On January 1, 2013, the top tax bracket for individuals rose to 39.6% (the top bracket used to be 35%). The 39.6% bracket applies to singles with taxable income over $400,000 and joint filers over $450,000. However, this new top tax bracket does not only impact individual income taxes. It also affects some business taxes, which will have the overall impact of raising income taxes even more.
Taxation of capital gains and qualified dividends
If you are a sole proprietor or an owner of/or in a partnership, limited liability company, or S corporation, your share of capital gains from the sale of your business’ property is subject to a 20% tax if you are in the 39.6% tax bracket. Last year, the top capital gain rate for this purpose was 15%.
If your business is incorporated and it distributes dividends to you which are treated as “qualified dividends,” those dividends are taxed at 20% if you are in the 39.6% tax bracket. Again, the top rate on qualified dividends was 15% last year.
Section 444 election
Partnerships and S corporations usually must use a calendar year (the same tax period used by its owners). However, they can elect to use a fiscal year if they make a special tax payment intended to thwart the benefit of tax deferral under the fiscal year. This election is called a Section 444 election, and the required payment is the highest individual income tax rate, plus one percentage point. Thus, the payment amount for 2013 is 40.6% (39.6% + 1%). Last year, the required payment was 36%. This required payment applies regardless of whether the owners in these electing entities are high-income taxpayers.
The required payment is due on May 15, 2013, for a company that has already made an election. The due date for a company first making the election in 2013 is May 15, 2014. The required payment is made with Form 8752, Required Payment or Refund Under Section 7519, which must be filed each year the section 444 election is in effect. Find out more about this required payment in IRS Publication 538.
Owners of personal holding companies (PHCs), which is a special type of C corporation that has limited ownership and receives certain types of income, may be subject to a special tax on excess passive income. The PHC tax rate for 2013 is 20%; it was 15% last year. Again, the rate applies without regard to the tax bracket of the PHC’s shareholders.
Accumulated earnings penalty
If a C corporation accumulates more than a set amount of its earnings rather than distributing it to shareholders, it may be subject to a special penalty. The corporation can accumulate any amount for the reasonable needs of the business (e.g., a proposed expansion project or a buyout of a retiring owner). Above these reasonable needs, accumulations are restricted to $250,000 ($150,000 for personal service corporations). Excess accumulations are taxed in 2013 at 20%; the penalty rate had been 15% last year. The penalty applies without regard to the tax bracket of the corporation’s shareholders.
Talk with your tax advisor to learn all of the ramifications that the new top personal tax bracket may have on your overall tax picture.