Now that the fiscal “cliff” is behind us and all we have to worry about is sequestration, many small businesses are focused on taxes. Don’t be fooled thinking you did not get a tax increase. There were many changes that could affect business owners, investors and households at certain income levels starting in 2013.
Besides the extension of the tax cuts for filers under $450,000 Married Filing Jointly (MFJ) there are many changes that affect small business owners, especially if you are an S-Corp, LLC or Sole Proprietor, basically anyone whose business income is passed through to their personal tax return.
First there is the increase in Medicare tax on anyone earning more than $200,000 this year. And remember even if you keep the profits in your business for next year’s operating expenses, you may be paying taxes on those profits before they are spent. Also keep in mind there is no income cap on Medicare like there is on Social Security, which is $113,700 for 2013. Therefore you could be caught in the extra 0.9 percent added to your payroll tax.
Next there is the fine print in the new tax code on phase out rules for certain exemptions. This includes education credits, personal exemptions and itemized deductions. Joint filers with over $125,000 taxable income start the phase-out on student loan interest. The American Opportunity Credit goes away starting at $80,000 for single filers and $160,000 for joint. The personal exemptions and itemized deductions start to phase-out on income over $250,000 for single filers and $300,000 for married taxpayers.
The Net Investment Income Tax (NII), also known as the Unearned Income Medicare Contribution Tax became effective this January. This is not part of the American Taxpayer Relief Act of 2012; instead it was passed as part of the Patient Protection and Affordable Care Act of 2010. This 3.8 percent surtax on Net Investment Income will be assessed on the lesser of NII or Modified Adjusted Gross Income that exceeds thresholds of $200,000 for single filers and $250,000 for married couples filing jointly.
There are many changes that did not catch the eye of the media as the focus on the fiscal cliff was mostly on concerns of tax brackets returning back to pre-2003. Even though many of the tax benefits were extended, more permanent language was inserted in the code that affect small business owners or households at the $125,000 and up income range.
The most significant changes were on incomes over $450,000 (MFJ) where the highest bracket of 39.6% was reinstated as well as long-term capital gains and qualified dividends rates increasing to 20 percent. For this group of taxpayers, the above mentioned phase out rules could add another 2 percent to their taxes in addition to the added Medicare (0.9) and Net Investment Income tax (3.8).
This will be a crucial year for tax planning for business owners and households with executive base pay, two earner incomes, college expenses and retirement plans. One advantage is we already know what the tax brackets and calculations will be for 2013 and 2014. Therefore, it may be prudent to adjust your financial plan and business strategies now to create optimum tax benefits.
Another benefit for small business owners is the ability to contribute up to $56,500 in their 401k plan depending on age and income. Contact your Certified Financial Planner® to review your situation early in the year. ----------------------------------------------------
Patricia Kummer has been an independent Certified Financial Planner for 26 years and is President of Kummer Financial Strategies, Inc., a Registered Investment Advisor in Highlands Ranch, 3 year Top Wealth Manager 5280. She welcomes your questions at www.kummerfinancial.com or call the economic hotline at 303-683-5800.Any material discussed is meant for informational purposes only and not a substitute for individual advice.