The 3 biggest tax stories of 2013 «
This year will go in history down as a pretty big one for tax developments. Here are the three most important stories for 2013.
1. Fiscal cliff legislation creates welcome tax certainty (at a cost for higher-income folks)
The American Taxpayer Relief Act (better known as the fiscal cliff legislation) was enacted in January. It included federal income tax hikes for higher-income folks: a top rate of 39.6% on ordinary income (up from 35%), a top rate of 20% on long-term capital gains and dividends (up from 15%), and resurrected phase-out rules for itemized deductions and personal and dependent exemption deductions (versus no phase-out rules for 2010-2012).
Thankfully most individuals are unaffected. They still pay the familiar Bush tax cut rates of 10%, 15%, 25%, 28%, 33%, and 35% on ordinary income and 0% and 15% on long-term gains and dividends. And they are unharmed by the resurrected deduction phase-out rules.
The fiscal cliff legislation also installed a relatively favorable federal gift and estate tax regime with a $5.25 million exemption for 2013, a $5.34 million exemption for 2014, and a flat 40% tax rate on the excess of taxable estate values over these exemption amounts.
The really good news: all these provisions are permanent instead of being subject to the dreaded “sunset” dates that caused so much recurring chaos in the not-so-distant past.
2. Obamacare tax hikes become reality
President Obama’s signature health-care legislation was enacted back in 2010, but it included a number of tax hikes that did not affect individual taxpayers until this year. Last year’s Supreme Court decision and Obama’s reelection locked in the following Obamacare tax changes for 2013 and beyond.
New 0.9% Medicare surtax on wages and self-employment income: This surtax hits unmarried individuals with wages and/or self-employment income in excess of $200,000 and married joint-filing couples with combined income from wages and/or self-employment above $250,000.
New 3.8% Medicare surtax on net investment income: This surtax hits unmarried individuals with positive investment income and modified adjusted gross income (MAGI) above $200,000. Married joint-filing couples will owe it if they have positive investment income and MAGI in excess of $250,000. The surtax only hits the lesser of: (1) your net investment income or (2) the amount of your MAGI in excess of the applicable threshold. Beware: the definition of net investment income is expansive. Among many other things, it includes capital gains, dividends, and the taxable portion of personal residence gains
ALSO SEE: How to avoid the new 3.8% tax on investment income
New $2,500 cap on health-care flexible spending accounts : Contributions to your employer’s health-care flexible spending account (FSA) plan are subtracted from your taxable salary. Then you can use the funds to reimburse yourself tax-free to cover qualified out-of-pocket medical expenses. Before 2013 there was no tax-law cap on healthcare FSA contributions, although many employers imposed their own caps. For this year and beyond, there’s a new $2,500 annual cap on healthcare FSA contributions.
New stricter limit on itemized medical expense deductions : Before this year, you could claim an itemized deduction for the excess of eligible uninsured medical expenses over 7.5%% of your adjusted gross income (AGI). For this year and beyond, the deduction threshold for most folks is raised to 10% of AGI. However if either you or your spouse will be 65 or older as of 12/31/13, the 10%-of-AGI threshold does not take effect until 2017 (the familiar 7.5%-of-AGI threshold will continue to apply to you until that year).
3. Supreme Court’s same-sex marriage decision has big tax impact for affected couples
In June, the Supreme Court concluded that the federal Defense of Marriage Act (DOMA) was unconstitutional. The decision had mostly favorable federal tax implications for same-sex couples who are legally married under state or foreign law, because these individuals are now considered married for federal tax purposes as well. For example, members of married same-sex couples can now use the more-favorable joint tax rate schedule, and they can generally transfer assets between themselves while alive or at death without owing any federal gift or estate tax. A same-sex spouse can also receive tax-free benefits provided by the other spouse’s employer, such as company-paid health coverage.
The one big disadvantage of being considered married for federal tax purposes occurs when both spouses have healthy amounts of taxable income. In this scenario, a married same-sex couple can wind up with a bigger combined federal income tax bill than if they were still considered single. This is the so-called marriage penalty in action.
After the Supreme Court’s decision, the IRS clarified that same-sex couples who are legally married under state or foreign law will be considered married for federal tax purposes even if they reside in states that don’t allow same-sex marriages. However, individuals who are not legally married under state or foreign law but who have entered into state-law domestic partnerships or civil unions are still considered unmarried for federal tax purposes.
Stay tuned for further action
We will probably see some tax legislation in the first quarter of next year to address the fate of various expiring tax breaks, such as the deduction for college tuition and fees. With the current hyper-partisan political climate and the 2014 mid-term elections in clear view, I make no further predictions.