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.