With all the political wrangling going on in Washington, there have been a lot of changes recently to our tax code that affect both taxes due as well as retirement accounts.  This article will provide a summary of the most relevant changes that were enacted to help you plan and navigate the year ahead.

2013 Retirement Account Limit Changes

  • 401k contribution limits increased to $17,500
  • SEP IRA & Solo 401k contribution limits increased to $51,000
  • IRA and Roth IRA contribution limits increased to $5,500
  • Roth IRA’s – The income limitation phase-out was slightly increased, starting at $112,000 and capping at $127,000 of MAGI for single filers.  For Joint filers, the phase-out is $178,000 to $188,000.
  • Traditional IRA contributions can now be tax-deducted regardless of income, so long as neither you nor your spouse is covered by an employer-sponsored retirement plan.  If your spouse is covered by an employer plan, there is a phase-out for deductibility from $178,000 to $188,000.  If both spouses are covered by employer plan, the phase-out is $95,000 to $115,000 in MAGI.
  • Roth 401k Conversion: If your employer offers a Roth 401k option, you can now “Convert” any portion of your 401k to a Roth 401k.  Previously there were much tighter controls around who was eligible to do it.
  • Health Savings Account (HSA) contribution limits increased to $3,250 for individual and $6,450 for families.  Deductible Minimums also increased slightly to $1,250/$2,500 while max out of pocket also increased slightly to $6,250/$12,500 for individuals/families.

2013 Tax Law Changes

Note: the detail contained in this article is meant to be a high-level summary of some key changes, we recommend you consult with a tax preparer for impacts related to your specific situation.

Payroll Tax Holiday Is Over

For 2010-2012, the Social Security tax withholding rate on your salary was temporarily reduced from 6.2% to 4.2%. If you’re self-employed, the Social Security tax component of the self-employment tax was reduced from 12.4% to 10.4%. For 2013, Social Security tax is applicable on income up to $113,700.

Rates on Ordinary Income & Long-Term Gains/Dividends

For most individuals, the federal income tax rates for 2013 will be the same as last year: 10%, 15%, 25%, 28%, 33%, and 35%. However, the maximum rate for higher-income earners (singles with taxable income above $400,000, married joint-filers with income above $450,000, heads of households with income above $425,000, and married separate filers with income above $225,000) increases to 39.6%.  The 39.6% rate only applies to income earned over those thresholds.  This same upper tax bracket will also have increased rates on long-term capital gains of 20%.  There is also a potential additional 3.8% Medicare surtax on certain investment income for this highest tax bracket.

Itemized & Personal and Dependent Exemption Deduction Phase-Out

For single filers earning $250,000 , $300,000 married joint-filing couples, $275,000 heads of households, or $150,000 for married individuals who file separate returns, there will be phase-out provisions for both itemized deductions as well as dependent exemption deductions.   Itemized deductions you are eligible to claim can be reduced up to 80% while dependent exemption can be eliminated altogether based on income.

Alternative Minimum Tax Patch Made Permanent

Congress has regularly “patched” the AMT rules to prevent millions more households from getting hit with this add-on tax, and somewhat surprisingly, the new law makes the patch permanent, starting with 2012. The change will keep about 30 million households out of the AMT zone.

Relatively Favorable Gift and Estate Tax Rules Made Permanent

For 2013 and beyond, the new law permanently installs a unified federal estate and gift tax exemption of $5 million (adjusted annually for inflation) and a 40% maximum tax rate (up from last year’s 35% rate). The right to leave your unused estate and gift tax exemption to your surviving spouse (the so-called exemption portability deal) was also made permanent.

Option to Deduct State and Local Sales Taxes Extended

In past years, individuals who paid little or no state income taxes were given the option of instead claiming an itemized deduction for state and local sales taxes. The option expired at the end of 2011, but the new law retroactively restores it for 2012 and extends it through 2013.

Charitable Donations from IRAs Extended

In past years, IRA owners who had reached age 70½ were allowed to make charitable donations of up to $100,000 directly out of their IRAs. The donations counted as IRA required minimum distributions, so charitably-inclined seniors with more IRA money than they needed could reduce their taxes by arranging for IRA donations to take the place of taxable required minimum distributions. This break expired at the end of 2011, but the new law retroactively restores it for 2012 and extends it through 2013.

Tax-Free Treatment for Forgiven Principal Residence Mortgage Debt Extended

This temporary rule (extended through 2013) allows for up to $2 million of Cancellation of Debt income (which is normally considered taxable income) from principal residence acquisition debt that was cancelled between 2007-2012 to be treated as a tax-free.

$500 Energy-Efficient Home Improvement Credit Extended

In past years, taxpayers could claim a tax credit of up to $500 for certain energy-saving improvements to a principal residence. This break expired at the end of 2011, but the new law retroactively restores it for 2012 and extends it through 2013.

2013 Tax Law Changes: Family-Specific Tax Credits & Deductions

Child Tax Credit Extended

The $1,000 maximum credit for each eligible under-age-17 child was extended through 2017.

Earned Income Tax Credit Extended

Legislation enacted in previous years increased the earned income credit for families with three or more qualifying children and allowed married joint-filing couples to earn more without having their credits reduced. These changes, which help lower-income families, were extended through 2017.

American Opportunity Higher Education Tax Credit Extended

The American Opportunity credit, which can be worth up to $2,500 and can be claimed for up to four years of undergraduate education, was extended through 2017.

Higher Education Tuition Deduction Extended

This write-off, which can amount to as much as $4,000 or $2,000 for higher-income folks, expired at the end of 2011. The new law retroactively restores it for 2012 and extends it through 2013.

$250 Deduction for K-12 Educators’ Expenses Extended

The $250 deduction for teachers and other K-12 educators for school-related expenses paid out of their own pockets was retroactively restored for 2012 and extended through 2013.