Congress was able to come up with a fiscal cliff deal at the last possible moment, but the deal will result in some significant tax changes for some Americans in 2013. If you want to know how your personal income taxes will change this year, read on.
Income Tax Changes in 2013
The tax changes for individuals and families is a mixed bag with the fiscal cliff deal. Thankfully a majority of the changes are permanent which allows for much easier planning across the board.
Social Security Tax Up 2%
Technically speaking, your Social Security tax paid out of each paycheck will increase by 2% in 2013 to 6.2%.
While some will call this a tax increase (because technically, compared to 2012, the rate is higher) in reality this is really a removal of a stimulus bill reduction in the tax rate. The Social Security tax has been set at 6.2% since 1990 (and hasn’t been below 5% since 1973!), and only in the last few years was it temporarily dropped to 4.2% through a stimulus bill. The idea was to put more money in the pockets of Americans so they would go out and spend — which is good for the economy.
Now that the economy is on the mend it was considered a fine time to let the temporary discount expire to put the rate back at the normal 6.2%. (And note that this tax rate only applies to the first $113,700 of taxable earnings. That amount is also an increase from 2012’s maximum taxable earning level of $110,100.)
Investment Income Tax Changes for Top Earners
One piece of the Bush-Era Tax Cuts dropped the income tax on investment (dividend and capital gains) income to 15% for all earners. Thanks to the fiscal cliff deal this is now locked in at 15%… except for the top wage earners. For those wage earners the capital gains and dividend income tax goes up to 20% from the previous year’s 15%.
Marginal Tax Rate Increase for Top Earners
Unfortunately for those in the top tax bracket their income tax went up across the board, not just for investment income. The top bracket paid a marginal 35% in 2012; that rate increases to 39.6% in 2013.
The 2013 Income Tax Brackets looks like this:
- Single: $0 – $8,925
- Married Filing Joint: $0 – $17,850
- Married Filing Separate: $0 – $12,750
- Single: $8,925 – $36,250
- Married Filing Joint: $17,850 – $72,500
- Married Filing Separate: $12,750 – $48,600
- Single: $36,250 – $87,850
- Married Filing Joint: $72,500 – $146,400
- Married Filing Separate: $48,600 – $125,450
- Single: $87,850 – $183,250
- Married Filing Joint: $146,400 – $223,050
- Married Filing Separate: $125,450 – $203,150
- Single: $183,250 – $398,350
- Married Filing Joint: $223,050 – $398,350
- Married Filing Separate: $203,150 – $398,350
- Single: $398,350 to $400,000
- Married Filing Joint: $398,350 to $450,000
- Married Filing Separate: $398,350 to $425,000
- Single: $400,000+
- Married Filing Joint: $450,000+
- Married Filing Separate: $425,000+
Alternative Minimum Tax Fixed
This is a big win for taxpayers. The dreaded AMT (or Alternative Minimum Tax) monster would come around each April to snag a few more taxpayers in its grasp. The decades old AMT was designed to keep the ultra-rich from being able to pay zero tax. A noble cause that left out one important detail: tying the income level to inflation. As time wore on and inflation drove incomes up, more and more households were caught by the Alternative Minimum Tax. Each year Congress would have to put an AMT patch bill in to essentially manually push up the income level. If they failed to do so, you might have ended up paying the AMT that year.
Thankfully, the AMT is now permanently patched. This will save millions of households from being caught by the AMT where many common deductions are thrown out.
Personal Exemption Phase Out
When you file your taxes you are given a personal exemption that reduces your tax liability. Starting this year that personal exemption will phase out for higher incomes. Single filers will have their personal exemption phase out at $250,000 while married couples filing joint will lose their exemptions at $300,000 (married separate filers will hit it at $150,000; head of household filers at $275,000).
Itemized Deductions Phase Out
Likewise there is a provision that will phase out up to 80% of your itemized deductions if you hit the income category. The income limits are similar to the above phase outs: $250,000 for singles, $300,000 for married couples, $150,000 for married filing separate, and $275,000 for head of household filers.
Gift and Estate Tax Permanent Changes
Another relatively positive change is in the estate tax. Similar to the Alternative Minimum Tax problem listed above, the estate tax was constantly in flux. It might be better to die next year than this year, or vice versa, based on those specific year’s estate tax rules.
Now the estate tax rule is permanent: you may pass on $5 million to your heirs without paying estate tax. The maximum tax rate did go up from 35% to 40% for individuals passing on more than $5 million, but for a majority of Americans a $5 million is more than enough. And like the AMT, that $5 million amount will rise each year with inflation.
One last plus: the right to leave your unused estate tax exemption to your surviving spouse was also made permanent.
Various Tax Credits and Deductions Extended or Made Permanent
There were several tax credits and deductions that were extended. The range of the extensions is through just 2013 all the way through 2017.
Child Tax Credit Extended Through 2017
This was thought to be at risk, but the $1,000 per child (under age 17) tax credit was extended through 2017.
$250 Educator Expense Deduction
As the husband to an educator I was glad to see this included. Educators can deduct $250 for items they buy out of pocket for their classrooms. (And most, if not all great teachers easily spend this each year.)
$500 Home Energy Efficient Credit Extended
This credit expired in 2011, but the new tax code brings it back not only for 2013 but retroactively for 2012. If you made some green energy or energy efficient upgrades to your home last year (or will in the coming year) you can take this credit.
Deduct State and Local Sales Tax Extended
This deduction expired in 2011, but has been extended for not only 2013 but retroactively to 2012 as well. It allows tax filers in states with little or no income tax to instead deduct state and local sales tax they paid instead.
Higher Education Tuition Deduction Extended
Likewise the tuition deduction ranging from $2,000 to $4,000 depending on your income level expired in 2011. It too has been extended for 2013 and retroactively put in place for 2012.
Earned Income Tax Credits Extended Through 2017
The increase in earned income tax credit income levels (to avoid the credits being diminished) were extended through 2017.
Mortgage Debt Forgiveness Income Tax Break Extended
When you lose your house to foreclosure or short sale, the bank is agreeing to wipe away thousands of dollars in debt on the mortgage. Under normal rules a forgiven debt counts as income for tax purposes. But with the housing market being crushed since roughly 2007 and many families losing homes to foreclosure, Congress has given a tax break on this specific type of debt forgiveness. That tax break has been extended through 2013.