While the issues of tax reform and tax simplification received predictable lip service last year, nothing was actually done to simplify your life as a taxpayer. In fact, as you prepare to prepare your 2013 return—or turn the job over to someone else—you may well find that things are more complicated (and more expensive) than ever. All the more reason to get an early start so you don't fall into a trap that costs you money.
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If you sold stock, mutual funds or other assets in 2013, you'll find that the already numbingly complex form for figuring the tax due has grown even more tortuous. The Schedule D Tax Worksheet has bulked up from 37 lines for 2012 returns to 45 lines this time around. The 22% inflation is needed to accommodate the new 20% rate for long-term gains for high-income taxpayers. You need to work through the form to see if any of your profits qualify for the 0% rate (they will if your taxable income is less than $36,250 on a single return or $72,500 on a joint return). The 15% rate applies to gains for taxpayers with taxable income above those levels and below $400,000 on single returns and $450,000 on joint returns. The new 20% rate hits gains reported by higher-income taxpayers—and those folks really pay 23.8% on long-term gains when the surtax discussed next is included.
The worksheet also applies a 25% rate to gains resulting from depreciation of real estate and a 28% rate to profit from the sale of collectibles. (In both cases, if you're in a lower tax bracket, your lower rate applies.)
The worksheet is intimidating, and it's a prime motivation for investors to turn to paid preparers or tax-prep software. But by patiently reading and following the step-by-step instructions, a paper-and-pen taxpayer can find a straight path through what at first appears to be a sadistic maze.
Surtax on investment income. The new 3.8% surtax on investment income appears for the first time on 2013 returns. If you owe it, you'll need to file Form 8960 to figure the damage. The tax hits investment income—from interest, dividends, capital gains, annuities and passive rental income, but not retirement-plan payouts—if your modified adjusted gross income (AGI) is over $200,000 if you're single or over $250,000 if you are married and file a joint return. (Modified AGI in this case is basic AGI plus any untaxed foreign income.) Follow the form carefully to make sure you don't pay the tax on any more income than you have to.
Surtax on earned income. Those who are still working might have to tackle yet another form, the new Form 8959 needed to figure the 0.9% Medicare surtax. This tax applies to wages and self-employment income if total earnings exceed $200,000 for a single taxpayer or $250,000 for married couples. For self-employed taxpayers, the surtax brings the Medicare tax rate to 3.8% for earnings over the threshold (the basic 2.9% plus 0.9%). For employees, the rate on affected earnings is 2.35% (the basic 1.45% plus the surcharge).
Squeeze on itemized deductions. Taxpayers younger than 65 face a higher hurdle to deduct medical expenses. Such costs are deductible now only to the extent they exceed 10% of AGI. If either you or your spouse were 65 by New Year's Day, however, you can still use the old 7.5% threshold.
This year's returns also bring the revival of the squeeze on itemized deductions and exemptions. Write-offs are reduced by 3% of the amount by which your AGI exceeds $250,000 if you're single or $300,000 if you file a joint return. Exemptions are cut by 2% for each $2,500 of AGI over those same thresholds. Worksheets in the tax instructions apply the vise.
On the bright side, taxpayers age 65 and older who use the standard deduction get a bigger write-off than younger folks. For a couple who are both age 65 or older, the 2013 standard deduction is $14,600 rather than the basic $12,200 on joint returns.