As Taxmageddon 2013 looms against the back drop of Election 2012 one thing is for certain: upper-income filers will take a hit in 2013 even if no new taxes are imposed, as will owners of some small businesses.
In Part One of our series on the tax outlook for 2013, we described how scheduled tax-law changes will affect capital gains – boosting taxes on long-term profits from 15% to 23.8% for some taxpayers. And, in Part Two, which ran last Thursday, we explained that dividend investors could suffer even more, with some seeing their tax bite rise from the current 15% to as much as 43.4%.
Those changes will have a major impact on individuals and couples in the highest income brackets, who will also see their marginal tax rates rise from 28% to 31%, from 33% to 36% and from 35% to 39.6%, respectively.
In addition, many of those taxpayers will see a significant reduction in the itemized deductions they can take.
Under the tax rules in effect for 2012, there's no overall limit on the number of itemized deductions you can take.
However, if the Bush cuts are allowed to expire, total allowable itemized deductions will be reduced by the lesser of 3% of adjusted gross income (AGI) above a certain threshold – expected to be about $174,450 for both individuals and couples in 2013 – or 80% of the amount of itemized deductions otherwise allowable.
I know, that's about as clear as mud, but I don't write the tax laws – which is why you should always have an accountant at least verify your calculations before filing, or actually prepare your returns in the first place.
The Nitty-Gritty of Taxmageddon 2013
Excluded from these calculations are itemized deductions covering medical and dental expenses, investment interest and casualty and theft losses, all of which are already subject to their own percentage limitations.
About the only way to minimize the impact of this change is to accelerate itemized deductions into 2012 where possible, though this strategy also has risks as increasing deductions this year may trigger alternative minimum tax (AMT) liabilities for some higher-bracket taxpayers. Again, check with your accountant to be sure before filing.
Although the actual taxes won't be collected until 2014, U.S. citizens and legal residents also need to be aware of new indirect levies they could face if they make certain deposits in offshore banks, brokerages or other foreign financial institutions (FFIs), or make certain payments to non-financial foreign entities (NFFEs). This levy, part of the Foreign Account Tax Compliance Act, will go into effect regardless of what happens with the Bush tax cuts.
Under the new law, FFIs and NFFEs will be subject to a 30% withholding tax on payments they receive from direct and indirect U.S. account holders unless they enter into agreements with the Internal Revenue Service (IRS) by June 30, 2013, to provide the IRS with the names, addresses, taxpayer I.D. numbers and account balances of all U.S.-owned accounts. They also must agree to comply with U.S. due-diligence standards and other reporting procedures on accounts owned by U.S.
If they do, of course, this guarantees the IRS will know any time you move assets offshore or acquire foreign holdings, ensuring they can assess the appropriate taxes when you file your U.S. returns. Covered transactions will include payments of interest, dividends, fixed or determinable annual or periodical income, and U.S.-source gross proceeds from sales of property that produces interest and dividend income.
What Taxmageddon Means for Small Businesses
2013 will also see several changes affecting owners of small businesses and certain corporations, the biggest being a sharp reduction in the portion of a depreciable asset's cost that can be expensed.
Under current law, up to $139,000 in costs for so-called Section 179 assets – which include most manufacturing and processing equipment, machinery, computers, software and other tangible property – can be deducted as an expense in the year acquired rather than capitalized and depreciated over time (though that allowable deduction is reduced dollar-for-dollar by the amount the assets exceed an investment ceiling, currently set at $560,000).
In 2013, computer software will no longer be considered a depreciable asset and the maximum allowable expense will be reduced to just $25,000. The total investment ceiling over which that $25,000 is reduced will also be cut to just $200,000.
This will substantially reduce business tax deductions in 2013 so owners should accelerate purchase of Section 179 assets into 2012 wherever possible in order to get the immediate tax benefit. New computer software should also be purchased before the end of 2012 since it won't be eligible for immediate expensing in 2013.
Taxpayers who realize gains from the sale of stock in some small businesses – so-called C corporations – are currently given certain tax preferences, depending on their holding periods, with respect to how those gains impact the alternative minimum tax liability. A significantly higher percentage of such gains will be used in the calculations for the AMT in 2013, so if you hold such stock and are considering selling, you should do so before the end of 2012 to take advantage of the current 7% AMT preference level.
Business owners who are currently structuring new ventures should also consult their accountants and other advisors as the new laws may make other types of entities preferable to C corporations for future tax purposes.
One other popular business strategy is to structure new ventures as so-called S corporations, or to convert existing C corporations into S corporations. However, under new laws that went into effect for 2012 corporate fiscal years, sale of assets by companies that converted from C to S corporations are subject to a 35% built-in gains (BIG) tax on the sale price of the assets over and above their aggregate value on the conversion date, if that date was less than 10 years ago.
That holding requirement is up from just five years in fiscal 2011. As such, owners of S corporations converted from C corporations less than 10 years ago should, if possible, defer the sale of assets beyond the new 10-year cutoff, after which the BIG tax will no longer apply.
In the final installment in our tax series, we'll provide an overview of the dozen or so other scheduled tax law changes that will affect some or all individual taxpayers in 2013 and the years beyond, including a sharp increase in employer withholding rates for FICA (Social Security, Medicare, etc.).
Related Articles and News:
- Money Morning:
Taxmageddon 2013: How to Prepare for Looming Tax Law Changes
- Money Morning:
Taxmageddon 2013 Hits Dividends Hard – Here's What to Do
- Money Morning:
Why Dividend Investors Should Worry About an Obama Victory
- Internal Revenue Service (IRS) – Tax Topics:
Topic 500 – Itemized Deductions