Retirement 2.0blog

Mary Beth Franklin: IRS' new definitions of 'income' a migraine starter kit

Five – count 'em five — categories now in play; several rungs of hell

Jan 28, 2013 @ 12:54 pm

By Mary Beth Franklin

+ Zoom
Mash-ups work better on the dance floor

I never thought that my 28-year-old son, Ross, who is a DJ, would have something in common with the U.S. tax code, which celebrates its 100th anniversary this year. But they share a common trait.

Ross spends many of his days and nights creating “mash ups” by overlaying the vocal tracks of one pre-recorded song with the instrumental tracks of another, creating a seamless new composition to delight his dance club audiences. The U.S. tax code, which has grown from 400 pages in 1913 to nearly 74,000 pages today—including 5,000 changes since 2001 alone—is one big mash up. But it's not exactly seamless. And it's not likely to delight, either.

As a result of the American Taxpayer Relief Act of 2012, which President Obama signed on January 2 of this year, and the 2010 Health Care Reform Act, there are now five different definitions of income beginning this year.

The first definition affects virtually everyone with a job. The employee portion of the Social Security tax, which was reduced to 4.2% for 2011 and 2012, is back up to 6.2% this year. In addition, the wage base to which the tax applies increased from $110,100 in 2012 to $113,700 this year. That translates into a tax increase of $2,450.20 for individuals with Social Security wages of at least $113,700 in 2013.

The second category involves earned income exceeding $200,000 for individuals and $250,000 for married couples filing jointly. In the past, everyone was subject to a Medicare tax at a rate of 1.45% on virtually all earned income. That tax remains in effect, but beginning this year, the rate is increased to 2.35% on earned income exceeding the $200,000/$250,000 threshold.

The next circle of tax hell involves Modified Adjusted Gross Income (MAGI) exceeding $200,000/$250,000. If you fall into this category and you have investment income, you will be subject to the new Medicare investment Income tax. The tax is assessed at a rate of 3.8% on the lesser of net investment income or MAGI in excess of those thresholds. Net investment income includes taxable, interest, dividends, and capital gains from the sale of traditional investment assets as well as investment real estate.

The fun doesn't end there.

Once your Adjusted Gross Income (AGI) exceeds $250,000 if you're single of $300,000 if you're married filing jointly, your income tax liability will increase as a result of two other tax provisions: a limit on itemized deductions and the personal exemption phase out.

The limitation on itemized deductions, known as the Pease amendment, reduces most itemized deduction by 3% of the amount by which the AGI exceeds the threshold of $250,000/$300,000. Itemized deductions can't be reduced by more than 80% and the reduction doesn't apply to medical expenses, investment interest, casualty and theft losses and gambling losses.

The personal exemption phase out eliminates 2% of the personal exemption amount—worth $3,900 for each member of your household in 2013—for each $2,500 of AGI in excess of the $250,000/$300,000 thresholds.

Finally, wealthy Americans whose taxable income—the amount left after subtracting itemized deductions—exceeds $400,000 if single or $450,000 are affected by two other new tax provisions: a new top income-tax bracket and a new higher tax rate on long-term capital gains and dividends.

For these high earners, the top tax bracket jumps from 35% to 39.6% starting this year. It's the first time the top tax bracket has been that high since the start of the 21st century. The maximum tax bracket for investment income for these folks jumps from 15% to 20%, and when combined with the new Medicare investment income tax, can be as high as 23.8% for some.

Robert Klein, a CPA and financial adviser from Newport Beach, CA, specializing in retirement income, said, “If you have income of at least $100,000 and you haven't retired TurboTax and rehired your CPA yet, you will do so after reading this.” Check out his terrific blog and his helpful side-by-side comparison of the 2013 federal income tax law changes at

I just realized there's one more thing that my son's music and the tax code have in common: they both give me a headache.


What do you think?

View comments

Recommended for you

Sponsored financial news

Upcoming Event

Oct 17


Best Practices Workshop

For the fifth year, InvestmentNews will host the Best Practices Workshop & Awards, bringing together the industry’s top-performing and most influential firms in one room for a full-day. This exclusive workshop and awards program for the... Learn more

Featured video


Stephanie Bogan: What's really holding advisers back from achieving their goals

The only thing holding financial advisers back from accomplishing what they want is the assumptions they're making, according to Stephanie Bogan, founder of Educe Inc.

Latest news & opinion

Fidelity wins arb case against wine mogul but earns a rebuke from Finra

In the case of investor Peter Deutsch, Fidelity doesn't have to pay any compensation, but regulator said firm put its interests ahead of his.

Plaintiffs win in Tibble vs. Edison 401(k) fee case

After a decade of activity around the lawsuit, including a hearing before the U.S. Supreme Court, judge rules a prudent fiduciary would have invested in institutional shares.

Advisers get more breathing room to make Form ADV changes

RIAs can enter '0' in some new parts of the document before their annual filing next year.

Since banking scandal, Wells Fargo advisers with more than $19.2 billion leave firm

Despite a trying year, the firm has said it will sweeten signing bonuses for veteran advisers.

Is LPL's deal sweet enough for NPH's 3,200 reps and advisers?

They will have to decide if the signing package they are being offered by LPL makes sense. A lot is hanging in the balance.


Subscribe and Save 60%

Premium Access
Print + Digital

Learn more
Subscribe to Print