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The Truth About Taxes in 2013

The new American Taxpayer Relief Act is actually going to create higher taxes for many of our clients.

Sandra L. Atkins and Helen Modly, 03/14/2013

Now that the dust has settled, it's time to take a look at how the American Taxpayer Relief Act of 2012 is really going to work. It doesn't look like much "relief" for most taxpayers. In fact, those with moderate to high income are only going to be relieved of the money in their wallets.

The new act is going to create higher taxes for many of our clients. Even if their taxable income isn't over the $450,000 threshold to join the new highest bracket of 39.6%, they may still pay higher taxes due to phase-outs of personal exemptions and itemized deductions. Anyone with income over $200,000 will also be faced with Medicare taxes on both earned income and investment income as a result of Obamacare. And the marriage penalty is back with a vengeance for couples where both spouses work and make similar incomes.

Sources of New or Higher Taxes That Take Effect in 2013

Ordinary income tax rate changes
Single taxpayers with taxable income above $400,000 and married couples with taxable income above $450,000 will fall into the new 39.6% bracket. For taxpayers under these amounts, their ordinary tax rates might actually go down a bit because the brackets were indexed for COLA.

Capital gains and qualified dividends tax rate
The same taxpayers that are subject to the new higher income tax bracket will also see an increase of 5% on the qualified dividends and long-term capital gains rate--from 15% to 20%.

Itemized deductions phase-out
Itemized deductions (except for medical, investment interest, and gambling losses) are subject to a phase-out of 3% of adjusted gross income (AGI) over $250,000 for singles and $300,000 for married couples. According to Don Farmer, CPA, in his annual income tax update, this adds 1% or more to the effective marginal tax rate, depending on the taxpayer's tax bracket.

Personal exemptions phase-out
Personal exemptions are subject to a phase-out of 2% for each $2,500 of AGI over $250,000 for singles and $300,000 for married couples. This means that at an AGI of $372,500 for singles and $422,500 for married couples, the exemptions are fully phased out. According to Farmer, this adds the equivalent of another 1% or more to the effective marginal tax rate for each exemption.

Medicare taxes
The Medicare taxes will be felt in two areas. A 0.9% tax on earned income over $200,000 for singles and $250,000 for married individuals will be withheld by employers for salaried employees. Self-employed taxpayers will have to calculate the tax on their return.

Sandi Atkins, CPA/PFS, is president of Focus Wealth Management, a fee-only registered investment advisor in Middleburg, Va. In 2008, she was named by Wealth Manager Magazine as one of the 50 Distinguished Women in Wealth Management.

Helen Modly, CFP, CPWA, is executive vice president of Focus Wealth Management, a fee-only registered investment advisor in Middleburg, Va. Modly has more than 25 years of experience providing wealth-management services. She is a member of NAPFA and president-elect for the National Capital Area chapter of FPA. She can be reached at info@focus-wealth.com. The author is a freelance contributor to MorningstarAdvisor.com. The views expressed in this article may or may not reflect the views of Morningstar.

The authors are not employees of Morningstar, Inc. The views expressed in this article are the authors'. They do not necessarily reflect the views of Morningstar.

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