By the time January 1, 2013 rolls around, it may be too late to take advantage of the current tax rates from the Bush era.  To refresh your memory, the Bush tax cuts were enacted in 2001 and 2003 and scheduled to expire in 2011.  President Obama signed legislation in 2010 that temporarily extended the Bush tax cuts through 2012.  It is unlikely that the Bush tax cuts will be extended again until the election is over, and even then it’s anyone’s guess as to what will happen.  So call your accountant and get your parachute ready, it’s time to start planning for the so called fiscal cliff.  Here are a few of the impending changes:

1) Individual Income Tax Rates:  Ordinary income tax rates will increase for most individuals in 2013.  Also, qualified dividend income will be taxed at ordinary income as opposed to the current long term capital gains rate.  Also, there will be a marriage penalty for many taxpayers by pushing them into the 28% tax bracket. 

Tax Brackets (2012 Dollar Amounts) Marginal Rate
Unmarried Filers Married Joint Filers    
Over But Not Over Over But Not Over 2012 2013
$0 $8,700 $0 $17,400 10% 15%
8,700 35,350 17,400 70,700* 15% 15%
35,350 85,650 70,700* 142,700 25% 28%
85,650 178,650 142,700 217,450 28% 31%
178,650 388,350 217,450 388,350 33% 36%
388,350 388,350 35% 39.6%

2) Long Term Capital Gains Rate:  The maximum rate on long term capital gains is scheduled to increase from 15% to 20%.  Additionally, tax payers in the 10 and 15% ordinary income tax bracket currently pay no long term capital gains tax.  They will be subject to a 10% long term capital gains tax in 2013.

Maximum Rates 2012 2013 2013 (including Medicare contribution tax)
Long-Term Capital Gain 15% 20% 23.8%
Qualified 5-Year Capital Gain 15% 18% 21.8%

Possible Strategy: Consider disposing of assets such as stocks, real estate and businesses which have a long term gain to avoid the possible tax increase.

 3) Dividend Income Rates: Bush created a special category of dividend income called “qualified dividend income” which allows dividend income received from domestic corporations and some foreign corporations to be taxed at the long term capital gains tax rate.   In 2013, this QDI will be taxed at the ordinary income tax rate. 

Maximum Rates 2012 2013 2013 (including Medicare contribution tax)
Qualified Dividend Income 15% 39.6% 43.4%
Ordinary Dividend Income 35% 39.6% 43.4%

Possible strategy:  Owners of closely held corporations should consider taking a higher than usual dividend payment in the current 2012 tax year to avoid the higher rate next year.

4) Medicare 3.8% Contribution Tax: A new 3.8% tax on ordinary income is going into effect in 2013 as a way of paying for Obamacare and will take place regardless of the extension of the Bush Tax Cuts.  This tax comes into play if your AGI or adjusted gross income exceeds $200,000 for unmarried individuals, and $250,000 for married couples.  Please consult your accountant on this issue, as it is quite complicated.

Possible strategy: Investors in pass-through entities such as partnerships, LLCs, and S corporations should also review the tax distribution language in the relevant entity agreement to ensure that future tax distributions will account for this new tax.

The above represents just a small portion of the changes that are going into effect for 2013.  I hope it helps you to start thinking about your tax planning strategy moving forward.  It helps to make sure your parachute is in proper working order before you are forced to jump off the fiscal cliff!  

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