In our March and April “Tax Strategist,” we highlighted several areas of the American Taxpayer Relief Act of 2012 (ATRA). The topics included: Personal Exemption and Itemized Deduction Phase-outs and New Tax Rates for Ordinary Income, Capital Gains and Dividends. This month we want cover two other major provisions of ATRA, involving surtaxes on certain wages and investment income.
Increased Hospital Insurance Tax
As part of the Affordable Health Care Act, beginning in 2013, the Hospital Insurance (HI) tax rate (currently at 1.45%) will be increased by 0.9% on individual taxpayer earnings (wages and self-employment income) in excess of compensation thresholds for the taxpayer’s filing status. Married taxpayers must combine their incomes subject to HI tax, when computing this additional tax. Thus, for wages the HI tax rate will be 1.45% up to the income threshold and 2.35% (1.45 + 0.9) on amounts in excess of the income threshold. The hospital insurance portion of the self-employed tax rate will be 2.9% up to the income threshold and 3.8% (2.9 + 0.9) on amounts in excess of the threshold. The income thresholds where this increase begins are $250,000 for married taxpayers filing jointly, $125,000 for married taxpayers filing separately, and $200,000 for all other taxpayers.
Employers are required to withhold the additional tax once wages exceed $200,000, but only on income from that employer. Employers cannot adjust the HI withholding based upon the employee having additional employment or a spouse who also works. Thus, there will be situations where the taxpayers will be under-withheld for the year.
Example: Jack and Jill are both employed. Jack’s wages are $175,000, and Jill’s wages are $150,000. Since neither employee’s wages exceed $200,000, their employers do not withhold the additional 0.9% for HI tax on either Jack’s or Jill’s wages. When they file their joint 1040 return, they must include $675 (($175,000 + $150,000 – $250,000) x 0.009) HI tax, as part of their total tax. Jack and Jill should adjust their income tax withholding, or make estimated tax payments to account for the extra HI tax and to avoid any underpayment penalty.
Unearned Income Medicare Contribution Tax
As part of the Affordable Health Care Act, a new tax takes effect beginning in 2013. The official name of this tax is the “Unearned Income Medicare Contribution Tax.” Even though the name implies it is a contribution, don’t get the idea you deduct it as a charitable contribution. It is, in actuality, a surtax levied on the net investment income of higher-income taxpayers.
The surtax is 3.8% on the lesser of your net investment income, or the excess of your modified adjusted gross income (MAGI) over a threshold based on your filing status. MAGI is your regular AGI increased by income excluded for working outside the country; net investment income is your investment income reduced by investment expenses.
The filing status threshold amounts are:
- $250,000 for married taxpayers filing jointly and surviving spouses.
- $125,000 for married taxpayers filing separately.
- $200,000 for single and head of household filers.
Example: A single taxpayer has net investment income of $100,000 and MAGI of $220,000. The taxpayer would pay a Medicare contribution tax only on the $20,000 amount by which his MAGI exceeds his threshold amount of $200,000, because that is less than his net investment income of $100,000. Thus, the taxpayer’s Medicare contribution tax should be $760 ($20,000 × 3.8%).
Investment income includes:
- Interest, dividends, annuities (but not distributions from IRAs or qualified retirement plans), and royalties,
- Rents (other than derived from a trade or business);
- Capital gains (other than derived from a trade or business);
- Home sale gain in excess of the allowable home gain exclusion;
- A child’s investment income in excess of the excludable threshold if, when eligible, the parent elects to include his or her child’s investment income on the parent’s return;
- Trade or business income that is a Sec. 469 passive activity, with respect to the taxpayer, and
- Trade or business income with respect to trading financial instruments or commodities.
Planning Tips:
For surtax purposes, gross income doesn’t include interest on tax-exempt bonds. Thus, one can avoid the net investment income surtax by investing in tax-exempt bonds. A taxpayer can also utilize the installment sale provisions to spread gains from capital assets, such as, rentals and business assets over a number of years to keep the investment income under the tax threshold.
Investment expenses include:
- Investment interest expense;
- Investment advisory and brokerage fees;
- Expenses related to rental and royalty income, and
- State and local income taxes properly allocable to items included in Net Investment Income.
Do you think you will never get hit with this tax, because your income is way under the threshold amounts? Don’t be so sure. When you sell your home, the gain is a capital gain, and to the extent that the gain is not excludable using the home gain exclusion, it will add to your income and possibly push you above the taxation thresholds. And, since capital gains are investment income, you might be in for a surprise. The same holds true for gains from selling stock and a second home. So when planning to sell a capital asset, be sure to consider the impact of this new surtax.
The surtax also applies to undistributed net investment income of trusts and estates. There are special rules applying to the sale of partnership and Sub-S Corporation interests.
If you are subject to these new and increased taxes on higher-income taxpayers, it may be appropriate to review your situation so that you can avoid any unpleasant tax surprises at the end of 2013, and to adjust your withholding and estimated taxes to prevent underpayment penalties. For assistance, contact the Experts at Henssler Financial: experts@henssler.com or 770-429-9166.
Disclosures
This article is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
