How will the major tax changes approved by Congress affect your returns?
Taxpayers will find out soon as they plug figures into their tax returns, due April 15, and see for the first time the impact of last year’s federal tax law changes.
To get an idea of what they might find, the Globe asked tax preparer H&R Block to create some tax return scenarios, calculating tax liability under both the 2012 and 2013 tax rules using the same income numbers for both years.
The result: Taxpayers who are married and filing jointly with income of $250,000 or less may be pleased to find their taxes declining a bit. Even couples making $450,000 — enough to trigger most of the thresholds for new taxes, phased-out deductions, and phased-out personal exemptions — probably won’t see a dramatic increase in their tax bill.
But as annual income rises above that level, so do tax bills. Despite all the news coverage about the new tax laws, that may still come as a surprise to many.
Moreover, the numbers will vary even among those with similar incomes, said Bob Lepson, vice president of financial planning at Braver Wealth Management in Needham. “The specific makeup of your income will make a big difference,” he said.
For example, a couple earning $1 million but with no investment income will be untouched by the new 3.8 percent tax on net investment income. That couple will also be subject to the phase-out of itemized deductions, but they’ll feel the sting more acutely if they have substantial itemized deductions such as a big home mortgage.
Taxpayer unhappiness, however, may not be directly related to any actual increase in taxes. People are often more focused on the size of the check that they have to write when they file rather than the amount of their total tax bill, said Jackie Perlman, H&R Block principal tax analyst. And the size of that check will depend largely on taxes withheld from paychecks and any estimated taxes paid in 2013.
According to H&R Block, here’s what happens to the tax bill of hypothetical couples whose salaries, investment income, property taxes, and family size are exactly the same as in 2012. In each of these scenarios, investment income is $25,000 a year while the amount of property taxes, mortgage interest, state and local taxes, and charitable contributions increases as income rises. While these scenarios are based on married couples filing jointly, the same principles apply to individual filers, but with lower thresholds.
THE $250,000 COUPLE
Married, employed, and with two dependent children, this couple doesn’t make enough to trigger any of the new tax thresholds. As such they escape:
■ The new 0.9 percent Medicare tax on earned income above $250,000 for those married filing jointly.
■ The 3.8 percent Medicare surtax on net investment income for those with modified adjusted gross income over the $250,000 married-filing-jointly threshold.
■ The phaseout of personal exemptions and itemized deductions, which is triggered when adjusted gross income exceeds $300,000 for couples filing jointly.
■ Higher tax rates, which go into effect once taxable income exceeds $450,000 for couples filing jointly. The top marginal rate jumps to 39.6 percent from 35 percent for 2012, and the top tax rate on capital gains goes to 20 percent from 15 percent.
This $250,000 couple, in fact, would experience a 1 percent decrease in taxes. The reason: Inflation indexing means personal exemptions increase to $3,900 per exemption in 2013 from $3,800 in 2012, a total increase of $400 for their family of four. As a result, this couple would pay $41,198 in taxes, which is $425 less than they paid for 2012.
THE $450,000 COUPLE
This couple makes just enough to trigger every new threshold except the higher income tax and capital gains tax rates. Under the 2013 rules, they lose their personal exemptions, get $4,500 trimmed from itemized deductions, and must pay the new Medicare and net investment income taxes.
Yet their 2013 tax bill is only $1,363 higher than it was for 2012, a 1.4 percent increase. Why so small? A “permanent patch” on the alternative minimum tax, or AMT, approved last year means this couple pays $6,844 less in AMT than they did for 2012. The AMT, originally designed to keep wealthy taxpayers from using tax loopholes to avoid taxes, was affecting a growing number of middle-class taxpayers because it didn’t automatically adjust for inflation. Last year, Congress replaced periodic annual “patches” with a permanent inflation adjustment.
Scenarios for couples with income at $750,000 and $1 million saw big jumps in their tax bills. Here couples lose their personal exemptions and see their itemized deductions trimmed more aggressively. Moreover, they feel the impact of the new 39.6 percent top-income tax rate and the 20 percent capital gains tax rate, and they owe more for the new Medicare tax and tax on net investment income.
At the $750,000 income level, the total tax bill jumps 10.6 percent, leaving the couple owing Uncle Sam $202,990 or $19,450 more in taxes. At $1 million, the couple will see a 12.8 percent increase and owe $33,105 more in taxes, bringing the total tax bill to $291,100.
Once taxpayers complete their 2013 returns, they’ll have some clearer guidelines for plotting tax-saving strategies. Those who find themselves facing big taxes on net investment income, for example, may want to make sure that income-producing investments such as taxable bonds are held in tax-advantage accounts such as IRAs and 401(k)s.
Tax-loss harvesting — selling some investments at a loss to offset capital gains — also may become an important way of reducing net investment income.
Given the complexity of today’s returns, some may want to make use of financial advisers to fine-tune portfolios to help reduce tax liabilities. Fidelity Investments is seeing growing demand for personalized portfolio services that help investors manage not only their money but also navigate the tax environment, said John Sweeney, executive vice president of planning and advisory services at the Boston-based mutual fund company.
“Investing for an after-tax return can be more complicated,” said Sweeney.