How the New Tax Code Affects You and Your Estate and Trust Planning?

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Tax Code Changes

This all seems to hinge on whether Congress extends the Bush Tax Cuts — if they do not the following will occur: click here for graphic.describe the image

There will be higher taxes for all

The lowest 10% individual income tax bracket will be eliminated. Thus the lowest bracket will be the 15% tax bracket. The existing 25% bracket will be replaced by 28%; the existing 28% bracket will be replaced by 31%, the existing 33% bracket will be replaced by 36%; and the existing 35% bracket will be replaced by 39.6%. Dramatic increase in taxes for all. Qualified dividends will also be taxed at these rates.

Higher tax rates on both Dividends and Capital Gains

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%

Capital gain tax rates will increase to 20% (18% for assets purchased after December 31, 2000 and held longer than 5 years). It had been 15% on capital gains and dividends. However we could see dividends tax rate soar to 39.6%. A 0% Tax had applied to capital gains and dividends for the persons in 2 lowest income brackets (10% & 15%). However, in 2013 they will pay 10% on long-term gains (8% for assets purchased after December 31, 2000 and held longer than 5 years) and 15 and 28% on dividends. The new 3.8% Medicare contribution tax will be imposed on the excess net investment income of individuals, estates and trusts. See below.

Maximum Rates

2012 2013

2013 (including Medicare contribution tax)

Qualified Dividend Income 15% 39.6% 43.4%
Ordinary Dividend Income 35% 39.6% 43.4%

Certain itemized deductions for high-income taxpayers will be subject to phase-out of up to 80%. Mortgage interest, state and local taxes, and charitable donations. If you itemize deductions and have 2013 AGI higher than $175,000 (or $87,500 married filing separate); be prepared for a large increase in taxes if you itemize.

Personal exemptions for high-income taxpayers will be subject to phase-out of up to 100%. In the 2012 tax year, personal exemption deductions were $3,800 each. Married couples with 2013 AGI above $265,000 and single filers with incomes over $175,000 will be subject to phase out.

The “Marriage Penalty” relief will expire and 15% tax bracket for single individuals will again exceed ½ the 15% bracket for married persons filing jointly. Standard deduction for married couples will return to an amount lower than 2x the amount of single taxpayers. Equating to fall from $11,900 to $9,900.

The new 3.8% Medicare contribution tax will be imposed on the excess net investment income of individuals, estates and trusts. Part of the Patient Protection and Affordable Care Act (PPACA) is scheduled to take effect regardless of whether Congress extends the Bush tax cuts. The 3.8 percent tax will be imposed on the lesser of the individual’s net investment income or the amount by which the individual’s modified adjusted gross income (AGI) exceeds certain thresholds ($250,000 for married individuals filing jointly or $200,000 for unmarried individuals). Investment income includes interest, dividends, income from trades or businesses that are passive activities or that trade in financial instruments and commodities, and net gains from the disposition of property held in a trade or business that is a passive activity or that trades in financial instruments and commodities. Investment income excludes distributions from qualified retirement plans and excludes any items that are taken into account for self-employment tax purposes.

Good news: Distributions from qualified retirement plans are not included in investment income for purposes of the tax. While distributions from traditional IRAs and 401(k) plans are not included in investment income for purposes of the tax, they do increase an individual’s modified AGI and may push the individual above the modified AGI threshold, thus subjecting the individual’s other investment income to the tax. Individuals may also consider converting their traditional retirement plan into a Roth IRA or Roth 401(k) this year since Roth distributions are not included in investment income and do not increase the individual’s modified AGI. Roth conversion would be taxable at ordinary rates, individuals should consider converting this year to avoid the higher ordinary rates scheduled to take effect in 2013.

Above the line student loan interest deductions will be limited by time. This deduction will apply only to interest paid during the first 60 months in which interest payments are required, whereas no time limitation existed before. The deduction will phase out over lower modified AGI amounts, which are projected to be $75,000 for joint returns and %50,000 for all other returns.

Heirs, estates, and qualified revocable trusts will no longer be able to take advantage of the $250,000 Home Sale Exclusion of gain from the sale of the decedent’s principal residence.

The maximum creditable expense for household and dependent care expenses will drop. They will decrease from $3,000 to $2,400 (for one qualifying individual) and from $6,000 to $4,800 (for 2 or more individuals). The maximum credit will decrease from 35% to 30% of creditable expenses. The AGI-based reduction in the credit will begin at $10,000 rather than $15,000.

The maximum child credit will drop from $1000 to $500 per child and cannot be used to offset AMT liability.

 

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