February 1, 2013
It appears that in the short term, Congress and the President have agreed on tax legislation to avoid the proverbial fiscal cliff. Instead of reviewing what would have happened had the law not passed, it seems more appropriate to explain the status of the law now that it has changed.
It should be noted that there are still other deadlines that are going to arise in 2013 relative to budget cuts, spending issues, and limitation of the public debt. Since the principal source of revenue is taxes, these other issues are driven by taxes, which are received by the government. Therefore, the economic future of the country will probably determine tax rates in the future as well as the other issues, such as spending.
The changes for individuals are as follows:
1. There are lower rates with special treatment of qualified dividends and capital gains, but with exceptions for high income tax payers. Rates for dividends are 0%, 15%, and 20% for most tax payers, but with those who have income over $400,000.00, (or $450,000.00 for those married filing jointly,) the rate is 20%. This is up from 15% at the maximum in prior years.
2. There is a 3.8% Medicare surtax for certain individuals.
3. The alternative minimum tax (AMT) has increased and is permanently indexed for inflation.
4. Individual tax rates for tax payers will now begin at 10% and rise to 39.6% for those in the highest brackets ($400,000.00 - single and $450,000.00 -married filing jointly)
5. The marriage penalty relief rises for a couple to have the standard deduction, and at the 15% bracket, the amount is two times that of a single person for a married person filing jointly.
6. Long term capital gains also maintains a 15% maximum tax on the gain, except for those in the highest bracket, where the tax rate also rises to 20%. For special situations, such as collectibles, the rate is a maximum of 28%.
7. For alternative minimum tax purposes, there is a phase out of itemized deductions and personal exemptions once a person reaches $250,000.00 of income or $300,000.00 for a married couple filing jointly. In these situations, a person may only receive up to 80% other itemized deductions.
For estates, it is worth noting that the exemption that was slated to reduce to $1 million in 2013, with a maximum tax rate of 55%, is not going to be law. The tax legislation basically continued the prior law that provided for a $5 million exemption, which is indexed for inflation. Therefore, in 2013, the exemption for a person who dies as a US citizen is $5.25 million. Any amount over that sum will be taxed at a flat rate of 40%. For married couples, they together have exemptions totaling $10.5 million, which each may pass on to the other without incurring any tax, as the portability benefit continues.
This basically means that if you die and don’t utilize your full exemption (currently $5.25 million), then your spouse may pick up the balance of the unused exemption on the second to die’s estate. However, it is important to note that a federal estate tax return must be filed for the first to die even if no tax is due, merely to claim that the unused exemption will be utilized in the future. This return is due 9 months from date of death in most cases, and unless the return is filed in a timely manner, the unused exemption is basically lost.
For gifts, the exemption is the same as that for estates, as the credit for estates and gifts is now a unified credit. This means that you may either gift the maximum amount during your lifetime, or at death, without incurring any tax. However, if you make a gift in excess of $14,000.00 per done, per year, a gift tax return is required to be filed, although no tax is due unless the exemption of $5.25 million is exceeded. If this amount is exceeded, then the excess is taxed at 40%.
Keep in mind that if you make gifts over that threshold and you are married, you can elect to take the option of what is known as "splitting the gift," whereby, even though only one of you makes a gift, if your spouse consents to the procedure, you are each deemed to have made one-half of the total gift, which could eliminate the tax.
Social Security payroll tax relief has also expired, as the prior reduction of 2% for employees has increased. This means that the tax rises from 4.2% to 6.2% for most individuals, and for those who are self-employed, the rate increases from 10.4% to 12.4%.
Although the government had proposed various changes to special techniques, such as grantor retained annuity trusts, dynasty trusts, and defective grantor trusts, none of the provisions of the law adversely affect these types of entities, so the planning strategies utilizing these types of trusts are able to continue.
With these changes in the law, although not as significant as anticipated, it is always important to consider planning strategies to reduce tax liability, if possible. Therefore, when having your 2012 income tax return prepared, you should consider discussing with your preparer the possibility for any changes that you should be attending to in 2013, such as possibly paying your charitable pledges and other itemized deductions in 2013, rather than 2014, so as to be sure that your itemized deductions are utilized. Otherwise, you may be required to file your return taking the standard deduction, thus eliminating the benefit of the itemized deductions. Once the year ends, it will be too late, so while you are gathering all of your information for 2012, be sure to consider any consequences or significant changes that will be taking place in 2013.
Another benefit that has been restored is the continuation of the charitable deduction that may be taken directly from an IRA if you are over 70 1/2 years of age. If this is the case, then the withdrawal from the IRA is not taxable, and while you do not get a charitable deduction, it is basically a ‘wash transaction,’ which is tax free to both you and the charity.
So, we have avoided the fiscal cliff for now, and everybody is impacted to one degree of another. 2013 will be an important year for those who need to plan for the future, so it is advisable to meet with your financial and legal advisors as soon as possible to establish your strategies going forward.
by: Hyman G. Darling