ATRA Tax Rates

January 2, 2013

The American Taxpayer Relief Act of 2012 (“ATRA”) affects income tax rates for 2013 and subsequent years. These rates do not sunset, so they will not change (except for inflation adjustments) until Congress passes legislation amending the tax law.

During the years immediately preceding this law we had six tax rates for ordinary income (that is, income other than long-term capital gain and qualified dividends): 10%, 15%, 25%, 28%, 33% and 35%. These rates were initially set to expire after 2010 and later extended through 2012. Expiration of these rates would have reinstated tax rates that were in effect under Bill Clinton, with the top rate returning to 39.6% and rates in the lower brackets increasing as well.

ATRA makes the lower rates permanent for income below these threshold amounts:

  • Single: $400,000
  • Head of household: $425,000
  • Married filing jointly: $450,000
  • Married filing separately: $225,000

These levels will be adjusted for inflation. Click here for the complete 2013 income tax rate schedules.

Although some proposals would have eliminated the 35% bracket, the final law does not. As a result, we now have seven tax rates for ordinary income: the six listed earlier, plus 39.6%.

See also: ATRA rates for capital gain and qualified dividend income

Quirks in the rate structure

Political compromises over the years have produced a quirky rate structure that never would have been chosen if we were writing on a clean slate. Here are some oddities, and how they came about.

Fractional tax rate. The first big tax law under Bill Clinton added two tax rates: 36% and 39.6%. The strange choice of 39.6% for the highest rate comes from the idea that above some level the tax rate should be 10% higher than the 36% rate that would otherwise apply. We no longer have the 36% rate, but the 39.6% rate has been restored by reference to the highest rate in effect under Clinton.

Starting point for 35% bracket. Tax brackets for the different filing statuses are generally more or less proportional, with the head of household brackets being wider than the single brackets, and the brackets for those who are married filing jointly being widest. For example, in 2012, the 28% bracket begins with income of $85,650 for single filers but at $142,700 for a married couple filing jointly. The political compromises around the 1993 tax law had the 39.6% bracket begin at the same $250,000 level for every filing status except married filing separately (for which it was half that amount). As a result, this tax bracket deviated from the general rule of making brackets proportional to the filing status. Tax cuts under George W. Bush reduced the 39.6% rate to 35%, but did not change the income level at which the rate applies. As a result, today’s 35% rate, like the previous 39.6% rate, is not proportional: it starts at the same dollar amount for singles, heads of households, and married couples, based on the original $250,000 but adjusted for inflation over the years.

Bracket less than $2,000. The new law brings the 39.6% rate back to life, but at levels set forth earlier, as negotiated in the fiscal cliff talks. Meanwhile, the 35% rate (which was created by reducing the former 39.6% rate) remains in place. By our unofficial calculation, after adjustment for inflation, the income level at which the 35% rate takes effect in 2013 is $398,350. That’s $51,650 below the level at which joint filers begin paying 39.6%, but for single filers the difference is only $1,650. This means that beginning in 2013 the 35% tax bracket for single filers will consist of less than $2,000.