From the desk of Peter Blatt

September 4, 2012

How the Government Plans to Tax Our Investments Now

You have only 150 days left until the new tax laws come into effect.  The health care law has been declared constitutional; the remaining provisions will be going into effect. One little known provision is a new 3.8% investment income surtax, also called the health care surtax or the Medicare tax; it will go into effect on January 1, 2013.

This new surtax will be assessed on the lesser of a) net investment income or b) the excess of modified adjusted gross income (MAGI) over the “threshold amount.” For married taxpayers filing jointly, the threshold amount is $250,000; married filing separately, $125,000; all other individual taxpayers, $200,000. For trusts and estates, it is the beginning of the top income tax bracket ($11,650 in 2012).

Stated another way: 1) If your modified adjusted gross income (MAGI) is less than or equal to the threshold amount that applies to you, you will not pay this tax. 2) If your modified adjusted gross income (MAGI) is greater than the threshold amount that applies to you, you will pay the 3.8% tax on the lesser of a) your net investment income or b) the amount of your MAGI over the threshold amount. Here are some examples of the application of the surtax.

Note that the surtax liability is determined on income before any tax deductions are considered. That means your deductions could put you in the lowest income tax bracket, yet you could still have investment income that is subject to the surtax. Also, the capital gain rate is scheduled to increase for high-income taxpayers to 20% in 2013, so the total tax on capital gains (with the surtax) could be 23.8% in 2013 and beyond.

The good news is that there are some steps you can take this year to help you avoid or reduce the amount of surtax beginning in 2013. Also, 2012 is an exceptional year for estate planning in general. The federal estate tax exemption is $5.12 million, which allows a married couple to transfer as much as $10.24 million from their estate with no estate tax. Under current law, this exemption is scheduled to shrink to $1 million in 2013. Other Bush tax cuts, including income and capital gain taxes, are set to expire at the end of 2012. With the new 3.8% surtax becoming effective in January, 2013 is on track to have the highest tax rates we have seen in years.

Until next time,