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2013 Tax Rate Changes

Here’s how the last-minute budget deal will affect you

I'm betting you've already felt the sharp pain in your wallet from the expiration of the Social Security payroll tax break. Perhaps some of you have given up your daily $5 morning cup of joe to make up for the $20 decrease in your weekly paycheck (based on $50,000-a-year earnings). Or maybe you're just learning to live with less, now that the payroll tax has returned to its traditional 6.2 percent rate.

Either way, that tax bite may be the biggest change most of you will feel in 2013. The last-minute "fiscal cliff" deal that went down over the New Year holiday kept the income tax rates the same for just about everyone and extended some of the Bush-era cuts.

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Are you learning to live with less, now that the payroll tax has returned to its traditional 6.2 percent rate?

But because that legislation was passed late (Jan. 2), the IRS says it's beginning to process tax returns on Jan. 30, eight days later than it had planned. April 15 is still the deadline for filing, however.

Here's how some of these tax rules for 2013 may affect you:

• The personal exemption increased by $100 to $3,900. There are a number of situations that allow you to take advantage of this credit. For example, if you provide at least half the support for an adult child who is under the age of 19, or age 24 if in college, and his or her income doesn't exceed the personal exemption of $3,800 in 2012, you may qualify for the exemption. The rules are similar for relatives (parents, aunts, uncles and the like) for whom you may care. But they don't necessarily have to live with you. If you provide at least half their support and they didn't earn more than $3,800 last year, you may take advantage of the credit.

There's another note about the personal exemption for 2013 — a provision phasing out higher earners' exemptions has been reinstated. So if your adjusted gross income exceeds $250,000 (for single taxpayers), $300,000 (for married filing jointly) or $275,000 (for head of household), this is the deal: For each $2,500 of earnings over the threshold, your personal exemptions are reduced by 2 percent.

  • The maximum earnings subject to the Social Security tax rose to $113,700, up from $110,100 last year.

  • Annual contributions to plans such as 401(k)s are at a maximum $23,000 — $17,500 in regular contributions, plus $5,500 in catch-up contributions for those 50-plus.

  • The threshold on medical deductions increased. You can only deduct medical expenses that exceed 10 percent of your adjusted gross income (up from 7.5 percent in 2012). However, if you are 65 or older, the threshold stays at 7.5 percent. Beginning in 2017, everyone will be subject to the 10 percent limit.

  • On a related note, the maximum on deductions for long-term care insurance premiums rose. This is a tax break that many people don't know about. If you're age 51 to 60, you'll be able to deduct up to $1,360; age 61 to 70, up to $3,640; after 70, up to $4,550 for such premiums.

"That extra couple of thousand dollars you pay for premiums could push you over the limit so you can deduct your medical expenses," says Gil Charney, principal tax researcher with the H&R Block Tax Institute.

  • For upper-income filers, there's a new 3.8 percent Medicare tax on investment income over the adjusted gross income threshold amount as a provision of the Affordable Care Act. If you're single, the threshold amount is $200,000; married and filing jointly, it is $250,000. Your net investment income (interest, dividends, annuities, investment gains and the like) that is greater than the threshold may be subject to the 3.8 percent tax.

  • The Medicare-funding hospital insurance tax rose by 0.9 percent to 1.54 percent for high earners, another provision of health care reform. The increase applies only to wages and net self-employment income that's in excess of $200,000 for single taxpayers and $250,000 for those married and filing jointly.

  • Flexible spending accounts now have a $2,500 annual cap for the first time. These pretax accounts, used to pay for family medical expenses, had no federal caps previously, although most employers had imposed a $5,000 cap.

  • The maximum federal rate on long-term capital gains remains at 15 percent for most filers.

  • The alternative minimum tax exemption amount is $51,900 (or $80,800 for married couples filing jointly).

  • College tuition breaks were extended. Through the American opportunity tax credit, families can take a credit of up to $2,500 in related expenses.

  • The child and dependent-care credit remains at a maximum 35 percent of $3,000 ($1,050) in qualified expenses for one dependent grandchild, or a spouse who needs care while you work, and 35 percent of $6,000 ($2,100 for two or more).

  • IRA owners age 70-1/2 can distribute from their IRAs up to $100,000 tax-free, as long as it's sent directly to a charitable organization. (This makes more sense for higher-income folks — some of their itemized deductions will be lost because of the deduction phase out starting this year, but the IRA distribution to a charity is 100 percent tax-free). The distribution can also be used as part or all of the annual minimum required distribution from IRAs.

Now that you're focused on filing your tax return, Mark Steber, chief tax officer with Jackson Hewitt Tax Service, says it's a good time to remind people to throw away their returns after about three years.

"If there's no fraud involved, the IRS can go back and look at returns for only three years, unless there is a gross understatement of income or fraud," he says. "Destroying old records and returns minimizes the risk of identity theft."

As always, check with your tax adviser for guidance regarding your personal situation.

Carole Fleck is a senior editor at AARP Media.