With the Supreme Court's ruling that the Patient Protection and Affordable Care Act, informally called Obamacare, is constitutional, it will continue into effect in 2013. Among the many provisions of the massive law is a 3.8 percent Medicare surtax on investment income.
While the recent Congressional banter has centered on whether to extend the Bush tax cuts, this Medicare surtax has not been widely discussed. Even if lawmakers extend the Bush tax cuts for 2013 (I think that they will), this new 3.8 percent tax will effectively raise the top tax rate on capital gains and dividends to 18.8 percent. If the Bush tax cuts do expire, the capital gains rate will increase to $23.8 percent in 2013.
About the Medicare Surtax
The new Medicare surtax is assessed on the lesser of (a) net investment income or (b) the excess of modified adjusted gross income (adjusted gross income plus foreign earned income) over a "threshold amount." The threshold amount for married taxpayers filing jointly is $250,000.00. For married taxpayers filing separately, it is $125,000.00, and for everyone else it is $200,000.00.
Note: Your "investment income" includes interested, dividends, royalties, and annuities.
In other words, if your income is more than $200,000 for a single person, $125,000.00 for a married person that doesn't file jointly, or $250,000.00 for a married couple filing jointly, you can expect to pay the tax. It will be assessed on your net investment income or the excess of your modified adjusted gross income over the applicable amount. If your income isn't over the threshold that applies to you, you don't need to worry about the tax.
Note: The amount of the surtax is based on your income before deductions are considered. Even if your deductions put you in a lower tax bracket, you could still pay the surtax on your investment income.
What You Can Do About It
If the Medicare surtax applies to you, there are a few steps that you can take now to reduce your tax liability beginning in 2013. Here are a few:
- Sell appreciated assets - If you have assets that you are thinking of selling, do it in 2012. That will save 3.8 percent Medicare surtax, which doesn't apply until January 1, 2013.
- Think about your real estate - The surtax could apply to your profit from sales of any real estate that is not a personal residence. Any depreciation will increase the amount owned. If you are considering selling the real estate soon, do it in 2012.
Note: Taxes on your principal residence would not be affected by the Medicare surtax unless your gain exceeds the $250,000.00 ($500,000.00 for couples) home exclusion. That would be a good problem to have in this market.
- Talk to your investment adviser about your investment portfolio - Will deferring income until 2013 push you over the threshold? Given that withdrawals from regular IRAs raise your adjusted gross income, should you consider a Roth conversion this year? Could the demand for tax-exempt bonds increase given that interest on them is exempt and won't increase AGI? These are all questions to discuss with your adviser.
No matter what happens in November, 2013 is on schedule to have the highest tax rates that we've seen in the past several years. Begin taking steps now to prepare for it.
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About Jeramie Fortenberry
I am an attorney
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