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Although 2013 has been a relatively quiet year from a tax perspective, U.S. taxpayers will soon face the expensive realities of last year’s legislation: the American Taxpayer Relief Act and the Affordable Care Act (“ObamaCare”).

Top earners should be prepared for higher annual tax liabilities and many will, inevitably, be playing catch-up with year-end tax payments. The attached newsletter contains a summary of what to expect when filing your 2013 tax returns and issues to consider when planning for 2014.

When filing your 2013 tax returns, you can expect:

American Taxpayer Relief Act. Top earners will be hit the hardest with:
1. A 39.6 percent tax bracket for individuals earning over $225,000 and married couples earning over $450,000;
2. A phase-out of personal exemptions and a limitation on itemized deductions; and
3. A 20 percent tax rate on capital gains and qualified dividends.

Affordable Care Act. This act, commonly referred to as the ObamaCare legislation, created two new surtaxes that will affect higher earners. Those surtaxes are:
1. Net Investment Income surtax of 3.8 percent; and
2. An additional Medicare tax of 0.9 percent.

Note: The income thresholds for being subject to these surtaxes are significantly lower than the other tax bracket thresholds. Therefore, a greater number of taxpayers will be subject to them.

Alternative Minimum Tax. The AMT exemption amounts have been permanently “patched” for 2013 and future years. The exemption amounts for 2013 are $51,900 for single individuals and heads of household and $80,800 for married couples filing a joint return and surviving spouses.

Note: Taxpayers that anticipate significant fluctuations in income from year to year should explore the benefits of shifting some AMT-triggering items from an AMT year to a non-AMT year.

Child Tax Credit. The child tax credit is $1,000 per qualifying child for 2013 and future years.

Medical Expense Deduction. Taxpayers who itemize deductions can claim a deduction for qualified unreimbursed medical expenses to the extent those expenses exceed 10 percent of adjusted gross income (AGI). This threshold is up from 7.5 percent. Taxpayers (or their spouses) who are age 65 or older before the close of the tax year, however, may continue to apply the 7.5 percent threshold through 2016.

Health Flexible Spending Accounts (Health FSAs). Beginning in 2013, annual contributions to Health FSAs are capped at $2,500. Any contributions in excess of $2,500 will be subject to income tax when distributed from the Health FSA.

Same-Sex Marriage. Following the U.S. Supreme Court ruling that struck down Section 3 of the Defense of Marriage Act, the IRS announced a general rule in Rev. Rul. 2013-17 recognizing same-sex marriages nationwide. All legally married same-sex couples will be treated as married for all federal tax purposes, including income, gift, and estate taxes.

Estate and Gift Taxes. We finally have a permanent structure that provides for a maximum federal unified estate and gift tax rate of 40 percent with an inflation adjusted $5 million exclusion for estates of decedents dying after December 31, 2012 and gifts made prior to death. The applicable exclusion amount, as adjusted for inflation, is $5,250,000 for estates of decedents dying in 2013 and gifts made by those decedents prior to death.

The annual gift tax exclusion has also been permanently established at $14,000 with a built-in inflation adjustment for future years. Spouses may split their gifts and effectively increase the per donee annual maximum exclusion to $28,000. As in all prior years, spouses may give an unlimited amount of gifts to one another without any gift tax consequences.

Business Tax Incentives. Bonus depreciation, enhanced IRC Section 179 expensing, the Work Opportunity Tax Credit, and many other business-friendly provisions are set to expire at the end of 2013. The annual dollar limitation on IRC Section 179 expensing for 2013 is $500,000 with an annual $2 million overall investment limitation.

When planning for 2014, you should consider:

You should plan for a continuation of the 39.6 percent tax bracket for the highest earners (individuals earning over $228,800 and married couples earning over $457,600), the phase-out of personal exemptions, a limitation on itemized deductions, and a 20 percent tax rate on long term capital gains and qualified dividends.

The Social Security wage base will increase to $117,000.

The ObamaCare surtaxes will continue to affect higher earners with a 3.8 percent surtax on Net Investment Income and an additional Medicare tax of 0.9 percent.

Contribution limits for Traditional and Roth IRAs will remain at $5,500.

Alternative Minimum Tax. The AMT exemption amount for tax year 2014 is $52,800 ($82,100 for married couples filing jointly).

Health Flexible Spending Accounts (Health FSAs). There will be a new carry-over allowance of up to $500 for Health FSAs. The $2,500 maximum amount is indexed for inflation after 2013. For 2014, the cap is projected to be $2,500, the same as in 2013.

Estate and Gift Taxes. Estates of decedents who die during 2014 have a basic exclusion amount of $5,340,000, up from a total of $5,250,000 for estates of decedents who died in 2013.
The annual exclusion for gifts remains at $14,000 for 2014.

Business Tax Incentives. For small businesses, the 2014 annual dollar limitation on IRC Section 179 expensing is set for $25,000 with an annual $200,000 overall investment limitation. As a result, purchases of otherwise qualifying property in excess of $225,000 will reduce the IRC Section 179 deduction to $0. Bonus depreciation is also scheduled to expire at the end of 2013.

There are many other incentives that should also be considered, including the Work Opportunity Tax Credit, Research Tax Credit, and various energy related incentives.