Category: Personal Finance
With the Supreme Court giving the go-ahead to the Obama health care plan, a major impact on income taxes will result in 2013 for households with income of $250,000 or more. If the Bush tax rates also expire, a double-whammy will be felt.
Last week, the Supreme Court upheld the requirement that all individuals purchase healthcare or pay a penalty. This key provision of the Patient Protection and Affordable Care Act was necessary for the healthcare bill to remain viable. While there are desirable healthcare reforms in the new legislation, it will come at a potentially high price for some taxpayers.
Effective January 1, 2013, ObamaCare increases the tax on investment income and the Medicare tax on earnings for high-income households. The current Bush tax rates are also set to expire the end of this year. Combining the impact of these two will significantly increase 2013 income taxes. In our example, high-income families may have an increase in their income taxes of 15% or more.
Medicare Payroll Tax Increase
Currently, everyone pays a Medicare payroll tax of 1.45% on all earned income. Beginning in 2013, this tax will be increased by .9% to 2.35% on earned income over $200,000 for individuals and $250,000 for married filing joint. This means that for every $1,000 over the limit, an additional $9 of Medicare payroll tax will be collected.
New Medicare Contribution Tax
Also beginning in 2013, a new Medicare contribution tax of 3.8% will be imposed on investment income, which includes interest, dividends, capital gain, net rental income and all other passive income. This is in addition to the ordinary income or capital gain tax that investment income is already subject to. The new tax will only be imposed on individuals with adjusted gross income above $200,000 ($250,000 for joint filers).
Bush Tax Rates to Expire at Year-end
Even without the additional taxes included in the healthcare mandate, 2013 will see the sunset of the Bush tax cuts enacted in 2001. Unless extended, both the ordinary income tax and capital gain rates will increase. Under current law, the individual tax rates range from 10% to 35%. Next year the lowest rate will be 15% and the highest will increase to 39.6%. The long-term capital gain rates will increase from 15% to 20% (from 0% to 10% for low AGI). Also, qualified dividends will no longer be taxed at the capital gain rate, but rather as ordinary income subject to an individual’s highest marginal tax rate.
Tax Impact on Investment Earnings and Capital Gain
Assuming the Bush tax cut is not extended and the new healthcare taxes apply, interest, dividends, short-term capital gains, net rental income and any other investment income subject to ordinary income tax rates will be taxed at 43.4% for those in the highest bracket (39.6% plus 3.8%). The long-term capital gain rate in 2013 will be 23.8% (20% plus 3.8%).
1. Take Long-term Gains in 2012. The difference between the taxing rate on long-term capital gain in 2012 and 2013 is potentially 8.8% (23.8% versus 15%). For anyone considering the sale of a business, investment securities or other assets, it would be beneficial to complete the transaction in 2012. The tax savings on a gain of $100,000 would be $8,800. The savings on a gain on $500,000 would be $44,000.
2. Contribute to Retirement Plans. Distributions from retirement accounts are not subject to either the Medicare payroll tax or the new Medicare contribution tax. Therefore, this provides an additional incentive to maximize your saving to your company retirement plan and your IRA.
3. Accelerate Income and Postpone Deductions. If tax rates are higher in 2013, it would be advantageous to bring as much income into 2012 as possible and to defer as many deductions as you can to 2013.
The combination of the expiration of the 2001 Bush tax cuts and the new taxes included in the Obama healthcare bill will have a major impact on taxpayers with incomes above the threshold amounts. In two examples explained below, the increased tax is more than $1,000 and $5,000 per month. The result will be a reduction in consumer spending, less saving for the future, or a combination of both. Effected individuals should discuss with their financial advisor the impact this will have on their future financial security and make adjustments as appropriate in their long-range planning.
Examples of Tax Increase Impact
Let’s assume a married couple has adjusted gross income of $340,000, consisting of $300,000 of earned income; interest from investments of $10,000; qualified dividends of $5,000; and $25,000 of long-term capital gain. For comparison purposes, we will simply calculate the income tax based on 2012 tax rates and the anticipated rates in 2013 without consideration of personal exemptions, deductions, credits, etc.
Using the 2012 tax rates:
• Earned income of $300,000 = $75,907
• Interest of $10,000 at the marginal rate of 33% = $3,300
• Qualified dividends of $5,000 at 15% = $750
• Long-term capital gain of $25,000 at 15% = $3,750
Total Federal Tax in 2012 = $83,707
Tax as a percent of AGI of $340,000 = 24.6%
Using the anticipated 2013 tax rates on the same income:
• Earned income of $300,000 = $83,656
• Interest of $10,000 at the marginal rate of 36% = $3,600
• Qualified dividends of $5,000 at the marginal tax rate of 36% = $1,800
• Long-term capital gain of $25,000 at 20% = $5,000
• Additional Medicare payroll tax of .9% on earned income over $250,000 or $50,000 = $450
• New Medicare contribution tax of 3.8% on investment income of $40,000 = $1,520
Total Federal Tax in 2013 = $96,026
Tax as a percent of AGI of $340,000 = 28.2%
The increased tax on the $340,000 of income is $12,319 or 14.7%.
I did the same comparison as above for $680,000 of total income ($600,000 earned income; $20,000 interest; $10,000 dividends; and $50,000 capital gains). The difference in tax owed was over $60,000. This represented a 30% increase!
Elaine E. Bedel, CFP, is president of Bedel Financial Consulting, Inc., a wealth management firm providing fee-only financial planning and investment management services for individuals, consulting services for corporate retirement plans, and investment advisory for institutions and endowments. She is the author of “Advice You Never Asked For…But wished you had!” available on Amazon.com. For more information, visit www.BedelFinancial.com or email to firstname.lastname@example.org.
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