The American Taxpayer Relief Act of 2012, which delayed the “fiscal cliff” aspect of the expiring tax laws, did more than just continue the existing tax brackets. Here is a brief summary of the tax changes for individuals. 

Continuation of Tax Brackets 

The ATRA law retains the existing tax brackets of 2012 and before, but adds one next tax bracket of 39.6% for incomes over $400,000. 

The new tax brackets for 2013 are as follows, (we list married filed jointly only; for brevity’s sake.)

• 10% on income from $0 to $17,850
• 15% on income from $17,850 to $72,500
• 25% on income from $72,500 to $146,400
• 28% on income from $146,400 to $223,050
• 33% on  income from $223,050 to $398,350
• 35% on income from $398,350 to $450,000
• 39.6% on taxable income over $450,000

The new 39.6% bracket was the highest bracket under the Clinton administration, although the levels were lower during that time. 

For head of household filers, the new 39.6% bracket applies at an income level of $425,000 and for single filers, the bracket applies at an income of $400,000.  

(In the rest of this column, we list only the income levels that apply to married filing jointly returns.) 

For persons with incomes in the 39.6% bracket, there are new capital gains and dividend tax rates as well. 

Capital Gains and Dividends

Also changed in the law, which received much less media attention at the time, are the new tax code for capital gains and dividends. 

The time period for long term capital gains remains at one year. Capital gains for periods of less than one year are added to and taxed as ordinary income. 

The long term capital gains rates remained unchanged for persons who are not in the 39.6% bracket. 

These are 0% capital gains rates for persons with incomes below $72,500 (the top of  the15% bracket) and 15% for persons with incomes above $72,500, but below $450,000. 

Persons with income over $450,000 will pay a new 20% rate on long term capital gains. 

The same new provisions also apply to dividends. Dividends from stocks held longer than one year will still benefit from preferential treatment of 0% for incomes up to $72,500 and 15% for incomes up to $450,000. 

Persons with incomes over $450,000 will now face a dividend rate of 20%, as they do with capital gains. 

Payroll Tax – Social Security 

The payroll tax holiday, meant to stimulate the economy for the past two years, was allowed to expire. 

This makes the FICA Social Security tax rate 6.2%, the level prior to 2% reduction enacted in 2011. 

It could have been argued that payroll taxes were increased by 48% (200 basis point increase over the 4.2% rate in 2012), but we never saw a mass media headline use that approach. 

Medicare Taxes – New Rates 

Medicare taxes, however, were raised to new higher levels.  There was also little fanfare over this increase. 

The Medicare tax rate of 1.45% was never altered by the Bush tax cuts, not was it part of the “payroll tax holiday” tax cut in Social Security contributions. 

For 2013 and beyond, the 1.45% tax rate applies to all payroll incomes with no upper limit. This is unchanged from prior tax law. 

However, for incomes exceeding $200,000, a new 0.9% Medicare tax is applied. This makes the Medicare tax rate 2.35% for incomes over $200,000. 

This Medicare tax is collected by employees and is not calculated as part of your return. 

Medicare Tax Rate – On Investment Income

A completely new aspect of the raised taxes in the ATRA bill is the Medicare tax on investment income. 

In addition to the increased Medicare tax on payroll income above $200,000, a new 3.9 % Medicare tax will be applied to net investment income over $250,000 (for married filing jointly returns).

This is in addition to the income tax paid on the net investment income and calculated separately. 

Again, there was very little media attention paid to this new increased Medicare tax on investment income.   

The Alternative Minimum Tax (AMT) 

The alternative minimum tax is designed to prevent taxpayers from avoiding tax through deductions and exemptions that would reduce the adjusted gross income (AGI) below certain levels. 

The alternative minimum tax is an alternative calculation of taxes owed, which must be applied if the reported AGI exceeds certain levels.  Whichever tax calculation yields the highest result is the tax that must be paid. 

For 2013 and forward, the AMT income levels are now $78,750 for married filing jointly returns, and $50,600 for single and head of household returns. These are roughly the same level as the top end of the 15% bracket. 

The new AMT levels will replace the levels of $45,000 and $33,750 that would have applied if the ATRA law had not been passed. 

The AMT, however, is still a complex calculation that is required, even if the result is no additional AMT tax.  

In our view, the AMT tax is a prime example of the complexity of the tax code and a core reason why a massive tax reform is needed, instead of the continued complexity of deductions and exemptions. 

Estate Taxes

Prior the passage of ATRA, the federal estate tax was 0% for all estate sizes. 

Had no action been taken, the federal estate tax would have risen to 50% for all estates over $1 million in size. 

The ATRA law changed the estate tax bracket to 40% for all estates, with a $5.25 million exemption.  This means an estate worth $6 million pays an estate tax of $300,000 (forty percent of the $750,000 over the $5.25 million exemption). 

In addition, the ATRA law retains the ability of a spouse to transfer their exemption level to their spouse’s estates, meaning a surviving spouse can apply a $10.5 million exemption to their estate before any estate tax is owed. 

Conclusions

The ATRA law has been widely portrayed as the avoidance of the fiscal cliff scenario that seemed so treacherous just a few months ago. 

However, the ATRA law did not address the sequestration issues that are now the center of the fiscal debate. 

Nevertheless, the ATRA law did remove some uncertainty about the future of taxation in the US, which is a positive for the economy. 

In particular, all of the ATRA tax brackets and provisions are permanent aspects of the law, with no set expiration date.  The rates and provisions could be changed by future legislation, but there is no temporary aspect of the new law as their was with the prior tax rates. 

In our view, the ATRA tax brackets will have little real impact on the federal spending problems, as the total amount of new revenue raised will likely be minimal (relative to the scale of the deficit). 

For the most part, the ATRA tax brackets were a political event, not a fiscal event. 

Nevertheless, from a selfish point-of-view, most taxpayers seem to be happy with the provisions of the ATRA tax law. 

Whether the passage of the ATRA tax brackets puts an end to persons blaming our fiscal troubles on the “Bush tax cuts” remains to be seen, however. 

Comments may be emailed to the author, Robert V. Green, at aheadofthecurve@briefing.com