The Affordable Care Act contained more than 40 tax code changes. Some of the changes are resulting in increased tax bills for higher-income taxpayers, which could come as a surprise to many of them on Tax Day.
The phase-out of itemized deductions and personal exemptions, and the increase in Medicare taxes, as well as changes in tax rates on net investment income, lead the list of changes at the top.
Phase-out of itemized deductions and personal exemptions return for higher-income taxpayers
The phase-out of itemized deductions and personal exemptions have returned for those married filing jointly with adjusted gross income above $300,000 ($150,000 MFS) and $250,000 for all other filers.
From tax year 2012 to tax year 2013, a couple who earns $450,000 would see their itemized deductions reduced from $89,500 to $85,000 due to new limits preventing higher-income taxpayers from claiming a percentage of their total eligible itemized deductions. The reduction is based on income; as income over the threshold increases, allowable deductions decrease.
For 2012, before the phase-out of personal exemptions, a married couple filing jointly who earned $450,000 and had two dependent children was eligible to claim $15,200 in personal exemptions. For 2013, the same couple wouldn’t be eligible to claim personal exemptions because they exceeded the phase-out threshold.
Even if individual incomes don’t meet withholding threshold, married couples could still pay the additional Medicare tax
The additional Medicare tax increases the portion paid by employees by 0.9 percent, making it 2.35 percent. This is applied to wages, tips and some fringe benefits that exceed $250,000 for those married filing jointly ($125,000 MFS) and $200,000 for all other taxpayers.
For example, with this change a couple who earns $450,000 pays $1,575 for total additional Medicare taxes for 2013, while in 2012 they paid nothing because the law didn’t yet apply.
For many of these taxpayers the additional tax is automatically withheld from their regular paychecks. However, those who are self-employed or pay estimated income tax should be aware that they also are subject to the additional Medicare tax if the threshold is crossed. Married couples whose individual incomes are less than $200,001 (the point at which employers automatically start withholding for the tax) should investigate making adjustments to their Form W-4s if their combined income will exceed the $250,000 threshold.
Net investment income tax applies when adjusted gross income threshold is met
Net capital gains from the sale of stock, dividends, investments and other sources are subject to the new net investment income tax when adjusted gross income thresholds are met. This means a home sale could trigger the tax when the gain isn’t excluded from income under the special rules for sales of homes.
Taxpayers whose filing status is married filing jointly with modified adjusted gross income exceeding $250,000 ($125,000 MFS) and all other taxpayers whose income exceeds $200,000 could be subject to the tax. For example, a couple earning $450,000 who also has $25,000 in interest and dividends pays $950 for this tax in 2013, while in 2012 they paid nothing because the law didn’t yet apply.
Going forward, offsetting capital gains with capital losses could be beneficial; the tax only applies to net capital gain, which is the amount left when losses are subtracted from gain.
But, there is some good tax news for higher-income taxpayers. Among the other things permanently extended starting in 2013 is no estate tax if estate assets are less than $5.25 million. Plus, any unused estate tax exclusion can be transferred to a surviving spouse. Also, taxpayers may gift up to $14,000 per person to as many people as they want without paying gift tax. However, not understanding how changes in gift and estate tax provisions impact specific circumstances can be costly for individuals and families. For protection against financial surprises, take confusion out of the equation and talk to a tax professional.
Michael Micheletti | H&R Block firstname.lastname@example.org