on the same income, plus the additional 3.8% tax discussed below. They would also lose some of their personal exemptions.
Another issue for this couple is the alternative minimum tax (AMT), which could affect their 2012 tax return. Since 2001, Congress has provided a "patch" every year that protects many couples from paying the AMT. But that patch expired and, so far, there’s not one for 2012. Just a short time is left to retroactively extend that patch or this hypothetical couple would end up paying about $10,000 more for AMT in 2012, bringing total taxes paid for 2012 to about $75,000. Ironically, they would not have an AMT issue in 2013 because their regular tax would be higher than the AMT.
Q: The federal health care reform law, upheld by the Supreme Court in June, includes some new taxes. Can you explain them?
A: Two key provisions in the Affordable Care Act will have a potential impact on higher-income taxpayers starting in 2013:
- A 3.8% Medicare contribution tax on net investment income, including dividends, interest and capital gains. Single taxpayers with modified adjusted gross income above $200,000 ($250,000 for joint filers) will pay this surtax on some or all of their net investment income. In our example above, the couple would pay an additional $950 on their dividends and capital gains due to this tax.
- A 0.9% additional Medicare tax on wages/self-employment income above $200,000 ($250,000 for joint filers).
Keep in mind that, starting in 2014, virtually all Americans must have health insurance or pay a tax penalty. Generally speaking, the penalty will be the larger of $95 per household member or 1% of net household income. Both the dollar amount and the percentage will increase in future years. If the couple has basic health insurance, they would not pay a penalty.
Q: Given all these possible tax increases and changes, what issues should investors discuss with their financial and tax advisors?
A: Any actions taken should make financial as well as tax sense. For example, if a stock or mutual fund pays substantial dividends, it might be a bad idea to sell it just because dividends become less advantageous tax-wise.
That said, if taxes do rise, you may want to take these tax moves into consideration with your advisors:
- What types of investments you should hold in future years, and for how long.
For example, dividends could be taxed at ordinary rates (maximum 39.6% and possibly the 3.8% surtax) instead of capital gain rates. On the other hand, an 18% (rather than 20%) long-term capital gain rate will generally apply to investments held for more than five years and purchased after Dec. 31, 2000.
- Whether it makes sense to increase your withholding or estimated taxes.
Payroll withholding will increase automatically to cover higher taxes on wages, but it won’t cover higher taxes on investments or other non-wage items.
Q: What can people do this year to be better prepared for possible changes ahead?
A: First and foremost, taxpayers should stay informed and only take action based on real tax changes — not political rhetoric and innuendo. Remember, many of these changes take effect in 2013 (for tax returns filed in 2014) — they don’t affect 2012 returns. Although we hope Congress takes action sooner rather than later, it’s possible we won’t know what 2013 taxes will look like until nearly the end of next year. Thus, taking action in 2012 to avoid 2013 tax ramifications may be a good idea — or may backfire. For example, selling an investment in 2012 may work out very well if it turns out the tax on the gain is higher in 2013. However, it could turn out that the long-term capital gain tax rate in 2013 stays the same, or is even lower. Again, stay informed and discuss all changes with your tax and financial professionals.
Have questions about how your personal tax situation could be affected by tax increases? Want to discuss options for lowering the impact? Contact your Ameriprise financial advisor.
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Own a business? Click here for specific questions related to business owners.
Q: Are there any unique concerns that retirees who are worried about rising taxes should discuss with their financial and tax advisors?
A: Distributions from retirement plans, such as traditional 401(k)s and IRAs, are generally taxed at ordinary income tax rates, regardless of the types of assets in the plan. So they might want to discuss retirement income strategies that could lower their taxable income in future years, in case their income tax rate rises. Also, retirees can set up automatic tax withholding on Social Security benefits, retirement plan payouts and other retirement distributions — if they’re interested in making sure they’re setting aside enough for taxes.
Q: What about recommendations on when retirees should tap retirement accounts?
A: The usual suggestion is to first spend down taxable non-retirement accounts, then taxable retirement accounts, and finally Roth accounts. The idea is to let deferred income in the retirement accounts continue to grow as long as possible. Keep in mind that this is general wisdom only and may not be the best way to go. For instance, as retirement accounts grow, the size of the required minimum distribution grows as well. If tax rates go up, more money is taxed at a higher rate. As always, it’s best to discuss strategy with your financial and tax professionals.
Q: How will the new health care reform mandate requiring individuals to have insurance affect retirees on Medicare?
A: The good news is that Medicare meets the health insurance requirement, so taxpayers with Medicare don’t need take any action to obtain health insurance.
Q: What specific types of tax changes could affect business owners?
A: Remember that most small business owners are sole proprietorships or pass-through entities, such as partnerships or S corporations. Income from these businesses is passed through to the owners at individual rates. So most businesses would face the same income and investment tax increases that individuals would face, along with the new 3.8% net investment income surtax on high-income taxpayers and 0.9% Medicare tax on high earnings, including net earnings on self-employment.
But there are possible tax changes specific to businesses, including decreased business deductions and tax credits in 2012 and beyond – unless Congress extends these provisions. The following tax credits expired at the end of 2011 and are not available, or are only available to a limited extent, in 2012:
- Research and development credit
- Indian employment tax credit
- Work opportunity tax credit
- Employer wage credit for employees who are active-duty military
Business owners will also see decreases in bonus depreciation and Section 179 deductions for tax year 2012 and beyond, unless Congress extends these provisions. For tax year 2012, bonus depreciation is allowed at only 50% instead of the 100% level seen in 2011. For tax year 2012, the Section 179 deduction for qualified property was lowered from $500,000 to $139,000 with a phase-out threshold of $560,000. In 2013 and future tax years, the Section 179 deduction will be reduced to $25,000 with a $200,000 phase-out threshold.
Q: By how much could business owners see their actual tax bills rise?
A: That question is very dependent on the type of business they have and what types of expenses they incur. Businesses that purchase significant assets, such as equipment and machinery, for example, could see their taxes rise substantially if the Section 179 and bonus depreciation tax benefits are greatly reduced.
Here’s an example: A business with $500,000 in income purchases a five-year property for $450,000 that qualifies for both Section 179 and bonus depreciation. Under 2012 rules, that business owner could get a $325,600 deduction. If these provisions expire in 2013, the business would only be allowed to reduce business income by the first year’s regular depreciation — or $90,000.
Q: What are some issues business owners should address with their financial and tax advisors?
A: Remember that any actions taken should make financial as well as tax sense. If business owners need to invest in business assets in coming months and could benefit from taking either bonus depreciation or the Section 179 deduction, they should consult a qualified advisor to help them determine if this is the right time to make these investments — considering those tax benefits may not be available in 2013, or may be greatly reduced. It is possible that Congress will extend bonus depreciation and keep the Section 179 deduction at the higher level. Both parties have introduced bills that include such provisions, but nothing is definitive at this point.
Q: How will the Supreme Court decision to uphold the health care law affect taxes for business owners — and when?
A: Here are some key provisions in the Affordable Care Act that could impact business owners:
- Small business credit: In 2012, small businesses with fewer than 25 full-time equivalent employees that pay an average annual wage of less than $50,000 per employee and pay at least 50% of the health insurance premium are eligible for a credit to help offset the increased cost of health care. The maximum credit can be up to 35% of the cost of the insurance premiums paid; that’s expected to go up to a 50% maximum in 2014.
- Additional Medicare withholding: Starting in 2013, single taxpayers earning more than $200,000 ($250,000 for joint filers) will have an increase in the Medicare tax of 0.9% on all wages and net employment income above that amount. Thus, the total Medicare tax rate will be 2.35% on all wages over $200,000 for singles ($250,000 for joint filers) earned during the year. Self-employed taxpayers will also pay the additional 0.9% on self-employment income over these thresholds that is subject to self-employment tax.
- Health insurance mandate: Beginning in 2014, all employers with at least 50 full-time equivalent employees are required to provide health insurance to their full-time employees and pay at least 60% of the premium cost. Employers that are required to provide insurance will be subject to a penalty if they fail to do so.
Information and opinions from third-party sources are believed to be reliable, but do not necessarily reflect the views of Ameriprise Financial. Accuracy and completeness cannot be guaranteed. This is for informational purposes and is not intended as advice designed to meet the particular needs of an individual investor. All calculations in this article are estimates.
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