In previous years, there have been a number of changes in United States tax laws and regulations which were beneficial for the majority of taxpayers. Many of these changes helped to reduce taxpayers’ income tax liability when filing a return with the IRS. Currently, it seems that the time for lower tax rates is over, and a wide variety of taxpayers will have a higher tax liability in years to come.
Key Takeaway - Taxes are Going Up
While it’s true that the United States tax laws do not experience significant changes every year, it’s also true that US tax law concepts have been evolving since the inception of the IRS. A variety of changes were enacted by the Bush Administration when George W. Bush was still in office, and these changes were in favor of taxpayers. Some of these changes were lower rates of taxation, additional credits, and more deductions. While these tax changes have been helping taxpayers in previous years, it’s important to realize that they were not permanent changes. For example, a number of these changes were set to expire last year. As such, tax rates were supposed to return to what they were before George W. Bush took office; but Congress decided to extend the same tax laws to the end of 2012.
It is a popular belief that the tax changes which are scheduled to expire this year will do so under the Obama Administration and rates will be as they were before the Bush Administration took over. If this is the case, every taxpayer has a one-time golden opportunity to take action before the end of 2012. The areas of greatest concern for taxpayers are that of income tax and estate planning (gift and estate taxes included).
Marginal Tax Rates Go Back to 39.6%
One significant change in income taxes will be that of the marginal rate of taxation. The ceiling is currently set at 35%, but it is expected to increase back to 39.6%. Another significant change which is expected is that of qualified dividends. In recent years, investors have been able to claim dividends as investment income, or capital gains – allowing dividends to be taxed at the capital gains rate of 15%. Dividends are expected to be viewed as income and may be subject to a tax of as much as 39.6%, depending on the value of dividends. Not only are dividends scheduled to be viewed as income, the long term capital gains rate of taxation will be increasing from 15% to 20%.
Additionally, the Medicare tax for high income brackets will increase to 3.8%. With this increase, there are also changes to the types of income which are subject to the Medicare tax; it will not be simply wages which are taxed, but also business and investment income.
What You Should Do - Realize All Possible Gains in 2012
Due to all the changes which are expected to take place in 2013, it will probably make sense to certain taxpayers to realize as much income as possible to be taxed in 2012 with current rates rather than having it taxed at a much higher rate in the future. In order to realize as much income as possible in 2012, there may be other obstacles facing certain taxpayers, depending on which avenue is taken. For example, a taxpayer may decide to roll a traditional IRA over into a Roth IRA to avoid taxation. For help determining the best course of action for you to avoid high tax rates in 2013 or other years to come, make sure to contact a tax professional at Taxes for Expats.
As far as gift and estate taxes are concerned, you should be looking forward to 2 major changes upon expiration of the tax rules which have significantly decreased taxpayers’ liability in recent years. Exemption amounts for the lifetime gift tax and estate tax are poised to change drastically. The estate tax exemption experienced a gradual increase from $675K in 2000 to $5.12M in 2012, and this increase in exemptions made it so that many estates were not taxed at all. The lifetime gift exemption experienced a similar increase from $675K in 2000 to $1M. Even though the increase wasn’t as significant as the estate tax exemption, it still decreased tax liability for a number of taxpayers. In 2011, these 2 exemptions were ‘unified’ and the ceiling was the same for both in 2011 and 2012. As such, both of these exemptions are scheduled to revert back to $1M in 2013, leaving many taxpayers open to a higher rate of taxation on property and gift values in excess of the exemption amount.
There are those who believe that only the gift tax exemption amount will return to $1M and the estate tax exemption will drop to $3.5M. This is merely conjecture, though, and there is really no way of knowing exactly what will happen.
Another significant change which is scheduled to occur is that of the marginal rate of taxation for gift and estate taxes. The highest rate of taxation for the gift and estate tax is currently 35%, but it is scheduled to revert back to its 2001 level of 55%.
New Concept - Portability
Another possible change involves a fairly new concept known as portability, which was introduced in 2011. Portability applies to the estate tax and allows married couples to transfer estate exemption amounts upon the death of a spouse. If one spouse passes away and did not use his/her full exemption amount, the remainder of his/her exemption is carried over to the estate of the spouse who remains alive. Currently, portability allows married couples to pass a total of $10M (combined) to heirs without any tax liability. Portability is scheduled to expire at the end of 2012, and it is unclear whether or not this concept will be extended upon its expiration.
Due to these changes which are likely to occur, it may be feasible for taxpayers with significant assets to pass these assets to heirs before the end of 2012. When taking this course of action, it makes more sense to pass down assets which are going to (most likely) appreciate in value. To discuss your options on how to best deal with upcoming tax changes, contact a US expat tax professional today.
I.J. Zemelman, EA is the founder of Taxes for Expats