Fiscal Cliff Deal and What’s Ahead in 2013 for Taxes on Income, Capital Gains, Dividends and Estates

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Congress and the Obama administration’s fiscal cliff deal means that 2013 federal tax rates will remain fixed for nearly 99% of the population. Only those earning $450,000/$400,000 (married/single) AGI will have a higher marginal tax rate in 2013, relative to 2012 levels. Below are the likely 2013 tax rates and inflation adjusted tax brackets (a slight increase over last year) from the Tax Foundation.

2013 Federal Tax Tables

With all the tax changes resulting from the fiscal cliff legislation and especially because of the payroll tax credit expiry, the Tax Policy Center estimated around 77% of American households would see a tax increase in 2013 compared to their 2012 tax levels. Here are some other tax impacts your could see in 2013.

  • The top income tax rate to rise to 39.6% from 35% for couples making more than $450,000 (singles making more than $400,000). The threshold for the top tax rate was raised significantly from the the $250,000/$200,000 originally proposed by President Obama. Current 2012 tax rates will be extended for all other income levels, though tax brackets may rise due to inflation.
  • The deal also contains provisions to raise top tax rates on investment income to 20% from 15% for higher income households. It also raises the estate tax top rate to 40% from 35%. Estates would receive a more-than $5 million exemption. This is up from the 35% that applies now to those over $5.12 million, but is still lower than the 45% rate and $3.5 million exemption that the President wanted. The exemption would be indexed for inflation. The alternative minimum tax (AMT) would also be permanently fixed to prevent it from expanding to more households and Congress having to apply a patch every year.
  • Personal exemptions and itemized deductions that existed in the Clinton-era would also be reinstated for couples making more than $300,000 (singles making more than $250,000). It also raises the estate tax top rate to 40% from 35%.

The IRS will publish final tax tables and other 2013 tax changes soon and I will be publishing updates and new articles covering these changes. Get these directly via RSSEmailFacebook or Twitter when published.

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2011 2013 possible tax rate changes[Update September 2012] While Democrats and Republicans alike want to keep the 2001 and 2003 tax reductions for families earning up to $250,000, President Barack Obama and congressional Democrats want to end the break for those who earn more. Republicans, contending a recovery from recession is no time to raise taxes, insist on continuing the Bush-era cuts for high-income people as well.  However, with more than 75% of national spending devoted to Medicare, Social Security, Defense and other mandatory programs, shrinking the huge federal deficit would require the cutting of all other discretionary outlay programs covering education, health care etc, that millions of Americans rely on.  Politically and practically this means that cost cutting alone cannot solve the deficit problem, which means the government is going to have raise taxes. According to a recent Barron’s review (subscription required), here are just a few of the possible tax changes over the next few years:

Federal Income Tax Rate Changes – Congress is set to debate new tax rates later this year ahead of the Bush tax cuts expiration in 2011. It is unlikely that Congress will let all the tax break’s lapse and will most likely settle on President Obama’s 2011 Budget tax proposals that extends the tax breaks for those earning less than $250,000 (married) or $200,000 (single).  This will result in an increase in the tax rates for only the top 2 tiers, which would rise to 36% and 39.6%, as shown in the table. Folks, in those brackets also would see their capital gains tax rate go up to 20% and dividends taxed as ordinary income as the associated Bush tax cuts lapse. The cost of continuing the tax cuts for the most prosperous Americans would be about $55 billion per year, which is hard to justify given the already massive national debt.

Most people, or 95% as claimed by the Obama administration, would see no change to their federal income tax rates. In fact their effective tax rates may actually be lower than they are now thanks largely to the $400/$800  making work pay tax credit which is being extended until 2013 under Obama’s 2011 budget proposals. Though, like all other spending measures in Congress, the future funding of this credit is by no means guaranteed.

The average tax rate for the 400 richest U.S. households fell to 16.6 percent in 2007 from 29.4 percent in 1993. There are about 5 million households earning more than $250,000 a year. By contrast, the Tax Policy Center found in April that 47 percent of Americans pay no income tax, largely the result of tax credits enacted under Bush and Obama. Those Americans do pay Social Security and Medicare payroll taxes.

There are also a number of tax increases in the recently approved health care reform to help pay for some of the new provisions. This includes a new Medicare tax on investment income and an additional 0.9% Medicare payroll tax for higher income earners on top of the 1.45% tax. There are also changes in limits on FSA’s (Flexible Spending Accounts) and a higher threshold on using medical deductions.  Starting in 2013 health care legislation for the first time would place a $2,500 limit on what can be contributed to employer-sponsored flexible spending accounts. The cap will receive annual cost-of-living adjustments. Employers currently set their own limits, typically between $3,000 and $5,000 in the absence of a government cap. This change would cost an average worker about $625 in tax savings Further, medical expenses will have to reach 10% of your adjusted gross income to qualify for a tax deduction, as opposed to today’s 7.5% standard. But seniors age 65 and older would be able to claim an itemized deduction at 7.5% of income through 2016.

All told, 85% of the tax burden under the new health care reform package will be shouldered by the top 1% on income earners, who will see an average increase of $28,500 to their tax bill, according to the Tax policy center.

If you feel that you will or may be hit by higher taxes then consider smart tax minimization strategies such as Roth IRA Conversions. Starting in 2010, individuals with any amount of modified Adjusted Gross Income are free to switch a traditional IRA to a Roth IRA, and spread the conversion tax due over two years. Removing the limit on conversions effectively eliminates the current income limit on contributions to Roth IRAs.  Another strategy is to accelerate income and  postpone deductions. Traditionally, the sensible move for most taxpayers has been to take deductions as soon as possible while seeking to delay some taxable income till the following year. However, you may want to consider reversing that formula, accelerating income (through stock sales or taking an early bonus) into 2010 so that it may be taxed at lower rates. A similar strategy might be employed on the deduction side. If you were planning large charitable contributions later in the year, for example, you could postpone them to early 2011 on the premise that if tax rates rise, the value of philanthropic donations as a means of offsetting income will be greater.

The extent to which the Bush tax cuts are extended will be a key focus in Congress and will have a significant bearing during the midterm elections which will determine who controls Congress and ultimately who makes long-term decisions over taxes. I will continue to follow this issue and encourage you to subscribe (free) via Email or RSS to get the latest updates.



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23 Comments on "Fiscal Cliff Deal and What’s Ahead in 2013 for Taxes on Income, Capital Gains, Dividends and Estates"

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Greg
Saturday 11:49 pm

We can argue all we want, there is NO right answer. For me personally, I would prefer the Obama budget. I do not get into the stock market, so much of the increases in tax do not apply to me. I understand the problems those who sell stocks do have.

What we truly need is term limits. Our leaders are using their position as a career.

jimmy
Saturday 11:15 pm
America has had a progressive tax system since 1916. Obama wants to return to the same rates of Clinton. All Obama wants to do is stop the Bush tax cuts to the rich. Back in 2001 McCain also wanted to do the same thing, until he sold his soul to the devil for this election. In 2001 John McCain said, “I cannot in good conscience support the Bush tax cut in which so many of the benefits go to the most fortunate among us, at the expense of middle class Americans who most need tax relief.” Fast forward to 2008: Corporates have made billions, but the middle class have lost their homes, jobs, their financial portfolio shrinking, their savings and retirement funds depleting. This is exactly was McCain was talking about in 2001 when he opposed Bush’s tax cuts. He envisioned it then and now that it has actually happened… Read more »
Fritz
Saturday 11:13 pm
Tough question. There is, and should be in my view, a progressive tax rate system. And, no, I do not advocate a 90% tax rate or anything like it. It is about balance, proportion, and practical observation about what is the baseline for any sustainable economic system. I’ve said before that I’ve been in that top tax bracket much more than I have not, once I finally got through my education. I have stated that I worked in a highly paid profession and paid well above market to get the best staff. I never, ever, felt that the government took too much or that I had too little left over, including before Reagan reduced tax rates. Instead, I would look at the net pay my highest paid staffers had after taxes and wonder how it was that they were going to have to live a life, buy a home, educate… Read more »
Mimikatz
Saturday 11:12 pm

We should keep all the cuts for people earning less than $100,000, if possible the cuts for people earning under $250,000. We really, really need to keep the higher zero bracket amount, the Earned Income Tax Credit and the larger child deductions. The rest can go.

The effect on capital gains is vastly overstated, as the 15% current tax rate affects only sales of assets held for over 1 year, the tax would revert to 20%, an increase of only 5%, and the tax is only on the gain, not the entire sale price. Besides, most investors probably are still carrying forward losses from the 2008-2009 collapse. If the top marginal rate reverts to 39.5% and dividends are treated as ordinary income (rather than taxed at 15%), that is a big deal for the rich, less so for people in the 25% bracket.

Josh
Saturday 11:11 pm
NO!!! It’s a Democratic administration. Of course he’s going to recommend raising taxes. Let the Dem’s get the heat from raising taxes and if Obama manages to return to a surplus, you can bet ol’ sock puppet Greenie will be at the front of the line worrying about how horrible it will be if the government manages to pay off the deficit. But he’s still only half right. The tax cuts on the top incomes needs to expire. Those cuts are just the worst kind of entitlement program ever. There needs to be a re-alignment in tax rates. Rates need to be made more progressive and mainly at the top incomes. They aren’t going to miss a meal. If they get cuts, the economy just slows down and in this economy, we need to keep money moving. Greenspan is a scourge to responsible economic policy. He should never be let… Read more »
FKH
Saturday 11:10 pm
Former Federal Reserve Chairman Alan Greenspan, whose endorsement of George W. Bush’s 2001 tax cuts helped persuade Congress to pass them, said lawmakers should allow the cuts to expire at the end of the year. “They should follow the law and let them lapse,” Greenspan said in an interview on Bloomberg Television’s “Conversations with Judy Woodruff,” citing a need for the tax revenue to reduce the federal budget deficit…. Ending the cuts “probably will” slow growth, Greenspan, 84, said in the TV interview. The risk posed by inaction on the deficit is greater, he said. “Unless we start to come to grips with this long-term outlook, we are going to have major problems,” said Greenspan, who led the U.S. central bank from 1987 to 2006. “I think we misunderstand the momentum of this deficit going forward.” Greenspan said reducing the deficit is “going to be far more difficult than anybody… Read more »
Taxes Kill Jobs
Saturday 11:09 pm

It’s an econ basic, raise taxes and revenue goes down. Cut taxes and people invest, start businesses, hire more staff, they spend money, AND revenue goes up. People stop taking risks, close up small businesses, and layoff people. The projected tax jumps combined the the uncertainty of further anti-business actions by the federal government will most likely result in higher (and longer periods of) unemployment AND reduced tax revenue.

DougK
Saturday 11:08 pm

Don’t raise taxes in this economy, geez. Ignore Greenspan and drop the Paul Krugman Keynesian economics immediately. We need a long term hiring freeze in government. It’s time to start laying off government workers. In addition, the Depts of Labor, Education, Energy, Commerce need to be cut drastically. Curtail pork expenditures from now on. No bailouts of states’ pension funds. After that, we need to aim for a 25% reduction of total expenditures. Security must be maintained providing Congress can be trusted to implement some intelligent cost saving moves.

Mark
Saturday 10:03 pm

The decision to cut taxes at a time when we were engaged in two wars was pure genius and politically motivated. President Bush and his advisors were probably confident that this would limit protests, and they were right. For those of you who are so worried about tax increases please refer back to the tax code of the 1950’s (you know the good ol’days and a time of unprecedented growth). The highest earners paid around a 50% rate…today it is around 25%. Care to explain that correlation?

marie
Saturday 10:02 pm

Get rid of all the income taxes on Federal and State levels and use the Fair Tax. It is a tax on ONLY what you buy. Not what you earn. So that way those who have money but do not pay income taxes due to not working pay taxes and those who work take home more money. Take a look at it. Google it. If nothing else it is a viable option to replace a broken tax system that is already in place.

Poitras
Saturday 9:59 pm

There is no economic model out there of whatever flavor — Keynesian or otherwise — that says that a tax increase is stimulative. In the long run, Obama has to do something about the deficit because the deficits they are running are totally unsustainable. The problem with the budget is more of spending (problem) than taxing. It will not be solved until they bring spending under control.

Isabell
Saturday 9:27 pm

The Bush tax cuts don’t just offer tax relief to the wealthiest Americans. They offer it to just about anyone who pays federal income taxes. Their scheduled demise next year will raise the tax bill of nearly every taxpayer, unless Congress makes changes and the president jumps on board

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Aury (Thunderdrake)
Wednesday 12:35 pm

Holy crap. Those dividend tax rates are insane. o..o

Excuse me while I hide my blue chips in tax havens. 8<

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