Tax Breaks for
Families and Students
& Increased Medicare Payroll Tax
legislation made permanent or extended several tax breaks
for families. In addition, several education breaks were
made permanent or extended.
Child Credit. For 2013 and beyond, the maximum credit
for an eligible under-age-17 child (Child Credit) was
scheduled to drop from $1,000 to only $500. The legislation
permanently installs the $1,000 maximum credit.
Adoption Expenses. The Bush tax cut package included a
major liberalization of the adoption tax credit and also
established tax-free employer adoption assistance payments.
These taxpayer-friendly provisions were scheduled to expire at
the end of 2012. The credit would have been halved and limited
to only special needs children. Tax-free adoption assistance
payments from employers would have disappeared. The
legislation permanently extends the more-favorable Bush-era
Education Credit. The American Opportunity Credit,
worth up to $2,500, can be claimed for up to four years of
undergraduate education and is 40% refundable. It was
scheduled to expire at the end of 2012. The legislation
extends the American Opportunity Credit through 2017.
College Tuition Deduction. This write-off, which can be
as much as $4,000 at lower income levels and as much as $2,000
at higher income levels, expired at the end of 2011. The
legislation retroactively restores the deduction for 2012 and
extends it through 2013.
Student Loan Interest Deduction. The student loan
interest write-off can be as much as $2,500 (whether the
taxpayer itemizes or not). Less favorable rules were scheduled
to kick in for 2013 and beyond. The legislation permanently
extends the more favorable rules that have applied in recent
Coverdell Education Savings Accounts. For 2013 and
beyond, the maximum contribution to federal-income-tax-free
Coverdell college savings accounts was scheduled to drop from
$2,000 to only $500, and a stricter phase-out rule would have
limited contributions by many married filing joint couples.
The legislation makes permanent the favorable rules that have
applied in recent years.
Medicare Payroll Tax
Medicare payroll tax is the primary source of financing for
Medicare, which generally pays medical bills for individuals
who are 65 or older or disabled.
Wages paid through December 31,
2012, were subject to a 2.9% Medicare payroll tax. Workers and
employers pay 1.45% each.
Self-employed individuals pay
both halves of the tax, but are allowed to deduct the
employer-equivalent portion (i.e., 1.45%) for income tax
Unlike the social security
payroll tax, which applies to earnings up to an annual ceiling
($113,700 for 2013), the Medicare tax is levied on all of an
employee's wages subject to FICA taxes.
Beginning in 2013, individuals who have wage and/or
self-employment income exceeding $200,000 ($250,000 if
married, filing a joint return; $125,000 if married, filing
separately) are subject to an
additional 0.9% Medicare tax (i.e., 2.35% total) on
their earned income exceeding the applicable threshold.
The employer portion of the Medicare tax
is not increased.
However, employers are required
to withhold and remit the additional tax for any employee to
whom it pays over $200,000. Companies are not
responsible for determining whether a worker's combined income
with his or her spouse makes the employee subject to the
Therefore, many individuals
(especially those who are married with each earning less than
$200,000, but earning more than $250,000 combined) should
adjust their federal income tax withholding (FITW) by
submitting a new Form W-4 to the employer or make quarterly
estimated tax payments to be sure they are not hit with an
underpayment penalty when filing their income tax return each
Self-employed individuals who pay both halves of the
Medicare tax (i.e., 2.9%) will pay a total Medicare tax of
3.8% on earnings above the thresholds. The additional 0.9% tax
is not deductible for income tax purposes. Self-employed
individuals should adjust their quarterly estimated income tax
payments to account for this additional tax.
Married couples with combined incomes approaching $250,000
should keep tabs on their total earnings to avoid an
unexpected tax bill when filing their individual income tax
return. At this time, the threshold amounts
($200,000/$250,000) are not adjusted for inflation.
Therefore, it is likely that
increasingly more people will be subject to the higher payroll
taxes in coming years.
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