A number of significant federal income tax provisions expired at the end of 2011, a fact that might be easily overlooked with so much attention being focused on the "Bush tax cuts" that are still in effect, but scheduled to expire at the end of 2012. And new Medicare-related taxes, effective in 2013, have received surprisingly little coverage. Of course, new legislation could always extend some or all of these provisions, but here's a quick summary of how things stand.
- Alternative minimum tax (AMT)-- A series of temporary legislative "patches" over the last several years has prevented a dramatic increase in the number of individuals subject to the AMT--essentially a parallel federal income tax system with its own rates and rules. The last such patch expired at the end of 2011. Unless new legislation is passed, your odds of being caught in the AMT net greatly increase in 2012, because AMT exemption amounts will be significantly lower, and you won't be able to offset the AMT with most nonrefundable personal tax credits.
- Qualified charitable distributions-- This popular provision allowing individuals age 70½ or older to make qualified charitable distributions of up to $100,000 from an IRA directly to a qualified charity expired at the end of 2011. These charitable distributions were excluded from income and counted toward satisfying any required minimum distributions that you would have had to take from your IRA for the year.
- Bonus depreciation and IRC Section 179 expense limits -- If you're a small business owner or self-employed individual, you were allowed a first-year depreciation deduction of 100% of the cost of qualifying property acquired and placed in service during 2011; this "bonus" depreciation drops to 50% for property acquired and placed in service during 2012, and disappears altogether in 2013. For 2011, the maximum amount that you could expense under IRC Section 179 was $500,000; in 2012, the maximum is $139,000; and in 2013, the maximum will be $25,000.
- State and local sales tax-- If you itemize your deductions, 2011 was the last tax year for which you could elect to deduct state and local general sales tax in lieu of state and local income tax.
- Education deductions-- The above-the-line deduction (maximum $4,000 deduction) for qualified higher education expenses and the above-the-line deduction for up to $250 of out-of-pocket classroom expenses paid by education professionals both expired at the end of 2011.
- Federal income tax rates-- After December 31, 2012, we're scheduled to go from six federal tax brackets (10%, 15%, 25%, 28%, 33%, and 35%) to five (15%, 28%, 31%, 36%, and 39.6%).
- Long-term capital gains rate-- Currently, long-term capital gain is generally taxed at a maximum rate of 15%. And, if you're in the 10% or 15% marginal income tax bracket, a special 0% rate generally applies. Starting in 2013, however, the maximum rate on long-term capital gains will generally increase to 20%, with a 10% rate applying to those in the lowest (15%) tax bracket (though slightly lower rates might apply to qualifying property held for five or more years). And while the current lower long-term capital gain rates now apply to qualifying dividends, starting in 2013, dividends will be taxed at ordinary income tax rates.
- 2% payroll tax reduction-- The recently extended 2% reduction in the Social Security portion of the Federal Insurance Contributions Act (FICA) payroll tax expires at the end of 2012.
- Itemized deductions and personal exemptions-- Beginning in 2013, itemized deductions and personal and dependency exemptions will once again be phased out for individuals with high adjusted gross incomes (AGIs).
- Tax credits and deductions-- The earned income tax credit, the child tax credit, and the American Opportunity (Hope) tax credit revert to old, lower limits and (less generous) rules of application. Also gone in 2013 is the ability to deduct interest on student loans after the first 60 months of repayment.
- Marriage penalty relief-- Tax changes that were originally made to address a perceived "marriage penalty" expire at the end of 2012. If you're married and file a joint return with your spouse, you'll see the effect in the form of a reduced 2013 standard deduction amount, as well as in lower 2013 tax bracket thresholds in the tax rate tables (i.e., couples move into higher rate brackets at lower levels of income).
Two new Medicare-related taxes created by the health-care reform legislation passed in 2010 take effect in 2013:
- Additional Medicare payroll tax-- The hospital insurance (HI) portion of the payroll tax--commonly referred to as the Medicare portion--increases by 0.9% (from 1.45% to 2.35%) for those with wages exceeding $200,000 ($250,000 for married couples filing jointly, and $125,000 for married individuals filing separately). The rate for self-employed individuals increases from 2.9% to 3.8% on any self-employment income that exceeds the dollar thresholds above.
- Medicare contribution tax on unearned income-- A new 3.8% Medicare contribution tax is imposed on the unearned income of high-income individuals. The tax generally applies to the net investment income of individuals with modified adjusted gross income that exceeds $200,000 ($250,000 for married couples filing jointly, and $125,000 for married individuals filing separately).