It finally happened. There was a tax deal! Congress settled half of the giant cloud of uncertainty strangely named the 'Fiscal Cliff.' As a tax professional, I am charged with helping my clients navigate through the confusing web of tax laws created by Congress to make sure they pay only as much tax as they are required to. For many, that means planning months and years ahead for certain events that are about to take place to make sure correct decisions are made. How are we supposed to do that when Congress can't even decide what the tax law is going to look like? Thankfully, most of the uncertainty is past. This post will be a short summary of the changes you can expect for 2013 in the way of payroll and tax laws. I'll have some suggestions and warnings as well for some of these issues.
- Tax rates - Starting in 2013, Congress allowed the top tax rate to go back to the levels that existed prior to 2001, which is 39.6%. That means annual income above $450,000 for married-joint filers and above $400,000 for single filers will be taxed at the new higher rate. The other rates remain the same as before. You can see the brackets of withholding rates for 2013 here, on page 4.
- Social Security tax increase - For 2011 and 2012 tax years, employees have been paying Social Security tax at the rate of 4.2% on taxable earning. Starting in 2013, the rate increases to 6.2% for all taxpayers. The limit on wages subject to this tax is $113,700.
- Additional Medicare tax - For withholding purposes, all taxable wages in excess of $200,000 will have an extra 0.9% tax for each individual employee. The challenge with this one is that the actual tax liability is calculated for married couples with wages in excess of $250,000. There are two issues. First, if a married couple will have total wages between $200,000 and $250,000, they will be over withheld by the Medicare tax of .9%. Secondly, if both spouses earn under the $200,000 threshold, but together earn more than $250,000, they will owe additional Medicare tax on their tax return of .9%. Your tax adviser can help you do this calculation. You will need to adjust your Form W-4 to accommodate the tax change.
- Tax on 'Unearned Income' - I've always thought that name was silly since all income is earned. But Congress means income beyond your regular salary will be taxed at 3.8% which up until this point has not been subject to a Medicare tax. This means dividends, rental income, interest and some other items. None of this is taken into account in payroll systems. You would need to lower your allowances claimed or make estimated payments to cover the shortfall. The income levels where this takes effect are the same as the Additional Medicare tax, AGI over $250,000 for joint married filers and $200,000 for single filers.
- Itemized deduction phaseouts - For tax year 2013 and beyond, the phaseout of itemized deductions has returned. That means that up to 80% of most Schedule A items can be phased out for taxpayers above certain limits. Those limits are now indexed for inflation.
- Increased retirement contributions - Employees can now contribute $5,500 to their IRAs and up to $17,500 to their 401(k) plans. Catch up provisions still apply to allow extra contributions if you are over 50.
- Alternative Minimum Tax - This one scared me the most. A large number of my clients would have been subject to the tax for 2012 without the permanent patch passed by Congress. For 2013, AMT exemption amounts were set at $78,750 for married filing joint and $50,600 for head of household filers. Finally, these amounts were permanently indexed for inflation.
There are of course many more changes. Check with your tax adviser to see which of them affect you directly. You may need to adjust your W-4 form. Remember, the ultimate goal is to have your payments (withholding) match your liability (calculated on your tax return) so that your refund or amount owed is as close to zero as possible. You can always use the free calculators at PaycheckCity to see what your check will look like under the new tax laws or under different withholding scenarios.