While legislation to avert the fiscal cliff enabled 2013 federal tax rates for most Americans to stay constant, it raised the threshold for those required to pay higher tax rates to $400,000/$450,000 (single/married) and included provisions to restart limits on certain itemized deductions and personal exemptions that were phased out and eventually removed as part of the extended Bush-era tax cuts. But the definition of higher income thresholds for these provisions is much lower than the one used for higher federal tax rates and so will apply to a lot more people. The adjusted gross income (AGI) thresholds agreed to under the fiscal cliff deal for these provisions are: $250,000 (single filers), $300,000 (married joint-filing couples), $275,000 (heads of households), and $150,000 (married filing separately).
The re-instituted phase-out limitation on itemized deductions cuts the amount of deductions you can take by 3% of adjusted gross income (AGI) above the specified thresholds but you cannot lose more than 80% of the affected itemized deductions. This means that tax payers whose AGI is greater than the specified income thresholds won’t be able to take all of the deductions associated with items like home mortgage interest, charitable donations and state/local income tax payments. While a lot of itemized deductions are affected by the 2013 itemized deduction limitation, some such as medical expenses, investment interest and gambling losses are not subject to the limit.
For an example of the above consider a married couple with income of $400,000 who file their tax return with $50,000 in itemized deductions. This couple is $100,000 above the itemized deduction AGI threshold ($400,000 – $300,000) meaning that their allowed deductions would be reduced by about $3,000 to $47,000—potentially adding to their tax liability by about $1,000.
You are allowed to deduct the personal exemption for yourself, your spouse, and your eligible dependents. The IRS estimated the personal exemption was worth $3,800 on average under 2012 rules. But with the new Personal Exemption Phase-out (PEP) the value of each personal exemption is reduced from its full value by 2 percent for each $2,500 above the above specified income thresholds. So using the example of the above couple, the couple would see a $2000 cut [(0.02*2500) * ($100,000/$2500)) in their personal exemption claims.
What This Means For You
If your AGI is below the above thresholds then you should see no impact from the above changes and can claim your personal exemptions and itemized deductions as you normally would. Higher income taxpayers though will face reductions and likely see higher tax bills in 2013 as the value of their personal exemptions and itemized deductions are reduced.