We mentioned in our last update that many of the details related to the tax changes surrounding the fiscal cliff legislation were hard to come by at that time. We now have more clarity on those changes and want to share some of the more important ones with you.

As mentioned previously, the bill permanently extends existing tax rates on incomes under $400,000 for individuals and $450,000 for joint filers. At the time of our previous update, there was some confusion over whether those income levels referred to adjusted gross income or taxable income. It is now clear that those numbers refer to taxable income. So, a 39.6% income tax rate now applies to taxable income over those threshold amounts.

The bill did not renew the 2 percent cut in the employees’ share of the social security payroll tax. Consequently, employees will receive smaller paychecks going forward which may come as a surprise to many as the “American Taxpayer Relief Act of 2012” was meant to tax the wealthy. The social security wage base also increases to $113,700 in 2013.

Health care reform, not the fiscal cliff deal, also will levy a new surtax of 3.8 percent on net investment income for those individuals with modified adjusted gross income above $200,000 and for those joint filers with modified adjusted gross income above $250,000. Most people were aware of this new tax, but thought it only applied to capital gains. It is broader than that. Investment income is defined to include interest, dividends, capital gains, annuities, royalties and passive rental income. It does not include tax-free interest and payments from retirement plans such as 401(k)s, IRAs and pension plans.

There is a permanent fix to the alternative minimum tax, as AMT exemption amounts are going up for 2013. These exemption amounts will automatically go up in future years as they are indexed for inflation. This fix will protect many middle class Americans from higher rates.

The personal exemption amount increases to $3,900, but is phased out for individuals with adjusted gross income above $250,000 and couples with adjusted gross income above $300,000. It is cut by 2% for each $2,500 of adjusted gross income over the threshold amounts. Itemized deductions also will be limited for those with the same income thresholds. The limit is 3% of the excess of adjusted gross income over the threshold amounts, but the total reduction can’t exceed 80% of all itemized deductions. For example, let’s assume that a couple has $350,000 of adjusted gross income. As to their personal exemptions, their income exceeds the threshold amount by $50,000. Fifty thousand divided by 2,500 equals 20. Twenty times 2% equals 40%. This means that this couples’ personal exemption amount will be reduced by 40% which equates to a $3,120 reduction ($3,900 times 2 times 40%). As to itemized deductions, $50,000 times 3% equals 1,500. Fifteen hundred dollars is the amount that the couples’ itemized deductions will be reduced by.

Medical expenses, investment interest expenses, casualty losses and gambling losses are exempt from this limitation. The threshold for deducting medical expenses rises from 7.5% of adjusted gross income to 10% of adjusted gross income for those under age 65.

The federal estate tax exemption amount rises to $5,250,000 for 2013, is portable between spouses and is indexed for inflation going forward; however, the estate tax rate rises from 35 to 40 percent. The annual gift tax exclusion amount rises to $14,000 per donee.

The bill extends for two years, through December 31, 2013, which means it includes calendar year 2012, the provision allowing tax-free distributions from individual retirement accounts to public charities by individuals age 70 1/2 or older, up to a maximum of $100,000 per individual each year. The bill provides a couple of transition rules to note. For those of you who might have forgotten to take your required minimum distribution, one of these rules allows you to treat distributions made in January 2013 as made on December 31, 2012 as long as you give the entire amount of the distribution to charity. Another rule allows you to treat a distribution from your individual retirement account made in December 2012 as a charitable distribution, if you transfer the December distribution to a charity before February 1, 2013.

For those of you who make estimated tax payments, please remember that your 4th quarter payment for 2012 is due today. We hope this helps clear-up some of the new tax rules now in place. As always, if you have any questions or comments about this update, don’t hesitate to contact us.

Sincerely,

Your THOR Team