We are beginning over here to re-review the tax aspects of ObamaCare after the Supreme Court’s decision last week. There are several tax changes, but today we will revisit the new investment income tax and the new earned income tax. These will happen in 2013, so let’s go over them.
Investment Income
If you are single, you will owe a new investment tax if your adjusted gross income (AGI) is over $200,000. If you are married, you will owe the new tax if your AGI is over $250,000. (I know, twice $200,000 is considerably more than $250,000. I did not write the law). If this is you, will owe a brand-new 3.8% tax on your investment income.
Let’s be clear: it is not necessarily ALL your investment income. Rather it will be on investment income over $200,000 or $250,000, as the case may be. If you are married and retired and your entire adjusted gross income of $250,000 is interest and dividends, you will owe no NEW tax. You will owe plenty of OLD tax, though.
What is investment income? Let’s go with the easy examples: dividends, interest, capital gains (short-term and long-term), royalties and annuities outside retirement plans
NOTE: Net investment income is also defined to include income from a passive activity. This concerns me, as the rental of a duplex is a passive activity, as is passthrough income to a “passive” member in an LLC. Under Section 469, these activities were considered “trades or businesses,” although the activity could be further tagged as “passive” or “nonpassive.” They were not however tagged as “investment.” This new tax appears to use the language differently from Section 469 and equates “passive” with “investment.” The IRS unfortunately has yet to issue formal guidance in this area.
How can this tax surprise you? Here are a few ways:
(1) You sell your business.
(2) You get married.
(3) You sell your principal residence, and the gain exceeds the $250,000/$500,000 exclusion.
(4) You inherit and sell stock from a parent’s estate.
Earned Income
If you are single, you will pay an extra 0.9% Medicare tax on your earned income over $200,000. If married, that threshold changes to $250,000.
What is earned income? The easiest way is to ask whether you paid or will pay social security or self-employment tax on the income. If the answer is “yes”, you have earned income. Note that this definition excludes your pension, 401(k) and IRA distributions.
Let’s go over a few examples.
EXAMPLE 1: A married couple filing jointly has $360,000 of adjusted gross income—$240,000 of wages plus $120,000 of interest, dividends and capital gains. They have $110,000 of investment income` over the $250,000 threshold. They will owe an extra 3.8% of that $110,000, or $4,180, in tax.
EXAMPLE 2: In the following year, the same couple has $400,000 of income, the difference being a $40,000 bonus. All their investment income is now above the threshold amount. Their new investment income tax will be $4,560. In addition, since their earned income is now above $250,000 they will owe the new earned income tax of $270 ((280,000- 250,000) times 0.9%).
EXAMPLE 3: After many years, you move from Purchase, New York. You sell your house for $920,000 and are single. Your exclusion amount on the sale is $250,000 so the taxable gain is 670,000. Assuming that you earned income is over $200,000, the new investment income tax will be $25,460 ((920,000 – 250,000) times 3.8%).
We will discuss other tax changes in a future blog. Some are delayed (such as the employer penalty) and others are already in place but are somewhat esoteric (the prescription drug fee).
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