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Understanding 2013’s Tax Changes

Potential income tax rate changes 2013

Potential income tax rate changes 2013

With all the recent political banter over the election behind us (I “Hope”), it is time to look forward into next year and make provisions for the impending tax change increases set to take place January 1st, 2013. Most notably, significant changes in the way capital gains and other investment income will be taxed.  It will be increasingly pertinent that investors take advantage of federal and state tax saving strategies like 1031 exchanges and current capital gains per-sale exclusion amounts allowed upon the selling of your personal residences, in order to improve upon your capital position.

20 PERCENT CAPITAL GAIN TAX IN 2013

In response to a sluggish economy, President Bush Jr enacted legislation to help stimulate economic growth in 2003.  Among the incentives were tax breaks with sundown provisions that made them expire at the end of 2010. Under the 111th Congress, The Tax Relief, Unemployment Insurance Reauthorization and Jobs Creation Act of 2010 extended the Bush-era tax cuts until the end of 2012. Beginning January 1, 2013, however, the long term capital gains tax rate will revert from the current 15 percent rate back to the former 20 percent capital gain tax rate that was in effect prior to 2003.

CAPITAL GAIN TAX EXPLAINED

A capital gain is the profit realized on the sale of a non-inventory asset, most commonly the sale of stocks, bonds, precious metals and real estate. As defined by the IRS, “Capital gains and losses are classified as long-term or short-term. If you hold the asset for more than one year before you dispose of it, your capital gain or loss is long-term. If you hold it one year or less, your capital gain or loss is short-term.” Short-term capital gains are taxed at the ordinary income tax rates. The maximum long term capital gains rate for most people is currently 15 percent, however is set to change beginning 2013, as discussed above. For lower-income individuals, the rate may be 0 percent on some or all of the net capital gain.

There are three exceptions where capital gains may be taxed at rates greater than the maximum allowable capital gains rate :

  1. The taxable part of a gain from selling Section 1202 qualified small business stock is taxed at a maximum 28% rate.
  2. Net capital gain from selling collectibles (such as coins or art) is taxed at a maximum 28% rate.
  3. The part of any net capital gain from selling Section 1250 real property that is required to be recaptured in excess of straight-line depreciation is taxed at a maximum 25% rate.

Capital gains and deductible capital losses are reported on Form 1040, Schedule D (PDF).

DIVIDEND INCOME TAX RATES IN 2013

The Bush tax cuts also created the concept of “qualified dividend income,” which currently allows dividends received from domestic corporations to be taxed at the taxpayer’s long-term capital gain rate, or 15%. Previously, all dividend income was taxed as ordinary income.  If Congress fails to extend these provisions,  taxpayers in the highest marginal income tax bracket will see an tax increase in qualified dividend income from 15 percent to 39.6 percent for dividends received.

Maximum Rates 2012 2013 2013 (including Medicare contribution tax)
Qualified Dividend Income 15% 39.6% 43.4%

3.8 PERCENT MEDICARE TAX IN 2013

Additionally, beginning January 1, 2013, a new 3.8 percent tax will apply on some investment income. It  will take effect under the national health care reform legislation that became law in March, 2010, the “Unearned Income Medicare Contribution”. That is, pursuant to IRC Section 1402 (C)(1)(A)(iii), the investment income to which this new tax applies includes “net gain” (to the extent taken into account in computing taxable income) attributed to the disposition of property that qualifies as a capital asset under Section 121 (capital gains), as well as gains on other property that are considered part of ordinary income. Also of relevance for rental property owners, this new tax applies to a real estate investor’s rental income if they have income above the $200,000/$250,000 income thresholds.

The net effect of these tax increases is a new 23.8 percent capital gains tax rate for higher income earners.

Maximum Rates 2012 2013 2013 (including Medicare contribution tax)
Long-Term Capital Gain 15% 20% 23.8%
Qualified 5-Year Capital Gain 15% 18% 21.8%

OTHER CHANGES

Lastly, if the Bush tax cuts are allowed to expire, ordinary income tax rates will increase for most individual taxpayers (see table of tax rates above) , there will be reduction in itemized deductions and in election to expense certain depreciable business assets, to name just a few other noteworthy changes set to take effect beginning 2013.

The content provided does not constitute legal/tax advice and is not intended to constitute advertising or solicitation for legal/tax services. Nothing in this Site should be construed by you as a source of legal/tax advice. You should not rely or act upon the contents of this Site without seeking advice from your own attorney/tax specialist.

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