For starters, the American Taxpayer Relief Act of 2012, which was the “fiscal cliff” agreement, established new tax rates and rules for many taxpayers. In addition, an important Supreme Court decision has greatly altered the tax law landscape for same-sex spouses. Here are some of the significant changes, as well as some general tips related to filing tax returns this year.
Same-sex marriage. In June 2013, the Supreme Court decided that part of the Defense of Marriage Act was unconstitutional and that federal law must recognize same-sex marriages sanctioned by state law. As a result, starting with the 2013 tax year, same-sex spouses are required to file a federal income tax return reflecting their marital status, either as married filing jointly or married but filing separately.
Many same-sex couples may find that this comes with the dubious privilege of having a greater income-tax liability. The so-called “marriage penalty tax” can force two-earner couples into a higher tax bracket and require them to pay more than they would if they had filed as nonmarried individuals.
Combining incomes may also make it harder for a same-sex couple to qualify for many other federal tax and nontax benefits, such as deducting contributions to an IRA or qualifying for tax credits for college costs. Finally, their state income tax filing status varies, depending on the rules of a given state.
Higher taxes on income, dividends and cap gains. Because of the American Taxpayer Relief Act, rates increased for most taxpayers starting in 2013. The temporary reduction in the Social Security tax from 6.2% to 4.2% was allowed to expire at the end of 2012, which meant an increase of $2,000 in taxes for $100,000 of wages. Also, for high-income taxpayers, the tax rate on ordinary income (wages, interest, rental income, etc.) increased, as did the tax rate on capital gains and dividends. These increases are just the basics. Several other new taxes that became effective in 2013 will further increase marginal tax rates.
Surtax on earned income. The Affordable Care Act introduced many new taxes to pay for the expansion of health care, and those have gradually become effective over the last few years. Starting in 2013, there was a new 0.9% surtax on salary and self-employment income above $200,000 for an unmarried individual and $250,000 for a married couple. Even if taxpayers are not affected now, over time they may be, even with salary increases that do not exceed the rate of inflation.
Surtax on investment income. The ACA also introduced a new 3.8% tax on investment income for individuals making more than $200,000 and married couples making more than $250,000. Like the surtax on earned income, the income thresholds for the surtax on investment income are not indexed for inflation. So, over time, more taxpayers, particularly those in two-income families, will become subject to the tax.
Personal exemptions and itemized deductions limited. ATRA allowed the return of limitations on personal exemptions and itemized deductions that were eliminated in 2010. They promise to make the tax system more complicated and less transparent. In general, taxpayers lose more of the benefit of personal exemptions and itemized deductions as income increases. These changes are estimated to increase the tax burden of a married couple with no children by around 4%.
There’s also a new, higher threshold for deducting medical expenses. Such medical expenses can now be claimed only if they exceed 10%. For taxpayers who are 65 or older, the 7.5% rule continues to apply until 2017.
Beware the IRA charitable contributions trap. For 2013, Congress extended the provision allowing individuals age 70½ or older to make up to $100,000 of charitable contributions using IRA required minimum distributions. The benefit of this approach is a complete income exclusion, as compared to the usual income inclusion with a charitable deduction that may or may not offset the income. However, there’s a trap for the unwary: If a taxpayer uses this provision, the IRA provider will still send a Form 1099-R showing it as a taxable distribution. Be sure to include the 1099 information on the return and properly note it as a qualified charitable contribution.