Tax Changes and How They Affect You

It’s an interesting time to be a tax practitioner. With the 2012 tax filing season just getting underway and the flurry of new changes brought on by the American Taxpayer Relief Act (ATRA) and Affordable Care Act (ACA), there are some lively conversations happening with our clients, our peers, in our professional journals and at conferences. As Congress continues to deliberate about spending cuts, ending tax loopholes or adding new tax increases, these conversations are bound to continue. Who said taxes were boring?

Many of the main features of ATRA and ACA have already been summarized in the popular press and in our firm communication dated January 2, 2013. But, it is up to us as advisors to help clients understand this and what it means for them. Of course, the answer will be different for each client circumstance, and your advisor will communicate this to you in the year ahead. However, we wanted to use this Viewpoint to highlight a few areas of the Acts that we believe will impact our clients on a wider scale.

Higher Individual Tax Rates May Impact You: Be Mindful of Out-of-the-Ordinary Income

ATRA made permanent the 2012 marginal tax rates for those with taxable incomes less than $400,000 (single) and $450,000 (married filing jointly “MFJ”). Above these income thresholds, ATRA reintroduced a top high bracket of 39.6%. Many were relieved to learn that the threshold would be applied above their typical annual income level, preventing them from being subject to the higher rate. However, keep in mind that other income recognition events can cause one’s annual income to spike higher than originally planned – stock option exercises, vesting of restricted stock, separation packages, and variable performance bonuses, just to name a few. You may actually be surprised to find yourself subject to this higher rate.

Medicare Hospital Insurance Tax of 0.9% on Earned Income: Monitor Your Paystubs for Withholding Issues

In June 2012, the Supreme Court upheld ACA. Included in this act is the levy of an additional Hospital Insurance (HI) tax of 0.9% on earned income above the $200,000 (single) and $250,000 (MFJ) thresholds. This tax only applies to the income in excess of these thresholds. Earned income is considered wages or self-employment income. Employers have been instructed to begin withholding the additional 0.9% tax for any employee once that employee’s income exceeds $200,000. This withholding may be sensible in a one-earner household or in a two-earner household where each earns more than $200,000. A potential issue arises with a two-earner household where one or both earn less than the $200,000. For example, if each earns $190,000, for a combined total of $380,000, neither employer will have withheld the additional 0.9% tax. However, their income exceeds the $250,000 MFJ threshold by $130,000, and they’ll owe $1,170 in additional HI tax when they eventually file their federal return. If they haven’t made sufficient estimated tax payments along with their other withholdings, they could find themselves in an underpaid, tax penalty situation.

Phaseout of Itemized Deductions and Personal Exemptions: Creeping in at Levels Below Highest Marginal Bracket

In the tax years 2010-2012, taxpayers at all income levels received the full amount of their personal exemptions and itemized deductions; no phaseouts applied. ATRA reinstates phaseouts at the $250,000 (single) and $300,000 (MFJ) adjusted gross income (AGI) thresholds.

Personal exemptions are phased out by 2% for every $2,500 over the threshold amount. This means that taxpayers will fully phase out the use of their personal exemptions at AGI levels of $372,501 (single) and $422,501 (MFJ). If a family has dependent children, it will lose the benefit of the children’s personal exemptions too.

Itemized deductions are phased out by 3% of AGI over the threshold amount. For example, a couple with a $500,000 AGI exceeds the threshold by $200,000. So, 3% of that excess AGI is $6,000, meaning that their allowable itemized deductions will be reduced by $6,000. Note, it’s NOT the total amount of itemized deductions that causes the phaseout; rather, it’s the level of the adjusted gross income. Therefore, taxpayers with large itemized deductions (charitable, mortgage interest, or otherwise) won’t see any phaseout unless AGI exceeds the stated thresholds.

Additionally, even if AGI does exceed the threshold, taxpayers shouldn’t be wary of increasing itemized deductions such as charitable contributions. Why? Because once a taxpayer understands his/her AGI and calculates the phaseout on the itemized deductions, any further itemized deductions beyond that phaseout amount will be fully deductible. In the previous example, the married couple knew their itemized deductions would only be phased out by $6,000 based on their AGI. If they choose to make additional contributions in excess of the $6,000 amount, they’ll be able to claim the full deduction for these contributions.

Capital Gains and the 3.8% Medicare Surtax on Investment Income: Which Rate Will Apply to You?

In recent years, taxpayers grew accustomed to a two-rate structure as it applied to long-term capital gains and qualified dividends. Taxpayers in the 10% and 15% marginal income tax brackets paid 0% tax, while taxpayers in the 25% and higher brackets paid 15% on their long-term capital gains and qualified dividends. It was fairly easy for taxpayers to quickly apply a 15% rate to a projected gain to determine the tax impact.

ATRA retained the 0% rate for taxpayers in the 10% and 15% brackets – a bonus for some of our retired clients relying on taxable brokerage account withdrawals, who are not yet subject to IRA minimum distribution rules. It also retained the 15% rate for those in the 25% – 35% brackets. Finally, ATRA increased the long-term capital gain/qualified dividend rate to 20% for those in the 39.6% marginal bracket.

But it doesn’t stop there. The ACA also introduced the 3.8% Medicare surtax on net investment income in excess of the $200,000 (single) and $250,000 (MFJ) AGI thresholds. Net investment income includes interest, dividends, capital gains, and rental income, among others. Layering the additional 3.8% surtax on top of the 15% and 20% brackets creates rate complexity as follows:

Single Income

Married Income

Long-Term Capital Gain Rate

Up to $36,250

Up to $72,500


Up to $200,000 AGI

Up to $250,000 AGI


Up to $400,000

Up to $450,000

15% + 3.8% = 18.8%

Above $400,000

Above $450,000

20% + 3.8% = 23.8%

Note, the 20% bracket doesn’t truly “exist.”  By the time income reaches the top marginal tax bracket of 39.6%, one is already subject to the additional surtax.

These differing rates will make tax planning even more challenging. One may make decisions about capital gain recognition earlier in the year, assuming the application of a given capital gain tax rate.  However, if overall income ends up higher later in the year, the previously recognized gains will, in fact, be taxed at a higher capital gain rate than planned. Timing of intentional capital gain recognition will prove to be critical in the years ahead.

Distributions to Charity from IRAs: Still Time to Take Advantage in 2013

We spend a good deal of time discussing charitable intentions with clients. One of the more favorable ATRA provisions is the ability for a taxpayer over the age of 70 ½ to distribute up to $100,000 tax-free from his/her IRA directly to a qualified charity. Doing so not only benefits the charity but the distribution can also be applied toward the taxpayer’s annual required minimum distribution amount. This can reduce the taxpayer’s overall income, possibly keeping the income at a level below the phaseout and surtax thresholds listed above. Note, however, that gifting appreciated securities directly to a charity is still a worthwhile strategy.

Moving Forward with Confidence

We’ve covered some of the details here, but please remember that there are countless others. As your 2012 tax returns are filed this spring, spend some time familiarizing yourself with your 2012 figures and start to think about any changes you anticipate in 2013. Your advisor will work with you in the year ahead to help you understand the impact of these new changes on your family.  Like you, we’ll also continue to keep our eyes and ears on Washington and stand ready to incorporate any new tax changes as they arise.

Truepoint Wealth Counsel is a fee-only Registered Investment Adviser (RIA). Registration as an adviser does not connote a specific level of skill or training nor an endorsement by the SEC. More detail, including forms ADV Part 2A & Form CRS filed with the SEC, can be found at Neither the information, nor any opinion expressed, is to be construed as personalized investment, tax or legal advice. The accuracy and completeness of information presented from third-party sources cannot be guaranteed.

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