What’s New on Your 2013 Form 1040

Last year’s W-2s and 1099s should be arriving in your mailbox or inbox soon. So it’s officially time to start thinking about filing your 2013 personal tax return.

Here’s what you need to know about the key tax law changes that took effect in 2013:

Higher Rates for Upper-Income Individuals

Most individuals will pay the same federal income tax rates for 2013 that they did for 2012 (10, 15, 25, 28, 33 and 35 percent). The exception is upper-income folks. For them, the American Taxpayer Relief Act (ATRA) raised the maximum federal rate for 2013 to 39.6 percent (up from 35 percent). The 39.6 percent rate affects singles with taxable income above $400,000, married joint-filing couples with income above $450,000 and heads of households with income above $425,000.

Same-Sex Married Couples Must File As Married

Thanks to a 2013 Supreme Court decision, same-sex marriages that are recognized under state or foreign laws must now be recognized for federal tax purposes. So folks who were married under such laws as of December 31, 2013 must use either married joint-filer status or married filing separate status for their 2013 returns.

In most cases, filing jointly will lower the couple’s combined tax bill. But not always. Regardless of the tax consequences, however, legally married same-sex couples cannot file their federal returns as unmarried individuals for 2013 and beyond.

Note that the IRS says that same-sex couples who have entered into state law civil union or domestic partnership arrangements (as opposed to state law marriages) are still considered unmarried for federal tax purposes.

Higher Capital Gains Rates and New Tax

Most individuals will also pay the same federal income tax rates on long-term capital gains and dividends as in 2012. But for upper-income folks, the ATRA raised the maximum rate for 2013 to 20 percent (up from 15 percent). The 20 percent rate affects singles with taxable income above $400,000, married joint-filing couples with income above $450,000 and heads of households with income above $425,000.

But that’s not all. Starting in 2013, upper-income folks can also expect to get socked with the new 3.8 percent Medicare contribution tax on all or part of net investment income, including long-term capital gains and dividends. In other words, the maximum federal rate on long-term gains and dividends for 2013 is actually 23.8 percent (20 percent capital gains tax plus 3.8 percent Net Investment Income Tax). In 2012, long-term gains and dividends were subject to a maximum tax rate of just 15 percent.

The new 3.8 percent Net Investment Income Tax (or NIIT) can also potentially hit other types of income too, such as:

  • Short-term capital gains;
  • Interest;
  • Rental income;
  • Royalties;
  • Income and gains from passive investments in partnerships, limited liability companies and S corporations; and
  • The taxable portion of gains from selling personal residences.

You will be hit with the NIIT if your adjusted gross income (AGI) exceeds $200,000 if you are unmarried or $250,000 if you are a married joint-filer. It’s charged on the lesser of your net investment income or the amount by which your AGI exceeds the applicable threshold.

Example: A married joint-filing couple with 2013 AGI of $300,000 and $75,000 of net investment income will owe the 3.8 percent tax on $50,000 (the lesser of their AGI in excess of the $250,000 threshold for joint filers or their $75,000 of net investment income). The NIIT equals $1,900 (3.8 percent times $50,000).

If the same couple has 2013 AGI of $350,000, they will owe the 3.8 percent tax on $75,000 (the lesser of their AGI in excess of the $250,000 threshold for joint filers or their $75,000 of net investment income). The NIIT equals $2,850 (3.8 percent times $75,000).

Additional Medicare Tax on Wages and Self-Employment Income

Before 2013, the Medicare tax on salaries and self-employment income was a flat 2.9 percent. For an employee, 1.45 percent was withheld from paychecks and the other 1.45 percent was paid directly by the employer. Self-employed sole proprietors, partners and LLC members paid the whole 2.9 percent themselves. That was then.

Starting in 2013, a 0.9 percent Additional Medicare Tax is charged on salary and self-employment income above $200,000 for an unmarried individual or combined salary and self-employment income above $250,000 for a married joint-filing couple. If you are self-employed, the 0.9 percent Additional Medicare Tax is owed as part of your self-employment tax bill.

Personal and Dependent Exemption Phase-out

Personal and dependent exemptions weren’t phased out from 2010 through 2012. Regardless of how much you earned, you could deduct the full amount of your allowable exemptions when calculating your federal taxable income.

But now an exemption phase-out rule is back on the books for 2013 and beyond. This may significantly lower or completely eliminate your personal and dependent exemption write-offs. In 2013, exemptions begin to be phased out at the following adjusted gross income (AGI) thresholds: $250,000 for singles, $300,000 for married joint-filing couples and $275,000 for heads of households.

Itemized Deduction Phase-out

Itemized deductions also weren’t phased out from 2010 through 2012. Unfortunately, the itemized deduction phase-out rule was resurrected for 2013 and beyond. This phase-out can significantly reduce your write-offs for home mortgage interest, state and local income and property taxes, charitable donations, and miscellaneous itemized deduction items, such as investment expenses and fees for tax advice and preparation.

The itemized deduction phase-out starts at the following AGI thresholds: $250,000 for singles, $300,000 for married joint-filing couples, and $275,000 for heads of households. Your affected itemized deductions are reduced by 3 percent of the amount by which your AGI exceeds the applicable threshold. However, the reduction cannot exceed 80 percent of the total affected deductions that you started off with.

Example: A married joint-filing couple has 2013 AGI of $500,000 and $75,000 of itemized deductions for home mortgage interest, state and local income and property taxes, and charitable donations. Under the phase-out rule, these deductions are cut back by $6,000 (3 percent of $200,000 of AGI in excess of the $300,000 threshold for joint filers).

Say a wealthy married joint-filing couple has 2013 AGI of $3 million and $100,000 of itemized deductions for home mortgage interest, state and local income and property taxes, and charitable donations. Under the phase-out rule, these deductions are cut back by $80,000 (the lesser of 3 percent of $2.7 million of AGI in excess of the $300,000 threshold or 80 percent of the $100,000 of affected itemized deductions).

Higher Threshold for Medical Deductions

Before 2013, you could claim an itemized deduction for medical expenses paid for you, your spouse, and your dependents, to the extent the expenses exceeded 7.5 percent of AGI. Starting in 2013, the hurdle is raised to 10 percent of AGI. However, if either you or your spouse was age 65 or older as of Dec. 31, 2013, the new higher AGI threshold will not affect you until 2017.

 Tax Season ID Theft Concerns

Tax season is a good time to remind you about the dangers of tax identity theft. IRS impersonation schemes continue to flourish. But the IRS never initiates contact with taxpayers by e-mail or social media to request personal or financial information. The initial contact with taxpayers is always through the U.S. mail. If you receive an e-mail or social media solicitation that appears to come from the IRS, imposters may be trying to steal your identity.

Filing Tips

Sometimes identity thieves file fraudulent tax refund claims using stolen personal information. If a thief files for a refund before you do, your refund will likely be delayed. The IRS typically takes about 180 days to resolve a typical ID theft case. Your first line of defense against fraudulent tax refund claims is to file as early as possible.

If you file electronically, save the file to a CD or flash drive and then delete the personal return information from your hard drive. Store the CD or flash drive in a safe place, such as a lock box or safe.

If you file by mail, go to the post office. Never send your tax return from an unlocked mailbox in front of your house.

If Fraud Strikes

Victims will receive a notice from the IRS if more than one tax return is filed under their Social Security numbers or if the income reported on their tax returns is less than the amounts reported on their W-2 and 1099 forms. If this happens to you, respond immediately by calling the number on the notice.

If you didn’t receive an IRS notice but believe your personal information has been stolen, contact the IRS Identity Protection Specialized Unit at 800-908-4490, extension 245. Fill out an IRS Identity Theft Affidavit and call your accountant for further guidance.

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