Tim Devlin’s Tax Planning Tips for New Taxpayer Thresholds

Timothy Devlin, CPA, Tax Partner, is advising clients that it is time to integrate their tax planning with the new threshold amounts that have been added to the Tax Code. The American Taxpayer Relief Act (ATRA) introduced new starting points for direct and indirect tax increases while it extended a handful of tax provisions with various adjusted gross income thresholds.

The new threshold amounts for 2013 listed below are the precursors to the new 39.6% income tax rate, the new 20% maximum tax on net capital gain, the 3.8% net investment income surtax, and the indirect tax increases caused by revived versions of the Pease limitation on itemized deductions and the personal exemption phase-out (PEP) limitation.

If Taxable Income is:

The Tax Is:

$0 – $17,850

10% of the taxable income

$17,851 – $72,500

$1,785 + 15% of the excess over $17,850

$72,501 – $146,400

$9,982.50 + 25% of the excess over $72,500

$146,401 – $223,050

$28,457.50 + 28% of the excess over $146,400

$223,051 – $398,350

$49,919.50 + 33% of the excess of $223,050

$398,351 – $450,000

$107,768.50 + 35% of the excess over $398,350

$450,001+

$125,846 + 39.6% of the excess over $450,000

 

Head of Household

If Taxable Income Is:

The Tax Is:

$0 – $12,750

10% of the taxable income

$12,751 – $48,600

$1,275 + 15% of the excess over $12,750

$48,601 – $125,450

$6,652.50 + 25% of the excess over $48,600

$125,451 – $203,150

$25,865 + 28% of the excess over $125,450

$203,051 – $398,350

$47,621 + 33% of the excess over $203,150

$398,351 – $425,000

$112,037 + 35% of the excess over $398,350

$425,001+

$121,364.50 + 39.6% of the excess over $425,000

Married Taxpayers Filing Separately

If Taxable Income Is:

The Tax Is:

$0 – $8,925

10% of the taxable income

$8,926 – $36,250

$892.50 + 15% of the excess over $8,925

$36,251 – $73,200

$4,991.25 + 25% of the excess over $36,250

$73,201 – $111,525

$14,228.75 + 28% of the excess over $73,200

$111,526 – $199,175

$24,959.25 + 33% of the excess over $111,525

$199,176 – $225,000

$53,884.25 + 35% of the excess over $199,175

$225,001+

$62,923 + 39.6% of the excess over $225,000

Individual Taxpayers

If Taxable Income Is:

The Tax Is:

$0 – $8,925

10% of the taxable income

$8,926 – $36,250

$892.50 + 15% of the excess over $8,925

$36,251 – $87,850

$4,991.25 + 25% of the excess over $36,250

$87,851 – $183,250

$17,891.25 + 28% of the excess over $87,850

$183,251 – $398,350

$44,603.25 + 33% of the excess over $183,250

$398,351 – $400,000

$115,586.25 + 35% of the excess over $398,350

$400,001+

$116,163.75 + 39.6% of the excess over $400,000

Will the 39.6% Tax Rate Affect You?

The most important new thresholds for 2013 involve the rate bracket amounts that begin the 39.6% rate. The threshold amounts are linked to taxable income and are: $450,000 for married individuals filing joint returns and surviving spouses; $425,000 for heads of households; $400,000 for single individuals; and $225,000 for married individuals filing separate returns. These figures will be adjusted for inflation post 2013.

Daszkal Bolton can identify strategic planning opportunities to avoid the top rate bracket. For clients in the 39.6% range, above-the-line deductions and exclusions (and the strategies to maximize them) are of the utmost importance. Personal exemptions and itemized deductions, below-the-line deductions, are now impacted by the revived PEP and Pease limitations and a bit more complex.

Impact of the 20% Capital Gains Rate!

The new top capital gains rate of 20% applies at thresholds that are the same threshold amounts that determine the start of the 39.6% rate, but computation becomes complex due to particular combinations of taxable income, net capital gain, gain from collectibles and unrecaptured depreciation.

Starting in 2013, the capital gains rates for individuals are:

  • The rate of 0% applies to the adjusted net capital gains if the gain is subject to the 10 or 15% ordinary income tax rate;
  • The rate of 15% applies to adjusted net capital gains if the gain is subject to the 25, 28, 33 or 35% ordinary income tax rate; and,
  • The rate of 20% applies to adjusted net capital gains if the gain is subject to the 39.6% ordinary income tax rate January 1, 2013.
  • Adjusted net capital gain for this purpose is net capital gain from capital assets held for more than one year, other than collectibles gain taxed at a maximum 28% rate, and unrecaptured Code Sec. 1250 gain from selling real property taxed at a maximum 25% rate.
  • Unchanged is the application of ordinary income rates to short term capital gains. Only long term gains (realized on the sale or disposition of assets held for over one year) can benefit from the reduced net capital gain rate.

Income Limits for Capital Gains & Dividend Tax Rates

Tax Rate

Single

Married

Filling Jointly

Married

Filing Separately

Head of Household

0%

Up to $36,250

Up to $72,500

Up to $35,250

Up to $48,600

15%

$36,251 to $400k

$72,501 to $450k

$36,251 to $225k

$48,601 to $425k

20%

Over $400k

Over $450k

Over $225k

Over $425k

When ordinary income exceeds the threshold amounts, all net capital gain is taxed at 20 percent. However, if ordinary income is below the threshold amount (assuming no gain on collectibles or unrecaptured 1250 gain), the amount of net capital gain taxed at 20% is the excess of ordinary income and capital gain beyond the threshold. To illustrate: should a married couple filing jointly have $375,000 in ordinary income, their first $75,000 in net capital gain is taxed at 15%, but any excess beyond $75,000 is taxed at 20% due to their $450,000 threshold amount.

Pertinent Pease and PEP Provisions

ATRA brought back the “Pease” limitation on itemized deductions which reduces the total amount of a higher-income taxpayer’s allowable itemized deductions by 3% of the amount by which their adjusted gross income (AGI) exceeds the applicable threshold. The amount of itemized deductions is not reduced by more than 80%, and medical expenses, investment interest, and casualty, theft or wagering losses, are excluded.

The “applicable threshold” levels of adjusted gross income that now apply are:

  • $300,000 for married couples and surviving spouses;
  • $275,000 for heads of households;
  • $250,000 for unmarried taxpayers; and
  • $150,000 for married taxpayers filing separately.

The amounts will be adjusted for inflation for tax years after 2013.

The personal exemption phase-out (PEP) is $3,900 in 2013. Similar to the Pease limitation, the personal exemption is subject to a phase-out that begins with an AGI of $150,000 ($300,000 for married couples filing jointly). It phases out completely at $211,250 ($422,500 for married couples filing jointly). Taxpayers with AGI over the threshold amount reduce their otherwise allowable deduction for personal and dependency exemptions by 2% for each $2,500 or fraction thereof by which the AGI exceeds the threshold amount ($1,250 for married taxpayers filing separately).

Phase-out Range for Personal Exemptions for 2013

Filing Status

Phase-out Begins

Phase-out Ends

Married Filing Jointly

300,000

422,500

Head of Household

275,000

397,500

Single

250,000

372,500

Married Filing Separately

150,000

211,250

Beware the 3.8% Net Investment Income Surtax

Thanks to the Patient Protection and Affordable Care Act, starting on January 1, 2013, a net investment income surtax applies on individuals that equals 3.8% of the lesser of:

  • Net investment income for the tax year; or,
  • The excess of the individual’s “Modified” AGI (MAGI) for the year over the threshold amount. The threshold amount in this case is: $250,000 for a taxpayer filing a joint return or a surviving spouse; $125,000 for a married taxpayer filing a separate return; and $200,000 otherwise.

(MAGI is AGI without the foreign earned income exclusion or other offset.)

Net investment income includes capital gains and losses, and also includes passive income and income from certain financial instrument trades and businesses, as well as rents. The threshold amounts are lower for the 3.8% surtax than the 20% maximum tax on net capital gains, so capital gains subject to the 20% tax are also subject to the 3.8% surtax, but net capital gain subject to the surtax may not necessarily be subject to the maximum 20% rate!

Other Threshold Considerations and Opportunities

ATRA opens up an important planning opportunity for clients by changing the treatment of retirement savings in a way that could impact the new threshold amounts. Participants with 401(k) s have been able to roll over funds to designated Roth accounts in the same plan subject to certain qualifying events or age restrictions. ATRA lifted most of those restrictions, and allows participants in 401(k) plans with in-plan Roth conversion features to make transfers to a Roth account at any time. Conversions can result in income which may push you into a higher bracket, capital gain or net investment income surtax threshold. Conversions need to be done wisely, over a period of years perhaps.

ATRA extended the provision allowing tax-free distributions from individual retirement accounts to public charities by individuals ago 70½ or older, up to a maximum of $100,000 per taxpayer per year. Taking advantage of this provision for charitable giving could reduce exposure to the new threshold amounts.

Contact Us:Minimizing exposure to the new threshold amounts for higher-income clients can be complex and should be included in clients’ tax planning. Although we must first ascertain if certain income should or should not be accelerated or postponed from a transaction perspective, scrutinizing an individual’s income in light of the new threshold amounts can afford clients the opportunity to consider their options. Contact Timothy Devlin, CPA, Tax Partner, to perform some due diligence on your tax planning for 2013. Tim can be reached at (561) 367-1040 or tdevlin@daszkalbolton.com.