Are You Prepared For Major Income Tax Changes On January 1, 2013?

Much has been written about changes to the estate and gift tax law scheduled to occur on January 1, 2013, particularly the reduction of the lifetime estate and gift tax exemption amount from its 2012 level of $5,120,000 to $1 million. The exemption for the generation-skipping transfer tax will also decrease from its 2012 level of $5,120,000 to a base level of $1 million. It is indexed for inflation from 2001, however, and is currently estimated to be $1,430,000. Significant changes to the income tax law are also scheduled to take effect at the same time, but these changes are only now beginning to receive similar attention. While Congress could still act to avert some or all of the changes, the divided nature of this Congress makes the prospect of any action before January 1, 2013, uncertain. This alert summarizes the most significant of the changes to the income tax law that will take effect on January 1, 2013, and suggests some steps you might consider to mitigate their impact.

Tax Rates

The maximum federal income tax rate on ordinary income will increase from its present level of 35 percent to 39.6 percent. The tax rate on long-term capital gain income will increase from its present level of 15 percent to 20 percent. The most dramatic increase will be to the rate at which qualified dividends are taxed. Qualified dividends are currently taxed at the same 15 percent rate as long-term capital gain income. Beginning January 1, 2013, dividends will be treated the same as other ordinary income and taxed at a maximum income tax rate of 39.6 percent.

Additional Medicare Taxes

Now that the U.S. Supreme Court has upheld the Patient Protection and Affordable Care Act of 2010, the additional Medicare taxes will take effect January 1, 2013, as planned, unless Congress acts to change them.

Employees currently pay a Medicare hospital insurance tax of 1.45 percent on their wages. Self-employed individuals pay 2.9 percent of net earnings from self-employment. Unlike taxes on wages and self-employment income for Old Age, Survivors and Disability Insurance, which are capped, the Medicare component of the social security tax has no ceiling. Beginning January 1, 2013, an additional 0.9 percent tax will apply to wages in excess of $250,000 for a married person filing a joint return ($125,000 for married persons filing separately) or $200,000 for an unmarried individual. This will make the total Medicare tax for these individuals 2.35 percent on their wages above the threshold amount. For self-employed individuals, the additional 0.9 percent will apply to their earnings from self-employment in excess of $250,000 for a married person filing a joint return ($125,000 for married persons filing separately) or $200,000 for an unmarried individual. The total Medicare tax for these individuals will be 3.8 percent on their earnings above the threshold amounts, which are not currently indexed for inflation.

Medicare Tax on Investment Income

A new Medicare tax on net investment income will also take effect beginning January 1, 2013. The rate for this new tax will be 3.8 percent and will apply to the lesser of an individual's i) net investment...

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