3.8% surtax... Real number scenarios (Part 2)

As promised, here are some real-world examples of when the new 3.8% surtax would apply to a tax return, and some examples of when it wouldn't apply at all.  I know I don't have to say this, but each tax situation is unique.  It will take some work to figure out if you are subject to the tax, so when we meet this summer during our mid-year planning sessions, we'll address the tax with you.  If you did not opt for a tax preparation package which offered mid-year meetings, you can always schedule an appointment for an advisory session.

Examples for your consideration:

1. A married couple filing jointly has $400,000 of adjusted gross income (or AGI):

• $240,000 of wages.  
• $160,000 of the income is composed of interest, dividends, and net gains from the sale of raw land.

Because they have $150,000 of investment income above the $250,000 threshold, they would owe an extra 3.8% on the $150,000 over the limit, or $5,700.

2.  A retired couple filing jointly has no wages, but does have taxable IRA payouts of $100,000; pension and social security payments totaling $60,000; dividends and taxable interest of $40,000; and $40,000 from the sale of two investments.  Total income = $240,000.

They owe nothing, because their income is below that $250,000 threshold.

3.  A single tax payer earns $60,000 of wages and nets a $180,000 windfall from the sale of a long-held investment. Total income = $240,000.

Because she has $40,000 of investment income above the $200,000 threshold she will owe $1,520 in tax ($40,000 x 3.8%).

4.  A single taxpayer has an income of $220,000, but it all comes from Social Security benefits and pension and regular IRA payouts.  

None of this income is subject to the 3.8% tax.

How would this 3.8% tax apply to the sale of a principal residence?

1.  It would apply if the net gain on the sale exceeds the $500,000 exclusion for joint filers (250,000 for single) and their income exceeds the adjusted gross income threshold.

So, if I have an adjusted gross income above the threshold that is then reduced by a large itemized deduction like medical expense or a charitable gift, what happens?

The tax applies.  AGI is calculated BEFORE itemized deductions.

What about trusts and estates?

Yep.

This tax applies to net investment income of more than $12,000 that isn't paid out to beneficiaries.

I hope this has been helpful.  Please let us know if you have specific questions on anything indicated here.  As we find more insightful analysis of the new law, we'll make sure to pass it along to you via our newsletter, this blog, our website and our Facebook page.

(These examples were adapted from The Wall Street Journal... for the education and good of all humanity.)

3.8% Tax on Investment Income, Say What?! (Part 1)

It's here, and the Supreme Court just made it official....get ready for two new taxes set to impact some of you beginning on Jan 1, 2013.  I am referring to the newly enacted 3.8% surtax on investment income and the 0.9% increase in the Medicare tax on wages and self-employment income.  In this blog, I will discuss the 3.8% surtax.


You hadn't heard about these?  Well, you're not alone.  Stay with me...


Are you a joint filer with an adjusted gross income above $250,000?
Are you a single filer with an adjusted gross income above $200,000?


What is your adjusted gross income (otherwise known as AGI)?
To find this out, look at the first page of your 1040.

This adusted gross income number includes interest, dividends, capital gains, wages and retirement income plus results from partnerships and small businesses.
**THIS NUMBER DOES NOT INCLUDE: Subtractions for itemized deductions like mortgage interest, charitable gifts, and personal exemptions.


Are you married, filing a joint return with your spouse, and do you see $250,000 or more on line 37 (or $200,000 or more if you're single)?  Listen up.


Starting January 1, 2013 (that is 5 and1/2 months, FYI) tax rates on long-term capital gains and dividends for these earners will jump from 15% to 18.8%... assuming Congress extends the current law.  If the current tax rates, also known as the Bush-Era Tax Rates, don't remain in place for next year, that number jumps substantially (the top rates would be 23.8% for long term capital gains and 43.4% for dividends....and that's not a typo).

This 3.8% tax applies only to investment income above the $250,000/$200,000 AGI threshold.  Things like wages and social security can raise your adjusted gross income, making the investment income more vulnerable to the tax.  In our next blog, we will cite examples to show you how you may be subject to the tax. 


So, your adjusted gross income is above the threshold...do you have any of this investment income on your tax return? 


Let's define "investment income"...

• Dividends
• Rents
• Royalties
• Interest (except municipal bond interest)
• Short and long term capital gains
• The taxable portion of annuity payments
• Taxable gain from the sale of a principal home above the $250,000/$500,000 exclusion
• A net gain from the sale of a second home
• Passive income from real estate 
• Investments in which a taxpayer doesn't materially participate, such as a partnership.

Income not subject to the 3.8% tax...

• Payouts from a regular or Roth IRA, 401K plan, or pension
• Social Security income
• Annuities that are part of a retirement plan.
• Life insurance proceeds
• Municipal bond interest
• Veteran's benefits
• Schedule C income from businesses
• Income from a business on which you are paying self-employment tax, such as a Subchapter S firm or a partnership.

This new tax is a game-changer for taxpayers with investment income and AGI in the "red zone."  I had a meeting with a client today who will be subject to an additional $1,000 in tax in 2013 because of this.  I am sure I'll see more of this as the year moves forward.  Now is the time to re-evaluate your investment allocation with your financial planner, in case your were wondering....

Examples to come in the next blog....stay tuned.

Inheritance? Try Again...

I read a great article in the Wall Street Journal today which stated that affluent investors put their heirs at the bottom of the priority list (a paltry 41% rank this as important) when ranking their financial concerns (Counting on an Inheritance? Count Again. - Wall Street Journal, Monday June 11, 2012, page R1).  The first....rising health-care costs at a whopping 79%.  This leads to a problem that I have recently seen, where children are paying for their parents' care.

I know that there is something noble about taking care of your parents.  After all, they (presumably) took care of you...gave you shelter and kept you healthy...maybe helped you with money when you needed it...maybe even paid for your college education.  There's nothing ignoble about planning for yourself, however.  It's what they'd want for you anyway.  While you're at it, ask them some questions now while they're in good health.

Clients sometimes tell me, "I need to save for my child's college, but I have nothing saved for myself." Here is the kicker....you can't borrow to save for retirement.  As much as you may hate it, you could borrow for your child's college education.  Think about it.  Throw in your parent's health care bills and now you have a financial disaster cocktail.  You have to plan for these things!

Pay thyself first - Save for yourself before you do anything else.  I had to see this in reality before I believed it.  I had a period in my life where I was saddled with a tremendous amount of debt, and I was afraid to save anything for myself.  But my financial planner convinced me that saving for myself was paramount....the debt would disappear if I had a disciplined plan for it.  And darn it, he was right!

For those of you in your 30's, ask your parents if they have long term care insurance.  It's not too late for them, if they're in the state of health that would allow them to be under-written (I don't know insurance law so ASK ABOUT IT).  Think about how little those monthly/annual premiums are in comparison to a year-long stay in a nursing facility, to say nothing of the peace of mind.  This is something I wish I had done 10 years ago, when someone mentioned it to me.  I'm sad to say I didn't.

The tax deductions for long term care insurance premiums aren't large, folks.  They're generally limited (in the cases of individuals) to anywhere from $350-$4,370 per taxpayer depending on your age.  For example, if you're below 40, your deduction is limited to $350/taxpayer.  The deductions go up as you get older.  You add them to your other medical expenses and if they exceed 7.5% of your AGI (10% of your AGI in 2013, generally, since the health care law is going to stand for now), you can deduct them.

For my self-employed clients....the tax deduction for long term care premiums is a little more attractive.  It's too complicated for a blog, but I'd love to help you run the numbers and see if you're eligible for a bigger tax deduction.

Bottom line....tax deduction or not....it's a good idea to at least talk about this.