2013 Tax Law Changes – What You Need to Know  

On January 2, 2013, the President signed into law the American Taxpayer Relief Act of 2012. Also, other pre-existing tax laws had created provisions that came into play in 2013. Here’s what you need to know regarding the law’s major provisions.

2013 gift and estate tax numbers Gift and Estate Tax Provisions

The federal estate and gift tax exemptions were scheduled to go back down to $1 million in 2013, but the new law keeps them both at $5,000,000, adjusted for inflation. As such, in 2013 the exemption amounts are $5,250,000 per person, or $10,500,000 per married couple. Also made permanent is “portability”: if one spouse dies without using the exemption (e.g., by passing everything to the surviving spouse rather than to children), the deceased spouse’s unused exemption can be transferred to the surviving spouse, who can apply it against later gift or estate taxable transfers (there is no portability of the generation skipping transfer tax exemption). The tax rate is increased from last year’s 35% to a new 40% rate.

Income Tax Provisions

Ordinary income tax rates stay the same for most people; 39.6% at high incomes. The current rates remain at 10%, 15%, 25%, 28%, 33% and 35%. Starting in 2013, however, there is a new rate of 39.6% for those with income over:

  • $400,000, if single
  • $450,000, if married filing jointly.

Long-term capital gains and dividend rates increase to 20% at high incomes. The good news here is that most dividends remain taxed at capital gains rates permanently (they had been scheduled to once again be taxed at higher ordinary rates), and that the 0% and 15% rates remain for most taxpayers. But a higher 20% capital gains and dividend rates applies to those with income over:

  • $400,000, if single
  • $450,000, if married filing jointly.

Alternative minimum tax patch made permanent. This helps middle income taxpayers more than high income taxpayers, but the alternative minimum tax exemption is now automatically indexed for inflation (avoiding the need for an annual Congressional “patch”).

New 3.8% Medicare surtax on net investment income. This is a brand new tax. Starting in 2013, there is a 3.8% additional tax on the lesser of (i) net investment income, or (ii) the amount that the individual’s adjusted gross income exceeds:

  • $200,000, if single
  • $250,000, if married filing jointly.

For purposes of this tax, “investment income” includes taxable income from interest, dividends, capital gains, rents, royalties, annuities, income from businesses involved in trading of financial instruments or commodities, and businesses that are passive activities to the taxpayer. It includes distributions from a nonqualified annuity contract but not from a qualified plan or IRA. Of course, if you have no net investment income, this tax does not apply.

Payroll tax holiday ends (2% increase). The Social Security portion of FICA payroll taxes paid by employees increases from 4.2% to 6.2% on wages up to $113,700. The parallel version of this tax for self-employed taxpayers under SECA rules similarly increases from 10.4% to 12.4% on self-employment income up to the same $113,700 wage base.

Medicare Tax increase of 0.9% on employees and the self-employed at high incomes. The Medicare portion of FICA paid by employees is normally 1.45% on all wages, with no limit. The parallel version of this tax for self-employed taxpayers under SECA rules is 2.9%, again on all self-employment income, with no limit. Starting in 2013, both of these taxes increase by 0.9% for wages or self-employment income over:

  • $200,000, if single
  • $250,000, if married filing jointly
    2013 individual income tax rates

Phase-out of personal exemptions and itemized deductions. For those with high incomes, increased tax rates aren’t the only reason they could pay more tax. Starting in 2013, personal exemptions and itemized deductions (e.g., write-offs for mortgage interest, local property taxes, and charitable contributions) will once again be phased out. This time the phase-outs begin at adjusted gross incomes over:

  • $250,000, if single
  • $300,000, if married filing jointly.

As for itemized deductions, they are reduced by 3% of the amount by which the taxpayer’s AGI exceeds the above thresholds. But the reduction cannot reduce itemized deductions by more than 80% (e.g., for a very wealthy taxpayer, a $100,000 charitable deduction could be reduced to $20,000).

Good news – Charitable IRA Rollovers re-introduced. Since 2006, IRA owners over age 70½ could make charitable donations of up to $100,000 per year directly from their IRAs without paying income tax. They correspondingly could not deduct the contribution, but this avoided the need to overcome limits on charitable deductions. The contribution also counted as an IRA required minimum distribution. This provision had expired at the end of 2011, but the new law retroactively restores it for 2012 and extends it through 2013. Also, there are two special rules IRA owners can use if they take action before January 2013 ends:

  • An IRA distribution that the taxpayer took in December 2012 can be transferred (partly or wholly, up to $100,000) to a charity before February 2013. This means it not only counts toward any 2012 RMD, but will make that portion of the December 2012 distribution tax-free.

  • An IRA distribution in January 2013 directly to a charity can be treated as if it had been made in 2012 under this rule, meaning it will not only be tax-free, but can satisfy a 2012 RMD, and will still leave the taxpayer room to make another charitable IRA rollover up to $100,000 in 2013.

What’s Next?

The new tax laws don’t address the debt ceiling or the “sequestration” issue, under which substantial across-the-board federal spending cuts are to automatically begin on March 1, 2013. And there is always a chance someone will be calling for further tax reform, so we just don’t know what Congress will do next. Nonetheless, the changes that have occurred make it clear that, now more than ever, it is important for clients to plan for their financial futures with the help of knowledgeable financial representatives and advisors.

This publication is not intended as legal or tax advice; nonetheless, Treasury Regulations might require the following statements. This information was compiled by the advanced planning attorneys of The Northwestern Mutual Life Insurance Company. It is intended solely for the information and education of Northwestern Mutual Financial Representatives, their customers, and the legal and tax advisors to those customers. It must not be used as a basis for legal or tax advice, and is not intended to be used and cannot be used to avoid any penalties that may be imposed on a taxpayer. Northwestern Mutual and its Financial Representatives do not give legal or tax advice. Taxpayers should seek advice regarding their particular circumstances from an independent tax advisor. Tax and other planning developments after the original date of publication may affect these discussions.

– To comply with Circular 230