Whew, that was close! At the last minute (actually a few hours after the last minute), the House of Representatives prevented the United States from falling off the "fiscal cliff" by passing the American Taxpayer Relief Act of 2012.
What does this mean to you? As far as income taxes go, for the vast majority of taxpayers it means more of the same. However, everybody who works will have to pay more Social Security taxes than they have over the last two years.
Unless you're in the top 1% income level, the new tax law does not increase or otherwise change your income tax rates from last year. The rates in effect for the last ten years are now permanent. Had Congress not acted, tax rates for everybody would have gone up to their pre-2001 levels.
The big change is for very high income taxpayers: those with incomes over $400,000 ($450,000 if married, filing jointly). The top income tax rate for these taxpayers goes up from 35% to 39.6%. But they will only pay this new rate on the portion of their taxable income above $400,000 or $450,000. Thus, for example, a single individual with taxable income of $401,000 in 2013 would pay $46 more in income tax due to the 4.6% raise.
Social Security Taxes
For the past two years, all working people have enjoyed a Social Security tax "holiday"--Social Security taxes were cut by 2% for everyone for 2011 and 2012. This holiday was always intended to be a temporary measure to help people during the recession. However, some people wanted to extend it for another year. This has not happened. The holiday has expired without any extension. This means that Social Security taxes will go back up to their old rates: employees will have to pay a 6.2% Social Security tax up to the annual wage ceiling of $113,700 in 2013. Self-employed people must pay a 12.4% Social Security tax on their net self-employment income up the same ceiling amount.
Thus, for example, a worker who earns $50,000 in 2013 will have to pay an additional 2% Social Security tax on that income--$1,000. The maximum increase for a person with $113,700 or more in income is $2,274.
Capital Gains Taxes
Special capital gains tax rates apply if you earn a profit from selling a "capital asset" such as corporate stock or your house. For singles with income above $400,000 and marrieds filing jointly with income over $450,000, the capital gains rate goes up from 15% to 20%. For everybody else, the rates remain the same which means people in the 25%, 28%, 33% and 35% brackets pay a 10% capital gains tax. The rate remains zero for people in the 10% and 15% tax brackets.
However, a new 3.8% investment tax took effect on January 1 as part of the funding for Obamacare. Singles with income above $200,000 and marrieds filing jointly with income over $250,000 must pay a 3.8% tax on their net investment income. This is added to the regular capital gains rate. Thus, the top rate will be 23.8% for those in the $400,000/$450,000 income levels.
Qualified dividends are taxed at the same rate as capital gains.
Tax Exemption Phase-Outs
Another highly technical change that only affects high-income taxpayers is reinstatement of phase-outs of personal exemptions and itemized deductions for single taxpayers with income over $250,000 and marrieds filing jointly with income over $300,000. This will increase their income taxes by about 1%.
Only estates worth more than $5 million will be subject to federal estate taxes--the same as last year. The top estate tax rate was increased from 35% to 40%.
Tax Credits Extended
Certain tax credits that were scheduled to expire or be reduced in amount have been extended. These primarily benefit low-income taxpayers and include the following:
- child tax credit
- American opportunity tax credit for tuition and related expenses
- earned income tax credit
- dependent care credit
- adoption tax credit, and
- credit for employer expenses for child care expenses.
Popular Tax Deductions Extended
Certain popular itemized tax deductions scheduled to expire at the end of 2012 have also been extended by two years. These include:
- the option of taking an itemized deduction for state and local general sales taxes instead of state and local income taxes
- the deductibility of premiums for mortgage insurance on a personal residence
- the $250 deduction for teachers who purchase school supplies out of their own pockets
- allowance of an itemized deduction for mortgage premium insurance.
- tax-free distributions for charitable contributions from IRAs by individuals who are at least 70 1⁄2 years old, and
- tax benefits for employer-provided mass transit.
In addition, an expansion of the deduction for student loan interest was made permanent.
Mortgage Debt Relief
The Mortgage Debt Relief Act of 2007, which makes up to $2 million of forgiven mortgage debt eligible to be excluded from income, has been extended through 2013. This prevents taxation of “shadow income” from foreclosures and cancelled debts.
Finally, the alternative minimum tax (AMT), a pesky tax provision that can ensnare higher-income taxpayers who have lots of deductions has been permanently "patched." Had this not been accomplished, as many as 100 million taxpayers would have been subject to the AMT instead of 30 million. This means that if you didn't pay the AMT last year or the previous year, you probably won't have to pay it this year.