Granada Tax Blog

From the morning after the election until after midnight on New Years the “fiscal cliff,” a supposedly monstrous combination of burdensome tax increases and draconian spending cuts provided cable television with more than enough material for ‘round-the-clock sensationalism not seen since well, 2011, when Congress was first unable to reach an agreement on the issue.

Even though the year-end coverage was difficult to avoid, most Americans presumably missed the finale – a 2am vote in the Senate early New Years Day.  Approval in the House was largely a formality and President Obama was able to utilize the technology of an autopen to sign the bill the next day without further interruption to his Hawaiian vacation.

Taxpayers are left to try and decipher how the new legislation will affect them.  Headlines suggest filers with taxable income below $450,000 (married filing jointly) or $400,000 (single) are safe from Washington’s new definition of wealthy and the associated tax hikes.  A closer look suggests that while those figures are the new thresholds for higher marginal tax rates, Washington will be implementing several creative measures to raise revenue from taxpayers earning significantly less.

Payroll Tax Holiday
The payroll tax holiday, a 2% reduction in the amount withheld from paychecks to help fund Social Security has come to an end.  For 2013 the 2% increase will be assessed on the first $113,700 of income earned. It is worth noting that the threshold of $113,700 is an increase from the limit of $110,100 in 2012.  As a result, some taxpayers will experience the combination of a higher tax rate on a larger share of their income for a maximum increase of $2,274.  The payroll tax is paid individually so married couples could see their combined tax liability increase by $4,548 from this provision alone.

Obamacare
Either because the law passed more than two years ago or because it is rather confusing, the Obamacare-related tax hike hasn’t received nearly the attention of the other tax increases.  Nevertheless, effective January 1st a 3.8% tax may be due on “unearned net investment income” (code for interest, dividends, capital gains and net rents among other sources of income).  Specifically the tax will be assessed on the lesser of the unearned net investment income or excess income as defined as adjusted gross income that exceeds the thresholds of $250,000 (married filing jointly) or $200,000 (single).
Be mindful that adjusted gross income is different than both gross income and taxable income.  As if the measures themselves weren’t confusing enough, the inconsistent metric for determining “income” deserves particular attention.

Medicare
Currently 2.9% of wages are withheld to help fund Medicare, a cost split between employers and employees.  In 2013 for wages, compensation or self-employment income that exceed $250,000 (married filing jointly) or $200,000 (single) an additional 0.9% tax will be due.
Interestingly, employers have been instructed to withhold the additional 0.9% tax once an employee’s wages exceed $200,000 without consideration for filing status or other income.  The additional withholding will continue for the remainder of the calendar year as there is no cap on the earnings subject to Medicare taxes.
Taxpayers with income from multiple employers may circumvent the withholding but will ultimately be liable for the tax.  Married filers with income between $200,000 and $250,000 can later apply for a credit to adjust for the additional withholding.

Pease Limits
Ohio’s late Democratic Representative Donald Pease passed in 2002 but the legislation bearing his name will be resurrected in 2013 after a twelve year hiatus.  This provision is not a tax but rather a limit on allowable tax deductions affecting those with adjusted gross income (AGI) of $300,000 (married filing jointly) and $250,000 (single) who haven’t been ensnared by the alternative minimum tax.
To the extent AGI exceeds these limits, a 3% reduction is applied to most itemized deductions – up to a maximum reduction of 80%.  (One notable deduction that doesn’t apply is for medical expenses.)
For example, a joint filer with $400,000 of AGI ($100,000 above the limit) may be subject to a 3% ($3,000) reduction in their allowable deductions.  Simply multiplying the reduction in the deductions ($3,000) by the marginal tax rate (33%) suggests an effective tax of $990.

Personal Exemption Phaseout (PEP)
The deduction for personal exemptions (generally $3,900 per family member) is also subject to phase-out in 2013 starting with adjusted gross income of $300,000 (married filing jointly) and $250,000 (single).
The aggregate exemption will be reduced by 2% for each $2,500 (or portion thereof) in which AGI exceeds those limits.  For example, a joint filer with $400,000 of AGI exceeds the limit by $100,000.  The $100,000 excess is divided by $2,500 for 40, which is multipled by 2%, thus reducing the deduction by 80%!  As a result, the ability to deduct personal exemptions is completely eliminated when AGI exceeds $422,500 (married filing jointly) or $372,500 (single).

The fiscal cliff may have been averted but a combination of higher tax rates and a reduction in deductions will affect millions of unsuspecting taxpayers.  In addition, another fight looms as Congress must address both the debt ceiling and scheduled Federal spending cuts in the coming months.  President Obama has suggested that as part of the pending negotiations additional tax increases may be considered.

Simplification of the tax code may be universally popular on the campaign trail but in practice it is clear that complicated provisions are proliferating.  Implementing a proactive, comprehensive tax planning is increasingly important to minimize your tax liability.

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The articles presented on this blog are general in nature and should not be assumed to be applicable to your situation. In addition, tax law changes daily and the articles on this blog are not updated to reflect these changes. Anyone receiving any part of the information on this blog should not rely on or act or refrain from acting on the basis of any matter or information contained in this blog without seeking appropriate tax, legal or other professional advice.
The transmission and receipt of information contained on this blog does not form or constitute a client relationship. Nothing in this blog constitutes legal advice. Opinions rendered by tax professionals are not authority.  You agree to hold Brendan Willmann, EA, forever harmless from any liability for your use or failure to use the information, advice, referrals, or suggestions provided by this blog at any time.