TAX UPDATE SUMMER 2013
Now that you have filed your 2012 income tax return it is time for me to alert you to some of the updates and changes that Congress has enacted which will likely affect you for your 2013 income tax return preparation.
There is a special deduction which has been extended and available for elementary and secondary education school teachers. The deduction is limited to $250 and reduces your adjusted gross income which is important for many other tax provisions which may be available to you. This maximum $250 deduction is reported on the front page of your tax return so you do not have to itemize your deductions in order to take advantage of this benefit.
If you have costs that you paid or incurred which are greater than $250 then those excess expenditures can be educted on Schedule A of your Form 1040 if you elect to itemize your deductions. In addition, those excess expenditures are subject to a 2% of Adjusted Gross Income (AGI) limitation which means that you will only be able to actually deduct the amount greater than 2% of your AGI. For instance if you spent $1,000 during 2013 you will be able to deduct $250 on the front page of your return and the excess $750 is limited. If your AGI is $35,000 then 2% of $35,000 is $700 and you would absorb that first $700 and only the $50 excess would be an allowable deduction.
The $250 deduction is available for classroom supplies, books, computer equipment, software and any other supplementary materials used in the classroom. This deduction is scheduled to expire at the end of 2013 so if you need to make an expenditure do so by December 31, 2013. The deduction is also available for principals, librarians and other classroom assistants who are considered full-time workers. Call me for more details so that we can discuss this and any other questions that you may have.
ITEMIZED DEDUCTIONS ON SCHEDULE A
If you elect to itemize your allowable personal deduction items on Schedule A then there are a few deductions that have been extended for 2013 and scheduled to expire at the end of 2013. One item is the sales tax deduction for those taxpayers who do not pay any or little state income taxes. Therefore, based on Tables established by the IRS you may be able to deduct the sales taxes paid on your consumption of goods and services. In addition to the Standard Table amounts you can also deduct the sales tax paid or incurred on big ticket items such as automobiles, boats, building materials, etc. You will need to have your receipts in order to deduct and verify the sales tax deduction. Contact me for more information.
The other Schedule A itemized deduction that is extended and scheduled for expiration after 2013 is the deduction for Mortgage Insurance Premiums (PMI). If you have a mortgage and are paying PMI then you could be eligible for this deduction. The deduction does have a phase-out provision once your Adjusted Gross Income (AGI) reaches 100,000.
It is completely phased out when your AGI reaches $110,000. Let’s discuss this opportunity.
CHILD TAX CREDIT
There is a Child Tax Credit available to qualified taxpayers who have a dependent child under the age of 17 at the close of 2013. The maximum credit is $1,000 and the good news is that it has now been made a permanent provision. The
amount was scheduled to revert back to a maximum of $500 beginning 2013 so this is a sure winner for those who qualify going forward. The credit is available to a taxpayer based on their filing status and modified Adjusted Gross Income.
The credit is phased-out as income rises. For a single taxpayer with one qualifying child the phase-out begins at 75,000
and is completely gone at $94,001. It is the same range for those taxpayers with a filing status of Head of Household. For taxpayers filing a married joint return the phase-out for one qualifying child is between $110,000-$129,001 and for a filing status of married filing separately it is half of that of at $55,000-$74,001. Give me a call so we can discuss in further detail.
Congress has extended a few tax benefits that will help you if you are paying for post high school education expenses. These benefits come in the form of both a deduction and a credit. A deduction remember is an item which reduces your taxable income while a credit is an item which reduces your actual tax.
The American Opportunity Credit is available for those taxpayers who have a modified adjusted gross income below a specified threshold amount depending on their filing status. The credit can be as high as $2,500 for each of the taxpayer’s qualifying students. A qualifying student could be the taxpayer, the spouse or a dependent child of the taxpayer. The $2,500 maximum credit is available for a married couple filing a joint return who has a modified AGI of less than $160,000. The $2,500 amount is reduced as the income grows to $180,000. After that level it is completely phased out. If you are a taxpayer whose filing status is single or head of household then the levels of income are half of those amounts beginning at $80,000 and ending at $90,000. A taxpayer who files as married filing separately cannot take advantage of the credit. In order to get th full $2,500 credit the taxpayer must pay a total of $4,000 in qualifying tuition, fees and required course materials. The first $2,000 qualifies for a 100% credit therefore $2,000 and the second $2,000 qualifies for a 25% credit which would be $500. This is especially attractive for those taxpayers who may be attending a community college where the tuition and fees are generally less expensive than those at a 4 year university. The credit is available for the first 4 years of post high school education. The provision has been extended through 2017. Contact me to discuss your needs.
Another education benefit that Congress has renewed is the deduction for Student Loan Interest. It is available even if you do not elect to itemize your deductions on Schedule A. The maximum deduction is $2,500 per year. It is available to all taxpayers except those with a filing status of married filing separately. There is a modified gross income test which begins at $60,000 and ends at $75,000 for a filing status of single and head of household and for a married couple filing a joint return it begins at $120,000 and ends at $150,000. The important issue to be aware of its that no matter what the filing status is on your return the maximum deduction is always only $2,500. If two single people file their returns each is eligible for the maximum $2,500. However, if those two single people were to marry and file a joint return then there is only one $2,500 deduction. And remember if they file married separately then they get no deduction. Contact me for more details.
And still another education benefit that Congress has extended for 2013 is the deduction for “qualified higher education expenses” which are also available for those taxpayers who do not itemized deductions on Schedule A. This benefit would be available for each qualifying student on the tax return. The deduction could be $2,000 based on your modified AGI or $4,000 if your modified AGI is lower than a specified threshold based again on your filing status. If your filing status is single or head of household and your income is $65,000 or less then you could be eligible for a $4,000 deduction. If your income is greater than $65,000, but is not greater than $80,000 then you would be eligible for a $2,000 deduction. Any amount greater than $80,000 disqualifies you from the deduction. For a married couple filing a joint return the $4,000 deduction is available if your income is less than $130,000. If its is more than $130,000 but not more than $160,000 then you would be eligible for the $2,000 deduction. If you are married but file separately from your spouse the deduction is not available to either of you.
There is good news to report about contributions to an Individual Retirement Account (IRA). The maximum contribution has been increased for 2013 up to $5,500. That is a $500 increase over the 2012 amount. Anyone who has “earned income” such as wages, salary and self employment is eligible to make the IRA contribution. The taxpayer with a modified AGI below specified thresholds based on filing status has the opportunity to deduct their contributions therefore paying less tax in the current year. Again the ability to deduct your IRA contribution is based on levels of income. For a married couple filing a joint return if your income is less than $95,000 you can deduct $5,500 in full for both you and your spouse even if only one of you has earned income. Therefore with a minimum of $11,000 of total earned income you could deduct it in full. As your modified AGI increases up to $115,000 you begin to lose the ability to deduct the contribution. However, the excess amount can be contributed to a Roth IRA which is a nonductible contribution but the growth will never be included in your gross income when you take a future distribution. Call me about the details of contributions and distributions of a Roth IRA and by the way if you are age 50 or greater on the last day of the tax year you can contribute an additional $1,000.
For taxpayers whose filing status is single or head of household you are eligible for a $5,500 deductible IRA when your modified AGI is $59,000 or less. When you have an income in excess of $69,000 you can no longer make a deductible IRA. Between $59,000 and $69,000 the $5,500 is phased out but again you should contact me about Roth IRA contribution.
There is a special rule only for married couples who file a joint return where one spouse either does not have any earned income or has earned income but is not eligible to participate in an employer’s pension plan. If this is your situation then for 2013 you can have a $5,500 deductible IRA contribution when your joint modified AGI is $178,000 or less. The $5,500 maximum deductible contribution decreases as your income grows between $178,000 and $188,000. And again if you and/or your spouse is age 50 or older on the last day of the tax year you can contribute an additional $1,000 for each qualifying spouse.
HEALTH CARE LEGISLATION ISSUES
2013 begins the era of the new medicare tax on wages and self-employment income of specified taxpayers based on their filing status and level of wages. Many taxpayers will not be affected by the imposition of this new tax but those who are or will be in the future need to be aware of the following changes. A new additional medicare tax of .9% will be imposed on wages in excess of certain amounts. A single taxpayer including those with a filing status of head of household will have the tax assessed against them on wage greater than $200,000. For a married couple filing a joint return that amount is $250,000 and for those with a filing status of married filing separately the amount is half of that at $125,000.
As an example, if a taxpayer who is single has wages of $225,000 which is $25,000 over the threshold amount of $200,000 then that excess $25,000 would have an additional tax of $225. If that taxpayer was married and filed a joint return with the spouse then there would not be an additional tax imposed because the threshold amount for a married couple begins at $250,000. However, if the taxpayer earned $225,000 and files a return separate from the spouse the excess amount would be $100,000 since the threshold is half that of filing joint, which is $125,000 as a result the additional medicare tax would be $900 which is .9% of $100,000.
There would be the same result for a taxpayer who is self employed. Call me soon to discuss your situation. There may be a need for you to either increase your withholding or increase your quarterly estimated tax payments. Note that employers are not required to withhold the additional tax until wages actually exceed $200,000 no matter what your filing status may be when you actually file the return.
In addition to the new medicare tax on wages and self employment income, there is also an additional medicare tax of 3.8% being assessed on what is called “net investment income” of specified taxpayers based again on the filing status. The 3.8% tax will be assessed on the lesser of a taxpayer’s net investment income or the excess of (if any) of the taxpayer’s modified AGI greater than a specified threshold amount. The threshold amounts are again based on filing status and fortunately are the same thresholds as we saw for wages and self-employment income of $200,000 for single and head of household, $250,000 for married joint and $125,000 for married separate. For example, if you are single and you have net investment income of $1,000 and your modified AGI was $250,000 your additional tax would be 3.8% of the lesser of $1,000 or 3.8% of the excess of $50,000 ($250,000 - $200,000). Therefore, you would pay an additional medicare tax of $380. If you were married filing a joint return you would not have an additional tax because the threshold would be $250,000 and there would be no excess (3.8% x $0 - $0). However, if you were married filing a separate return your excess would be $125,000 and you would pay 3.8% of the lesser of the excess $125,000 or 3.8% of the $10,000 which would still result in $380.
For this purpose net investment income includes the gross income from taxable interest, all dividends, annuities, royalties, rents income from passive activity and gain from the disposition of non business property. Form the gross income you will subtract all expenses related to these items of income. Contact me so that we can discuss the major details of this change. Your investment income will not include any distributions from pension plans of any kind including IRAs and it will not include any item which is not included in gross income for federal income tax purposes. Therefore, municipal bond interest is not included and the excluded gain from the sale of your principal residence is not included.
Also there is a major change which began in 2013 for the ability to deduct medical expenses on Schedule A. Prior to 2013 a taxpayer had to reach a 7.5% floor amount before the first dollar of medical expenses could be deducted. As an example if the taxpayer had an Adjusted Gross Income (AGI) of $100,000 in 2012 then the taxpayer would absorb the first $7,500 of eligible medical costs before they could deduct the first $1. Therefore, if they incurred $10,000 of medical costs not covered by insurance or reimbursed then they would have an allowable deduction of $2,500. however, beginning in 2013 the floor has increased to 10% so there would be no excess amount which could be deducted.
There is a special transition rule available for those taxpayers who are age 65 or older during 2013-2016. They will still be able to use the 7.5% floor amount. However, once the transition period is over beginning in 2017 they also will be limited by the 10% floor. Only one of the spouses needs to be 65 or older in order to qualify for the 7.5% during the transition period.
If you have been taking advantage of your employer’s §125 plan and making annual contributions to the Health Flexible Spending Account (FSA) then you need to be alerted to the fact that your annual contribution amount is now limited to $2,500. The contributions to the FSA are not subject to any federal taxes which includes income tax, social security tax and medicare tax. Prior to the 2013 change employers were permitted to determine the amount allowed to be contributed to their specific plan. This means that if your employer’s plan in 2012 and earlier allowed you to contribute up to $6,000 in the FSA you did not pay any tax on $6,000. However, beginning in 2013 the excess amount over $2,500 is now included in gross income since it cannot be contributed to the FSA and subject to all the federal taxes. As a result of this you may be required to increase your federal tax withholding or increase your quarterly estimated taxes.
TAX RATE ISSUES
On January 1, 2013 Congress and the President finally came to an agreement on the rate structure for the 2013 income tax rates and were able to agree to continue the 10% income tax bracket which was supposed to have expired on December 31, 2012. In addition, there was much controversy about restoring the 36% and 39.6% brackets which were instituted during the Clinton Administration and temporarily set aside during the Bush Administration. Most taxpayers were not impacted by any change in tax rates now in force because the graduated rate structure of 10%, 15%, 25%, 28%, 33% and 35% are still here. The 36% bracket was not restored but the 39.6% was restored and the table below illustrates the impact during 2013 based on filing status.
Filing Status > Amount
Single > $400,000
Head of Household > $425,000
Married Joint > $450,000
Married Separate > $225,000
Note: There will not be a 36% bracket as would have resulted with the sunset provisions of the 2001 Act.
Note: Trust and Estate will no longer have a 35% bracket. It is replaced by 39.6%.
In addition, the long-term capital gain rate has been left in tact at 15% except for those taxpayers who are in the 39.6% bracket. Those taxpayers will be taxed at a 20% long-term capital gain rate. However, for those same individuals’s in the 39.6% bracket if they have excess dividend income in 2013 then the excess is taxed at 39.6% instead of being capped at 15%.
PHASE-OUT OF ITEMIZED DEDUCTIONS AND PERSONAL EXEMPTIONS
For 2013 every taxpayer will be eligible for a personal exemption and a dependency exemption of $3,900 for each qualifying dependent. However, certain taxpayers based on their filing status with an AGI greater than a specified threshold amount will begin to lose the benefit of those exemptions according to the schedule below:
Filing Status > Threshold
Married Couples & Surviving Spouses > $300,000
Head of Household > $275,000
Single > $250,000
Married Separate > $150,000
Once the taxpayer is beyond the phaseout level no exemptions are allowable. As a result the taxpayer is paying an effective rate which is greater than the amounts in the brackets.
For itemized deduction issues on Schedule A the total itemized deductions begin to be phased-out at specified dollar amounts with the excess multiplied by 3%. As a result while specific itemized deductions (such as mortgage interest charitable contributions, etc.) are not disallowed, total itemized deductions are reduced by the phase-out rule. Again the effective rate of tax paid is greater than the rate according to the graduated rate tables. The phase-out is based on filing status and is the same AGI test as for the phase-out of exemptions as stated below.
Filing Status > Threshold
Married Couples & Surviving Spouses > $300,000
Head of Household > $275,000
Single > $250,000
Married Separate > $150,000
As your tax professional, I assure you that I will be keeping a watchful eye on Congress and on IRS actions which may affect your business and your tax filings in the New Year. I will be happy to address any concerns and answer questions you have about any of the issues covered in this newsletter. Thank you for the opportunity and privilege of allowing me to serve as your tax professional this past year.
Stephen W. McKown