Income Tax Update

With the elections a week away, there is a lot of talk of tax reform.  No matter who wins the presidential election, it will not be an easy road. 

The Joint Committee on Taxation, a nonpartisan congressional group that works with House and Senate tax writers has recently released a study that includes their recommendations for tax reform.  It is independent of any proposals made by either Obama or Romney.  It would lower tax rates, but at the expense of some big tax breaks.

Perhaps the most important recommendation made by the committee is the elimination of all itemized deductions.  This means that write-offs for mortgage interest, charitable contributions, medical expenses, property taxes, etc. would be eliminated.  All taxpayers would have to take the standard deduction. 

The proposal would also eliminate preferential tax rates on capital gains and qualified dividends.  This income would no longer be taxed at 15%, but would be considered ordinary income, subject to regular tax rates.

Interest on state and local bonds would now be taxed.  This would apply to all bonds sold after 2012.  Existing Municipal bonds would be covered under a grandfather clause, and would remain tax-free.

AMT (Alternative Minimum Tax) would also be repealed. All of these proposals assume that the Bush era tax cuts would lapse after the 2012 tax year, and would peg rates at about 1 to 1.5 % less than the pre-Bush rates.  Also assumed is that the child tax credit and earned income credit requirements would remain as they are now.  Exclusions for retirement plan contributions and employer-paid health insurance would also remain untouched.  Also, the tax savings generated by this plan could be used for deficit reduction, but at the expense of the 1% to 1.5% decrease from pre-Bush tax rates.

It will be interesting to see what happens tax-wise after the elections.  Expect big changes.

Tax changes for 2013:

The Social Security wage base will increase to $113,700, a $3600 increase over the 2012 figure.  This is the amount of earnings that are subject to withholding for Social Security.  The employer's rate of 6.2% will remain the same, but the employee's current withholding rate of 4.2% will probably go back up to the previous rate of 6.2%.  Again, this applies only to the first $113,700 of wages.  Earnings above that amount are not subject to Social Security withholding. 

Medicare withholding will remain at 1.45% of all compensation for both the employer's and employee's shares.  However, single filers earning over $200,000 will be subject to a 0.9% surtax.  Married filing jointly filers will also be subject to the same surtax if their earnings exceed $250,000.  The surtax does not affect the employer's Medicare rate, and self-employed workers will also be subject to the surtax.

Social Security benefits will increase 1.7%.  This increase is pegged to the inflation rate.

The maximum contribution to 401(k) plans will increase $500, to $17,500.  The maximum contribution for workers older than 50 years will remain at $23,000.  The maximum allowable contribution to IRAs and Roth IRAs will also increase $500, to $5500, with an extra $1000 catch-up contribution allowed to people over 50.

The above information is paraphrased from the October 26, 2012 edition of the Kiplinger Tax Letter.