Impact of Higher Individual Federal Tax Rates

Media outlets have focused a great deal of attention on the topic of increased individual federal tax rates, especially on high-profile athletes. Yes, tax rates have increased for some, but not for everyone. While most wage earners have seen their take-home pay shrink due to higher payroll taxes, high-income taxpayers are really feeling the pain of higher tax rates in addition to new taxes.

Let’s take a look at the reasons for the higher federal tax rates on ordinary income and investment gains. First, the Patient Protection and Affordable Care Act (2010 Health Care Act) added a new 3.8% net investment income tax (NIIT). This new tax is paid, in addition to other taxes, on the lesser of (1) net investment income or (2) the excess of modified adjusted gross income (MAGI) over specific threshold amounts. Those thresholds are $250,000 (joint filers), $125,000 (married separate filers), and $200,000 (single and HOH filers).

Next, the American Taxpayer Relief Act of 2012 (2012 Taxpayer Relief Act) added a new 39.6% rate for taxpayers with taxable income of at least $450,000 (joint filers), $250,000 (married separate filers), $425,000 (HOH filers), and $400,000 (single filers). Finally, the 2012 Taxpayer Relief Act also added a new 20% capital gains rate on gains in excess of the threshold amounts listed above.

What this means is that, starting this year, a taxpayer’s marginal tax rate on ordinary income could increase from 35% in 2012 to 39.6% in 2013. In addition, the tax rate on long-term investment gains could increase from a maximum of 15% in 2012 to 20% in 2013. When coupled with the NIIT, the marginal rate on ordinary income could be as high as 43.4% compared with a maximum of 35% last year. And, unfortunately, the tax rate on long-term investment gains could be as high as 23.8% (20% + 3.8% NIIT) in 2013 vs. 15% in 2012.

The 2010 Health Care Act also added the Additional 0.9% Medicare Tax. This tax is assessed on wages and self-employment income in excess of specific MAGI threshold amounts: $250,000 (joint filers), $125,000 (married separate filers), and $200,000 (single and HOH filers).

So, now more than ever, effective tax planning is necessary to minimize your tax bill. There are many ways to reduce the impact of federal taxes.

Please contact Martini, Iosue & Akpovi by phone at (818) 789-1179 if you have questions or want more information on this tax-saving opportunity.

 

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