One element of the Patient Protection and Affordable Care Act of 2010 (“Obama Care”) takes effect on 1/1/2013. It is a 3.8% surtax on unearned income. The collection of this new tax , called the “Medicare Tax,” is dedicated to support the Medicare Trust Fund. It affects individuals, estates, and trusts. In addition, the Bush tax cuts are scheduled to sunset which means a return of the 39.6% top tax rate. These two rates when combined means you could be paying tax at a rate of 43.4%. Also, the capital gains rates are scheduled to increase from 15% to 20%. Therefore, tax planning for 2012 and 2013 is crucial.
Very simply, those affected by the new tax brackets will be single filers with modified adjusted gross income (MAGI) in excess of $200,000, married filing jointly with MAGI over $250,000, and married filing separately with MAGI over $125,000. Taxpayers who fall into this situation will pay an additional 3.8% surtax on their “net investment income.” Net investment income is interest, dividends, royalties, annuities, and rent income from passive activities and capital gains. The calculations of net investment income are beyond the scope of this blog, but what’s important is to know the thresholds.
One of the most talked about events where this tax may rear its ugly head is the sale of your personal residence. You would have to realize a gain on the sale in excess of the IRC Sec 121 exclusion of $500,000 (married filing jointly) and meet the MAGI criteria. This new tax could also come into play on the sale of a vacation home or inherited investment property.
Another area where the tax may be applicable is on an installment sale. If you have the opportunity to sell an asset in 2012, this would eliminate the possibility of the new 3.8% surtax and the scheduled higher capital gains tax. Be careful to “run the numbers” because the alternative minimum tax (AMT) may kick in.
The above tax we discussed is a tax on unearned income. So for those who may have nothing but earned income (wages, commissions, etc.) and thought you were home free, sorry, you have not escaped. There is a second new tax as part of this bill that taxes earned income at 0.9% (.009). This tax is also subject to the MAGI threshold amounts.
We have just discussed a small sliver of what’s to come. These are very uncertain times. Long-term planning can help mitigate risk. As always, tax planning should not only look at the tax implications but should take into consideration the economic effects of any transaction. Multi-year planning is essential. We can help you stay vigilant.