What a difference a week makes. After months of “will they or won’t they?” — they did. Both houses of Congress passed a tax deal this week and they did so overwhelmingly and in a nonpartisan fashion.
What does it mean
for families
The Senate vote was 89-8 in favor and the House vote was 257-167 in favor. The new tax deal varies quite a bit from what most taxpayers expected under the old law. Here’s what the new tax picture looks like for families in 2013.
Income tax rates
Income tax rates stay put for most taxpayers. The federal income tax rates for 2013 will be the same as last year for most taxpayers: 10 percent, 15 percent, 25 percent, 28 percent, 33 percent and 35 percent. However, taxpayers at the top, defined as individuals with incomes above $400,000 and married couples filing jointly with incomes above $450,000, will see a bump to 39.6 percent.
Alternative Minimum Tax
The Alternative Minimum Tax is now indexed to inflation — permanently. That’s a huge change since, for the last forty years, Congress has scrambled to “patch” the exemption to keep pace with inflation and other increases. Without the fix, nearly half of households with incomes between $75,000 to $100,000 — an estimated 30 million families — would have been subject to the AMT, meaning higher taxes.
Capital gains tax
Capital gains tax and dividend rates stay low. Most taxpayers will pay capital gains at a 15 percent rate with one exception: Taxpayers at the top will see a boost to 20 percent. As with income tax rates, “taxpayers at the top” means $400,000 for individual taxpayers and $450,000 for married couples filing jointly.
Medicare tax
Taxpayers at the top are still subject to the 3.8 percent Medicare tax. That tax was crafted as part of the new health care act, which was not modified as part of the tax deal. That means that unearned income like dividends and interest could be taxed at rates of up to 43.4 percent . Remember that while children subject to the kiddie tax are taxed at their parents’ rates for purposes of the Medicare tax, the normal rules for children’s income still apply, which means that children are not subject to the tax just because their parents might be.
Medicare surtaxes
Another tax which was a part of the new health care act, Medicare surtaxes for high income taxpayers, also remained unchanged. Generally, employees pay into Social Security at a rate of 6.2 percent of income up to the cap and into Medicare at a rate of 2.35 percent for all wages . Under the new law, those taxpayers with wages over the income thresholds are subject to an additional .9 percent Medicare tax.
Payroll tax cut
The payroll tax cut has expired. The payroll tax cut, which reduced payroll tax contributions on the employee side by 2 percent, expired on December 31, 2012, and was not renewed. That means that all families with at least one working parent will now see at least a 2 percent decrease in their take home pay.
Exemptions and deductions
Exemptions and deductions will be limited for high-income families. Generally, as income increases, the ability to claim personal exemptions for dependents and itemized deductions is phased out. Phase-out for those tax breaks will begin at the adjusted gross income of $250,000 for individual filers and $300,000 for married couples filing jointly.
Next up: More tax changes that can affect your family
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Child tax credit
Credits for families with children were extended. Families keep the $1,000 child tax credit for five more years. Also extended for five years? The Earned Income Tax Credit.
Medical deductions
Medical deductions will be harder to claim in 2013. The tax deal did not eliminate changes to the threshold for claiming medical expenses. Beginning in 2013, taxpayers who itemize can only deduct those medical expenses which exceed 10 percent of AGI . That means that fewer families will be able to claim medical expenses, making pretax plans more attractive.
The American Opportunity Tax Credit
A major tax break for education was extended. The American Opportunity Tax Credit for education remains through the tax year 2017.
Above the line deductions
The new law extends a few above the line deductions for taxpayers. Chief among them: The deduction for school teachers out-of-pocket expenses and the tuition and fees deduction for students.
Sales tax deductions
The option to deduct state and local sales taxes in place of state and local income taxes was also extended for a year. That’s a valuable benefit for taxpayers in states like New York, New Jersey and Illinois with relatively high sales tax rates or those in states that have no state income tax, like Texas and Delaware.
Adoption credit
The adoption credit was not only extended, it was made permanent. The amount of the credit will be at least $10,000 and will be indexed for inflation. Unlike previous years, the adoption credit is not refundable, meaning that if the credit exceeds your tax liability, you cannot have the excess credit refunded to you.
Estate and gift tax exemption
The federal estate and gift tax exemption was fixed permanently at $5.12 million with a maximum tax rate of 40 percent. The law also makes permanent the portability piece of the federal estate tax; that allows spouses to share unused exemptions, meaning that a married couple could leave more than $10 million to their family without paying a dollar in federal estate tax.
With all of these changes in store, what should you do? There is no crystal ball. And absolutely no one knows what’s going to happen in 2013. The best advice is to plan for tax laws in place as of today — but stay educated and be flexible.
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