2013 Brings Two New Taxes to High Income Taxpayers

With the fiscal cliff stealing the spotlight over the holidays, very little attention was given to two new taxes that started January 1. 

Thanks to the Affordable Care Act (also known as Obamacare) the first wave of tax increases rolls out in 2013 to help fund the massive 2010 health care reform.  The new taxes on wages and investment income are expected to raise about $318 billion over 10 years. 

Granted the bulk of these taxes fall mainly on the wealthy and the health care industry, but sooner or later we will all be paying more.  To find out who pays and how much, keep reading:

Increased Medicare payroll tax

Currently, the Medicare payroll tax is 2.9% and it applies to earned income only.  An employee is responsible for 1.45% of the tax and it’s deducted automatically from the paycheck.  The employer kicks in the other 1.45%.   

Under the new tax provision, most taxpayers will continue to pay the 1.45% Medicare tax, but single people earning more than $200,000 and married couples earning more than $250,000 will owe an additional 0.9% on earned income above these thresholds.  

Employers will collect the extra 0.9% on wages exceeding $200,000 just as they would withhold Medicare taxes and remit them to the IRS. However, companies won’t be responsible for determining whether an employee’s income from other sources or combined income with his or her spouse makes them subject to the tax.  This means that some employees will have to pay additional Medicare taxes when they file income tax returns and others will get a refund for amounts overpaid.

Example 1

If you’re married and you and your spouse each earn $150,000, your employers will withhold 1.45% for Medicare tax, because neither of you exceeds the $200,000 individual threshold. But if you file a joint tax return, your combined earned income of $300,000 is $50,000 above the married filing jointly threshold. This means you will have underpaid your Medicare tax by $450 (.9% of $50,000) and will owe the additional amount when you file your taxes.

Example 2

If you are a self-employed single person with self-employment income of $300,000 you will pay a 2.9% Medicare tax on the first $200,000 and a 3.8% tax on the remaining $100,000.  This means you will owe an additional tax of $900 under the new tax provision.  (.9% * $100,000 = $900) 

New Medicare tax on Investment income

This one is kind of a big deal because it’s the first time a Medicare tax will be assessed on unearned income.  It applies to most joint filers with adjusted gross income (AGI) above $250,000 and single filers with AGI above $200,000.  AGI is the number at the bottom of the front page of Form 1040. 

The new tax is complex, but in effect it is a flat tax on investment income above the $250,000/$200,000 threshold. 

Investment income includes:

• interest, dividends, annuities, royalties, rents
• capital gains – including any profit you make on the sale of your residence if it exceeds the amount you are allowed
• income from a passive trade or business 

Investment income does not include:

• Income from a business in which you are an active participant
• Distributions from an IRA or qualified retirement plan
• Gain on the sale of an active interest in a partnership or S-corporation
• Gain inside a tax deferred annuity
• Distribution from a tax-free Roth account
• Interest from tax-exempt municipal bonds (Obama has proposed changing this) 

For those whose income levels are well below the $250,000/$200,000 threshold, keep in mind that all it takes is one transaction to push you into the 3.8% tax territory (i.e., sale of real estate with a large gain or conversion of an IRA into a Roth account).

Example

If a married couple earns $200,000 in wages and $100,000 in capital gains, $50,000 will be subject to the new tax, creating an additional $1,900 tax liability.  ($200,000 wages + $100,000 CG = $300,000 income - $250,000 threshold = $50,000 * 3.8% = $1,900).

As you can see, the wealthy are going to bear the brunt of this tax.  If you fall in these income levels and have investments, visit with me.  Tax advisers have already found ways to minimize the impact of this tax.   Contact my office to see how we can help.