Anticipating 2013 Tax Changes

By Christine Benz, Morningstar

Investors have had a tough slog during the past decade, but you can't say it's because of the tax regime. Dividends, taxable as ordinary income during the late great bull market of the 1980s and 1990s, have been taxed at or below 15% since 2003. The same goes for long-term capital gains, which were taxed at rates of 28% or higher as recently as the late 1990s.

But all of that is set to change in 2013. Barring congressional action, dividends will again be taxable at ordinary income tax rates starting next year, and the highest income tax rate will pop up from 35.0% currently to 39.6% in 2013. Long-term capital gains, meanwhile, will be taxable at 20% for most investors and 10% for those in the 15% tax bracket or lower. A new Medicare surtax will also kick in that will levy a tax on high-income households' investment income, and the estate tax will ensnare many more estates if the exemption exclusion drops to $1 million, as it is scheduled to do next year.

Income Tax - Income tax rates are going up almost across the board in 2013, and the highest tax rate will jump from 35.0% currently to 39.6% in the 3.8% Medicare surtax on unearned income above certain levels (more on this below), and it's clear that certain high-income households could see a meaningful bump up in the taxes they owe beginning in 2013.

Dividends - Qualified dividends, now taxable at a 15% tax rate for most investors and a 0% tax rate for those in the 10% and 15% tax brackets, will be taxable at ordinary income tax rates.

Capital Gains - The increase in capital gains rates that's set to go into effect in 2013 isn't as drastic as the bump-up in the dividend tax. Capital gains rates for most investors are set to jump to 20% from 15% in 2013; those in the 15% tax bracket will pay tax at a 10% rate.

Estate Taxes - Barring Congressional action, in 2013 the estate tax regime will go back to levels not seen in more than a decade, with a 55% tax rate on estates worth more than $1 million. That's quite a turnabout from where things stand for 2012, with the estate tax rate of 35% and estates of less than $5,120,000 exempt from estate taxes. Given that the $1 million amount would affect a broad swath of middle-class households (estates can encompass investment assets as well as residential real estate), it would be surprising if there were no Congressional action, but it's still worth keeping on your radar.

Medicare Surtax - Beginning in 2013, a 3.8% Medicare surtax will go into effect for higher-income individuals (as well as estates and trusts) with net investment income above a certain threshold. Specifically, the surtax will be imposed on the lesser of an individual's net investment income for the year or modified adjusted gross income, or MAGI, of more than $250,000 for married taxpayers filing jointly. (The threshold is $200,000 for single filers.) If your modified adjusted gross income doesn't exceed those thresholds, you don't need to worry about the surtax.