Key Changes That Impact Middle-Income Taxpayers in 2014

Starting in 2014, taxpayers will see a number of new tax laws hit the books thanks to the Affordable Care Act. While many of the changes are set to impact wealthier taxpayers, there are several tax measures that will have an impact on individuals and families earning less than $250,000. Even though April is still a few months away, middle-income earners need to be aware of what they can expect in the coming tax season.

The Good:

One of the most troublesome aspects of the federal tax code has been the alternative minimum tax, which is designed to make sure that taxpayers entitled to certain deductions, exclusions or credits pay a minimum amount in taxes. The biggest problem with the AMT is that it was never indexed for inflation, which meant that middle-income taxpayers became increasingly subject to the tax in recent years.

Instead of creating another temporary patch for the AMT, lawmakers permanently indexed the tax for inflation earlier this year which means fewer middle-income filers will have to worry about getting hit with the tax. It’s also good news for taxpayers who paid AMT in previous years, since they may be eligible to take a special minimum credit against their regular tax this year. If you’re still concerned that you may have to pay AMT, you can use the Alternative Minimum Tax Assistant on the IRS website to find out if you’re liable for the tax.

The Bad:

As part of the health care law, a new surtax will be imposed on net investment income starting in 2014. The 3.8% tax applies to interest, dividends, rental and royalty income, non-qualified annuities and income from certain business activities. Gains from the sale of stocks, bonds and mutual funds, capital gain distributions from mutual funds, investment property gains and gains from the sale of an interest in a partnership or S corp. are also subject to the tax.

Whether or not you have to pay the tax is determined by your income. For 2013, the threshold limits are $250,000 for married couples filing jointly, $125,000 for couples filing separately and $200,000 for single filers or filers who claim head of household. If you have investment income and make over the limit for your filing status, you’ll have to pay the tax. It’s also important to note that the threshold limits aren’t indexed for inflation.

The Ugly:

Middle-income filers who normally deduct qualified medical expenses may find it harder to get a write-off next year. For 2013, you could deduct non-reimbursed medical expenses that exceeded 7.5% of your adjusted gross income. In 2014, the threshold limit bumps up to 10%, making it more difficult to qualify for the deduction. The 7.5% limit will stay in place for taxpayers over age 65 through the end of 2017.

According to the Internal Revenue Service, approximately 10 million families claimed the medical expense deduction in 2009, the last year that data was available. The majority of those who claimed the deduction were in the middle class, with an average annual income of just over $53,000. The number of middle-income taxpayers who are able to deduct their medical expenses in future years may drop dramatically as a result of the new limit.

The Undetermined

There’s one more tax that Americans need to be on the lookout for starting in 2014 but it’s unclear how many filers will be affected. Starting next year, taxpayers who lack qualifying health insurance coverage will be subject to a tax penalty. For 2014, the tax will be 1% of your adjusted gross income or $95 per person, whichever is higher. The penalty goes up to 2% of AGI or $325 starting in 2015 and increases to 2.5% or $695 in 2016.

The Congressional Budget Office estimates that around 6 million taxpayers could face the tax penalty, with the middle-class representing a significant chunk of those affected. A premium tax credit will help offset some of the cost of insurance for low- and middle-income families but there are no definite figures on how much credit taxpayers will qualify for.

Tax time will be here before you know it and getting prepared now can help you to avoid any surprises when you file. Middle-income earners, in particular, need to know what to expect to avoid taking a big tax hit.