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Annette Nellen
Annette Nellen
What's my rate?

A few legislative changes effective for 2013, as well as the U.S. Supreme Court’s DOMA decision, may cause many individuals to wonder what their 2013 tax rate is.

December 12, 2013
by Annette Nellen, Esq., CPA

The American Taxpayer Relief Act (ATRA), P.L. 112-240, wrought something that had not been in effect for more than 10 years—a permanent rate structure, starting in 2013. It also brought back the phaseouts for itemized deductions and personal exemptions, with new threshold amounts. In addition, changes to the alternative minimum tax (AMT) remove millions of low- to middle-income individuals from its reach. Two new taxes included in the Patient Protection and Affordable Care Act (PPACA), P.L. 111-148, and the Health Care and Education Reconciliation Act, P.L. 111-152 (together, the health care reform laws), namely the additional Medicare tax and net investment income tax, are effective starting in 2013.

These changes will likely cause many individuals to wonder what their average or marginal tax rates are. It will not be easy to answer that question as it is affected by such factors as filing status, the nature of their income, and the mix of their deductions. One more 2013 change that will affect some taxpayers is the U.S. Supreme Court’s decision in Windsor, No. 12-307 (6/26/13), and the IRS’s release of Rev. Rul. 2013-17. This change will both enable and require legally married same-sex couples to file their 2013 and beyond returns as married filing jointly or separately. Tax rates, phaseouts, and special rules apply differently to a married couple than to single filers. This new filing status will likely lead many same-sex married couples to also ask for 2013—what is my rate?

This article summarizes these new rules that affect an individual’s tax rate(s) and liability for 2013 to help answer a client’s question that might come in some variation of the following:

  • What is my tax rate?
  • Am I a high-income taxpayer subject to new higher rates and special taxes?

The 39.6% bracket

Under ATRA, individuals are subject to the highest income tax rate of 39.6% on taxable income that exceeds these thresholds for 2013:

  • Married filing jointly and surviving spouses, $450,000;
  • Married filing separately, $225,000;
  • Single, $400,000; and
  • Head of household, $425,000.

The above brackets, provided in Sec. 1, are indexed annually for inflation (see Rev. Proc. 2013-35 for the 2014 thresholds and tax tables).

The tax rate schedules for 2013 for each filing status showing income ranges for the 10%, 15%, 25%, 28%, 33%, 35%, and 39.6% brackets follows. [Joint Committee on Taxation, General Explanation of Tax Legislation Enacted in the 112th Congress (JCS-2-13) (Bluebook), page 88.]

Capital gains tax rate structure

ATRA provides a permanent capital gains rate structure of 0%, 15%, and 20% on adjusted net capital gains and qualified dividends. The rate structure applies as follows (Sec. 1(h)):

  • 0% if otherwise taxed at 10% or 15%;
  • 15% if otherwise taxed above 15%, but below 39.6%;
  • 20% if otherwise taxed at 39.6%;
  • 25% maximum rate on unrecaptured Sec. 1250 gains; and
  • 28% maximum rate on collectibles and Sec. 1202 gains (with some exceptions).

Phaseout of itemized deductions and personal exemptions

ATRA provides new, inflation-adjusted amounts for two long-standing phaseouts:

  • Sec. 68: Overall limitation on itemized deductions; and
  • Sec. 151(d)(3): Phaseout of personal exemptions.

For 2013, the phaseout starts when adjusted gross income (AGI) reaches the following thresholds:

  • Married filing jointly and surviving spouse, $300,000;
  • Married filing separately, $150,000;
  • Single, $250,000; and
  • Head of household, $275,000.

Top AMT rate of 28%

ATRA permanently increased the AMT exemption amount for individuals and indexed the AMT exemption amount,  the dollar level at which the exemption begins to phase out, and the threshold for the start of the 28% AMT rate. In 2013, individuals are subject to the top AMT rate of 28% if their “taxable excess” (alternative minimum taxable income (AMTI) less the exemption amount) is $179,500 for all filing statuses other than married filing separate, which has a limit of $89,750 (Sec. 55 and Rev. Proc. 2013-15).

Net investment income tax

Two new taxes that start in 2013 were enacted by the health care reform laws in 2010. The net investment income tax, also referred to as the 3.8% Medicare tax, applies to individuals with net investment income and modified AGI (MAGI) above a specified threshold (Sec. 1411):

  • Married filing jointly and surviving spouse, $250,000;
  • Married filing separately, $125,000;
  • Single, $200,000; and
  • Head of household, $200,000.

The above amounts are not indexed for inflation.

The tax equals 3.8% of the lesser of:

  • Net investment income; or
  • The excess (if any) of MAGI less the threshold amount.

The MAGI is defined as AGI plus the excess of the Sec. 911(a)(1) foreign earned income exclusion amount over deductions or exclusions under Sec. 911(d)(6).

Additional Medicare tax

The other new tax for 2013, also created by the health care reform laws, is part of the hospital insurance (Medicare) tax imposed on wages (Sec. 3101(b)) and self-employment income (Sec. 1401(b)). The thresholds that must be surpassed for this additional 0.9% employment and self-employment tax to apply are as follows:

  • Married filing jointly and surviving spouse, $250,000;
  • Married filing separately, $125,000;
  • Single, $200,000; and
  • Head of household, $200,000.

While the dollar value of these thresholds is the same as for the net investment income tax, the measure of the thresholds differs. MAGI is used for the Sec. 1411 net investment income tax, while wages and/or self-employment income are used for the additional Medicare tax. As with the net investment income tax thresholds, those for the additional Medicare tax are not indexed for inflation.

For an individual or married couple with both wages and self-employment income, the threshold to be applied for the self-employment income is first reduced by the wages unless they are Railroad Retirement Tax Act wages (Regs. Sec. 1.1401-1(d)(2)).

Example. Ed and Amy are married and file a joint return. In 2013, Ed has wage income of $230,000, and Amy has self-employment income of $160,000. The threshold to be used to determine the additional Medicare tax on the self-employment income is $20,000 ($250,000 threshold less the $230,000 of wages). Additional Medicare tax owed is $1,260 [($160,000 self-employment income less revised threshold of $20,000) × 0.9%].

Same-sex married couples

A same-sex married couple will have a new rate structure for 2013 because they will file their federal return reflecting their marital status (married filing jointly or separately). This change is the result of the U.S. Supreme Court’s Windsor decision, which held that Section 3 of the Defense of Marriage Act (DOMA) is unconstitutional. Section 3 defined “marriage” for federal purposes as “only a legal union between one man and one woman as husband and wife.” Following the Court’s ruling, the IRS issued Rev. Rul. 2013-17, which provides that a return filed on or after Sept. 16, 2013, by a same-sex married couple must reflect that marital status. This is true regardless of whether the couple currently reside in a state that recognizes their marriage.

In addition, these couples will face a lower threshold for application of the net investment income tax and additional Medicare tax ($250,000 for married filing jointly versus each having a $200,000 threshold if a nonmarried filing status applied). They will face other married-filing-jointly thresholds that are less than double the single or head-of-household thresholds, such as for the phaseout of itemized deductions and personal exemptions.

Summary

The special rules and taxes described above operate in different ways, which will likely leave individuals wondering what the tax effect is of having one more dollar of income. Consider the differences summarized in the following table for a married couple filing jointly in 2013.

Tax or Rule

Threshold Value When Applicable

Threshold Definition

Tax Affected

39.6% rate

$450,000
(unless the excess is adjusted net capital gains and qualified dividends, which would be taxed at 20%)

Taxable income

Regular tax
(Chapter 1 tax)

Phaseout of itemized deductions and personal exemptions

$300,000

AGI

Regular tax
(Chapter 1 tax)

28% AMT rate

$179,500

Taxable excess (AMTI less AMT exemption)

AMT
(Chapter 1 tax)

Net investment income tax

$250,000

MAGI (AGI plus excess of Sec. 911(a)(1) exclusion amount over deductions or exclusions per Sec. 911(d)(6) related to the Sec. 911 exclusion)

Unearned income Medicare tax (Chapter 2A tax)

Additional Medicare tax

$250,000

Wage and self-employment Income

Employment tax

 

These rules and special taxes will likely leave individuals wondering how they work in combination. That is not easy to explain because of the different definitions for the threshold amount. Consider the following:

Example. In 2013, Joe, a single individual, has wage income of $230,000 and interest income of $10,000. His personal exemption is $3,900 and he has $20,000 of interest expense on acquisition debt and $16,100 of state income taxes. Thus, Joe’s AGI is $240,000 and his taxable income is $200,000.

Tax or Rule

Effect on Joe

39.6% Rate

Joe’s taxable income is $200,000, which is below the $400,000 threshold for the 39.6% rate.

Phaseout of itemized deductions and personal exemptions

Joe’s AGI is $240,000, which is below the $250,000 threshold for these phaseouts.

28% AMT rate

Joe is subject to the 28% AMT rate. His taxable excess is $194,250 ($220,000 of AMTI less an exemption of $25,750). Joe owes $669 of AMT (tentative minimum tax of $50,800 less regular tax of $50,131) (Form 6251, Alternative Minimum Tax—Individuals).

Net investment income tax

Joe is subject to this tax because his MAGI exceeds $200,000 and he has net investment income. Joe owes net investment income tax of $380 ($10,000 × 3.8%) (Form 8960, Net Investment Income Tax—Individuals, Estates, and Trusts).

Additional Medicare surtax

Joe is subject to this tax because his wages exceed $200,000. The tax is $270 ($30,000 × 0.9%). This tax should have been withheld from Joe’s wages by his employer and included on his W-2, Wage and Tax Statement (Form 8959, Additional Medicare Tax).

 

Joe’s total federal taxes reported on his 2013 Form 1040, U.S. Individual Income Tax Return:

• Regular tax $50,131
• AMT 669
• Net investment income tax 380
• Additional Medicare tax 270
Total $51,450
Average tax rate 21.44%

Joe’s marginal tax rate—what rate his next dollar of income would be taxed at—depends on whether that dollar is wages, investment income, or neither. Also, as Joe’s income increases, his AMT exposure decreases as he is already in the 33% tax bracket for regular tax purposes.

While the additional Medicare tax will show up on Joe’s Form 1040, including it in his average or marginal tax calculation is somewhat misleading because other employment taxes Joe paid are not included on his return. To enable Joe to see all that he paid to the federal government or to figure his average tax rate, his share of payroll taxes on his wages should also be included (in addition to the $270 additional Medicare tax already included above).

The new rate structure and two new health care reform taxes in place for 2013 will likely leave some clients with questions about their total federal tax liability, marginal tax rate, and the impact of tax planning and additional income. Unfortunately, it won’t always be easy to explain.

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Annette Nellen, Esq., CPA, is a tax professor and director of the MST Program at San José State University. She is an active member of the tax sections of the AICPA, ABA, and California State Bar. She is a member of the AICPA Tax Executive Committee and Tax Reform Task Force. She has several reports on tax policy and reform and a blog.