Broker Check

New Tax Law a Real Pain for Taxpayers

by Howard Hook, CFP®, CPA

As published on and in The Princeton Packet, January 31, 2013

The American Taxpayer's Relief Act of 2012 (ATRA) is just about a month old and already there is much confusion as to what the law contains and what effect it will have on taxpayers.

Misconception #1: None of the changes enacted under the law apply to the 2012 tax year.

In actuality, a good amount of the law is retroactive back to January 1, 2012. The past few years, Congress has renewed expiring tax breaks in December and made them retroactive to the beginning of that tax year. ATRA has extended some of these items permanently, such as the Alternative Minimum Tax (AMT) patch, and other provisions have been extended between two to five years.

Making tax laws retroactive is normally not good policy since it creates uncertainty and inaction. The retroactive changes made by ATRA were even more frustrating to taxpayers since the law was not enacted until after December 31, 2012, and made it impossible to plan at all for 2012.

Misconception #2: Only taxpayers in the top tax bracket will see an increase in their taxes under the law.

Much has been made of the fact that only taxpayer's in the highest tax bracket ($400,000 for single taxpayers and $450,000 for married couples) will see an increase in their Federal Income Taxes. This, however, is simply not true.

The past two years, taxpayers have seen a two percent reduction in the amount of social security tax that has been withheld from their paychecks. This provision expired at the end of 2012 and was not renewed under ATRA. Therefore, all taxpayers, regardless of their tax bracket, who have earned income subject to social security tax being withheld will see a decrease in their paychecks. For example, someone earning $50,000 a year will see their take home pay decrease by $1,000.

Taxpayers under the age of 65 in lower tax brackets may also see their income taxes go up because the threshold for deducting unreimbursed medical expenses is increasing from 7.5 percent to 10 percent of adjusted gross income.

In addition to the change in the threshold for deducting medical expenses, taxpayers whose adjusted gross income exceeds $250,000 ($300,000 for married couples) will lose a portion or all of their personal exemptions, and could lose as much as 80 percent of their itemized deductions under the new law.

Misconception #3: Now that the rates are permanent, tax planning will be simpler.

With each new tax law that is passed, the degree of complexity involved in preparing your tax return goes up another notch or two. The changes enacted under ATRA are no different. For example, prior to ATRA most taxpayers had to deal with two long-term capital gains rates for the sale of their stock or bond investments: 0 percent and 15 percent. Now, ATRA, along with the Patient Protection and Affordable Care Act (passed in 2010), increases from two to five the number of long-term capital gains rates: 0 percent, 15 percent, 18.8 percent, 20 percent and 23.8 percent. ATRA also sets different thresholds for different portions of the law when determining which taxpayers a particular portion applies to, which also creates confusion when trying to plan.

There is no argument that planning is easier when you know what the law will be for the next several years (and hopefully longer). Lawmakers are to be applauded for making many of the temporary provisions we have had to deal with these past many years permanent. However, even permanent tax laws can be and are often times changed. Probably the best advice is to assume nothing is permanent beyond the next several years. Keeping up on current tax policy may not be the most exciting way to spend your time, but it may go a long way toward proper planning.