For several years, through 2012, Americans paid income tax at six rates, ranging from 10% to 35%. Now, a higher rate has been added: 39.6%, which was the highest income tax rate as recently as 2000. In 2013, the 39.6% rate is imposed on income over
❖ $400,000 for single taxpayers,
❖ $450,000 for married couples filing joint returns and surviving spouses,
❖ $225,000 for married individuals filing separately, and
❖ $425,000 for heads of households.
The 39.6% tax rate, like all tax rates, is imposed on taxable income. That’s the number you report after taking tax deductions. Example 1: Ross Austin, a single taxpayer, has total income of $520,000 in 2013. After deductions, Ross has taxable income of $480,000. Thus, $80,000 of his income will be taxed at the maximum 39.6% rate.
When 39.6% = 20%
Prior tax legislation capped the tax on most long-term capital gains at 15%. Taxpayers also owed no more than 15% on qualified dividends, which include most dividends paid to investors. The new law retains this relatively low ceiling for most people. However, taxpayers who have taxable income in excess of the 39.6% rate threshold will owe 20% tax on their long-term gains and their qualified dividends to the extent that these gains and dividends would otherwise be taxed at the 39.6% rate. Example 2: Ross Austin from example 1 has a $60,000 net long-term capital gain in 2013. Ross has $480,000 of taxable income, which is $80,000 over the threshold for the top bracket, so Ross owes 20% tax on his $60,000 capital gain. Suppose, though, that Ross has a $100,000 long-term gain this year. Ross is $80,000 over the relevant threshold, so $80,000 of his gain will be taxed at the maximum 20% rate, whereas the other $20,000 of his gain will be taxed at 15%.
Shifting gears
Taxpayers below these higher income thresholds will continue to owe tax at rates as low as 10%. Moreover, taxpayers in low tax brackets will owe 0% on taxable long-term capital gains and qualified dividends. Therefore, income shifting strategies have a greater payoff now than they have had recently for high-income taxpayers. If you report substantial income, you may save more tax now by shifting income to children just beginning their career or to retired parents. Our office can go over these and other tax reduction strategies.