The American Taxpayer Relief Act of 2012 (ATRA), perhaps more colloquially known as the “Fiscal Cliff” legislation, made several changes to the income tax landscape for 2013 and beyond. ATRA, of course, is just one of the elements that will affect high-income taxpayers in 2013. There is also the additional 0.9% Medicare tax on wages and a new 3.8% Medicare surtax on net investment income. Additionally, the 2 percentage point Social Security payroll tax holiday was not renewed. Thus, high income individuals will find that, depending on the amount and composition of their taxable income, their income tax liability in 2013 could be considerably greater than it is for 2012.

This Alert analyzes the federal tax positions of three hypothetical taxpayers, a single individual with $500,000 of gross income primarily from wages and taxpayers filing a joint return with gross incomes of $1 million and $5 million consisting of wages, portfolio and business income. Each of these sample taxpayers has representative amounts of earned/business, investment income, and itemized deductions based upon IRS published statistics for taxpayers with these levels of income. The examples illustrate the difference between the tax liability of each respective taxpayer for 2012 and 2013.

The key tax changes affecting these taxpayers in 2013 are:

  • An increase in the top ordinary income rate to 39.6% from 35% for taxable income in excess of $400,000 for individual filers and $450,000 for married joint filers
  • The expiration of the reduced employee portion of the Social Security payroll tax of 4.2% (commonly referred to as the “payroll tax holiday”) — back to 6.2%
  • The additional 0.9% Medicare tax on wages and self-employment (SE) income over $200,000 for individual filers and $250,000 for married joint filers
  • The increase in the tax rate on long-term capital gains and qualified dividends to 20% from 15% for income over $400,000 for individual filers and $450,000 for married joint filers
  • The 3.8% Medicare Contribution Tax on net investment income for income over $200,000 for individual filers and $250,000 married joint filers
  • Reinstatement of the personal exemption phase-out (PEP) and the 3% threshold for certain itemized deductions (Pease limit)
  • The alternative minimum tax (AMT) patch

The income and deduction characteristics are based on the IRS SOI Individual Statistical Tables for tax year 2009, with an adjustment for the level of long-term capital gains to historical levels.

As you can see, the tax bill for 2013 is likely to be significantly higher than 2012 for taxpayers who have taxable income in excess of $250,000. Taxpayers should plan accordingly — even if they are making estimated payments equal to 110% of their 2012 tax bill.