Funding of the Social Security program has been a growing concern for years now, and new tax law changes for 2013 will target at least one portion of that problem.
Thanks to Taxmageddon 2013, your take home pay is about to shrink.
In the first three parts of our series on the tax outlook for 2013, we reviewed the impact of proposed changes on capital gains, dividend income and the treatment of certain taxes for the wealthy and small businesses.
Today, we'll look at scheduled changes in the FICA withholding structure, as well as a number of other 2013 tax law revisions that individual taxpayers need to be aware of.
FICA is short for the Federal Insurance Contributions Act, the Depression-era law that imposed payroll taxes to fund America's Social Security retirement and disability programs. Withholding for the Medicare elder-health program was added in the 1960s.
The FICA tax is imposed on both employees and employers, who are required to withhold a certain percentage of a worker's wages (up to a specified limit) when paychecks are issued, and match that sum when passing the withheld monies on to the government. (A similar tax is imposed on self-employed individuals, who are responsible for both halves, again up to a specified limit.)
What Taxmageddon 2013 Means for FICA Taxes
FICA taxes started at less than 3% total, but rose steadily over the past 50 years, surpassing 15% in 2010. However, they were reduced for the 2011 tax year by the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010, with the reduction subsequently extended for the 2012 tax year.
The withholding tax rate for 2011 and 2012 was 4.2% of gross wages up to limits of $106,800 in 2011 and $110,100 for 2012. The Medicare withholding tax for employees was 1.45% of total wages, with no limitation. Employers had to match all contributions, so the total FICA tax was 11.3% up to the $110,000 limit.
To date, the FICA reductions have not been extended, so the employee withholding percentage will rise to 6.2% in 2013. For workers, that's $620 for each $10,000 in gross wages, up from $420 per $10,000 in 2012 – or $6,820 total if you make the $110,000 limit.
The Medicare tax will also increase by 0.90% for higher-income earners – from 1.45% to 2.35% for couples making more than $250,000 and individuals making $200,000 or more. The employer Medicare share will remain unchanged, so the total tax for lower-bracket workers and employers will climb to 15.3% (6.2% + 6.2% + 1.45% + 1.45% = 15.3%), and to 16.2% for upper-income earners (6.2% + 6.2% + 2.35% + 1.45% = 16.2%).
Although no announcement has yet been made, the limitation on wages subject to FICA will also likely increase in 2013 – probably to around $112,500 based on the recent rate of annualized inflation.
Sadly, there's no way around this tax increase, so your only real strategy is to recognize that the government will be taking as much as $3,403.75 ($112,500 x 8.55% – $110,000 x 5.65% = $3,403.75) in extra FICA withholding from your paycheck in 2013, and budget accordingly.
The minimum withholding rate for income taxes will also rise in 2013 based on the increases in the tax brackets (discussed in more detail in Part Two of our series) and higher marginal tax rates. Most workers will face a hike in the basic withholding rate from 28% to 31% (though this rate can be reduced based on exemptions claimed). Withholding rates on supplemental wages up to $1 million will rise from 25% to 28%, with rates climbing from 35% to 39.6% on supplemental wages in excess of $1 million.
Big Changes in Exemptions and Deductions
Beginning in 2013, higher-income taxpayers will also face a phase-out of personal exemptions. All taxpayers now get a personal exemption of $3,800, but in 2013 that will start to shrink once income exceeds an inflation-adjusted level – not yet officially announced, but expected to be $261,650 for married joint filers and $174,450 for single taxpayers.
Married couples who don't itemize their deductions will see a decrease in their standard deduction in 2013. Now, couples get double the standard deduction allowed single taxpayers, but that will drop to just 167% of the single deduction, which is currently $5,950. That means, based on 2012 numbers, the standard deduction for couples will fall from $11,900 to just $9,900 in 2013.
Fewer medical and dental expenses will be deductible for younger taxpayers as well. Currently, health expenses in excess of 7.5% of adjusted gross income (AGI) are deductible, but that threshold will rise to 10.0% in 2013 – though the 7.5% limit will continue until 2016 for taxpayers or spouses age 65 and older.
Credits to offset expenses for dependent care will fall in 2013 – from $3,000 to $2,400 for a single individual and from $6,000 to $4,800 for two or more individuals. The maximum dependent-care credit will drop from 35% to 30% of allowable expenses – or, if you use the AGI-based formula, from $15,000 to $10,000.
The maximum child-care credit will decrease from $1,000 to $500 per child, and the credit can no longer be used to offset liabilities under the alternative minimum tax (AMT). Earned income tax credits will also be phased out on joint returns, depending on the number of qualifying children claimed.
Taxpayers already struggling with student-loan debt will see a cut-off date applied to their interest deductions. Currently, interest on student loans is deductible from AGI for as long as payments are made, but starting in 2013, above-the-line deductibility of interest will be phased out after 60 months. The phase-out will be based on reduced AGI limits, currently projected to be $75,000 for couples filing jointly and $50,000 for all other returns.
Students enjoying up to $5,250 in income exclusions for employer-paid on-the-job training and continuing education will see an end to those benefits in 2013. In other words, employer assistance with educational expenses will now be taxed as regular income.
Finally, 2013 will see three changes related to home ownership:
- Heirs, estates and qualified trusts will no longer be able to exclude up to $250,000 in gains from the sale of a decedent's principal residence, with the full amount becoming subject to estate taxes.
- Debt forgiven in connection with the foreclosure of a principal residence will again be considered taxable income, unless the homeowner losing the property is in bankruptcy or has officially been declared insolvent.
- The special itemized deduction for mortgage insurance premiums paid on loans taken out after 2006 expires in 2013.
In summary, then, whether or not ObamaCare survives, the Bush tax cuts are extended or a reconstituted Congress makes new cuts or imposes new levies in the wake of the November elections, the abundance of tax law changes will almost certainly demand you seek professional assistance in both planning for your 2013 taxes – and filing them.
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:
Taxmageddon 2013: These Filers Are in the Crosshairs
Encyclopedia Entry: Federal Insurance Contributions Act tax
- Internal Revenue Service (IRS) – Tax Topics:
Topic 751 – Social Security and Medicare Withholding Rates