The end of the year is always interesting to tax professionals like me. We get to talk with many people and discuss a variety of tax situations. If the truth be told, however, most taxpayers don’t have to do anything special at the end of the year. For those taxpayers who don’t itemize, the timing of when a deduction is made is not important. There is no tax advantage to make a contribution on December 31, 2012 versus January 1, 2013. It doesn’t matter is the local treasurer has the check to pay that winter property tax on December 31 or January 1. But for those taxpayers who do itemize, there are plenty of chances to influence the final tax bill. Making an early charitable contribution or paying those property taxes in December can make a difference. There are, however, actions to be taken that can affect that final tax bill for taxpayers who don’t itemize. For example, most experts feel that capital gains rates are going to increase in 2013. Therefore, it may be advantageous to realize capital gains in 2012. Currently, capital gains rates are 5% for taxpayers in the 10% and 15% tax brackets and 15% for taxpayers in the 25% and higher brackets. In a special quirk of the law thanks to President Bush, the 5% tax rate is reduced to zero for 2012. It’s doubtful that this special 5% reduced to zero tax will make the cut in 2013. Most likely, the new rates will be 10% for those in the 15% tax bracket and 20% for those in the 25% and higher tax brackets. To re-state, the 5% lowest tax will probably disappear. Just having the rates increase from 5/15% to 10/20% is enough to provide incentive to realize gains. Throw in the 0% incentive and many taxpayers are going to be happy they sold assets in 2012. In addition, most experts feel that tax rates will increase for single taxpayers with income of least $200,000 and joint filers with income at least $250,000. Now, in all fairness, taxpayers with incomes at that level are in the top 2% or so of all income filers. In other words, not many taxpayers are going to be affected by increasing these tax rates. Whether it is fair or not to single them out and increase their taxes is not something I care to comment on. After all, what’s fair about taxes in the first place? Historically, our rates are low today. Part of the argument of increasing the rates of today brings up the fact that the top rates back in the 1950’s, 1960’s and 1970’s were as high as 92% while today we don’t get above 35%. We have plenty of room to increase rates and still be well under those historically high rates of the past. What the proponents tend to leave out of the argument is that practically no taxpayers paid that highest rate of 92%. Perhaps less than 1000 people per year paid that highest rate. Today, the top 2% of tax filers means that over 2 million taxpayers would be affected by an increase in the top rate. That’s quite a difference.
It’s important to point out that our tax system is based on marginal and effective tax rates. Understanding the meaning of those terms helps us to understand how our tax system works. Marginal is the highest rate at which the dollars are taxed. In 2011, single taxpayers with taxable income of $379,151 and above were taxed at the marginal tax rate of 35%. A single taxpayer with taxable income of $379,151 has a marginal tax rate of 35%. Every additional dollar earned by that taxpayer will be taxed at a marginal tax rate of 35%. Effective tax rate is the blended rate that the taxpayer pays on the all of the money reported by that taxpayer. A single taxpayer with $379,151 of income would pay total tax of $110,017. This is an effective tax rate of 29.02%. The taxpayer pays 29.02% on each and every dollar earned during the year. As the taxpayer earns more money, more money is taxed at the higher rate and the effective tax rate will increase.
Another important point to recognize in our system is the difference between taxable income and adjusted gross income. Traditionally, the Internal Revenue Service will report the marginal and effective tax rate statistics based on taxable income. Taxable income is computed by subtracting itemized deductions and the exemption amounts. Adjusted gross income is total income before the itemized deductions and exemption amounts are subtracted. Adjusted gross income will be higher than the taxable income. Therefore, the effective tax rate will be lower for our single taxpayer above if adjusted gross income is used as the starting point instead of the lower taxable income. A single taxpayer with taxable income of $379,151 would have received a minimum of $5,800 standard deduction and a $3,700 exemption amount. Adjusted gross income of this taxpayer would be at least $388,651. This puts the taxpayer in the 35% tax bracket so the taxpayer’s marginal tax rate would still be 35%. The taxpayer’s effective tax rate would decrease to 28.3% because the adjusted gross income is higher than the taxable income. Whether our marginal tax rates will increase in 2013 which will cause the effective tax rates to increase for 2013 and the following years is yet to be seen. Unfortunately, my crystal ball is a bit cloudy today. This is Jerry Coon signing off.
Jerry Coon is an Enrolled Agent and
a Registered Tax Return Preparer.
He owns Action Tax Service on
Northland Dr. in Rockford.
Contact Jerry at his website: