The Investment Income Tax

The upcoming Medicare surtax will affect investments.

How will the 3.8 percent Medicare tax affect your investments?

The tax on investment income is due to increase by at least 3.8 percentage points. If lawmakers can’t reach an agreement, the increase could go up even higher.

The 3.8 percent surtax — the amount of the Medicare surtax on high earners under the Affordable Care Act — will be levied on investment income for individuals who earn more than $200,000 a year, or $250,000 for a couple.

While some might be planning on the health care law being repealed, it’s still best to plan as if the tax will be levied. This means that the more difficult taxes to estimate are on capital gains and dividends.

The Run Down

  • Provisions of the Patient Protection and Affordable Care Act will affect investments;
  • Specifically, effective by January 1, 2013, an additional Medicare tax of 3.8% will apply to unearned income, specifically the lesser of net investment income or the amount by which adjusted gross income exceeds $200,000 ($250,000 for a married couple filing jointly; $125,000 for a married person filing separately);
  • To minimize the impact, examine all of your long-held investments and consult with your financial advisor on selling any with big gains before the end of the year;
  • Consider adjusting your investments to reduce the impact of the increase;
  • Concentrate on researching investments that actually rise in value, regardless of what tax you might eventually pay.

The capital gains tax is at a current historic low of 15 percent. If Congress allows the tax rates set in 2001 and 2003 to expire on December 31, the capital gains tax would go to 20 percent next year. When you factor in the 3.8 percent Medicare tax, the capital gains tax will be either 18.8 percent or 23.8 percent for high earners.

The dividend tax is also at 15 percent, but may go as high as the income tax rate. Should the Bush-era tax cuts expire, the rate for the highest earners would be 39.6 percent. These earners would also be subject to the additional 3.8 percent surtax, bringing the total dividend tax to as much as 43.4 percent.

“There is some evidence that when you raise the capital gains rate, people hold on to assets longer,” Eric Toder, co-director of the Tax Policy Center, a nonpartisan research group, recently told the New York Times. “Fifteen to 18.8 percent is not a big deal; 23.8 is somewhat bigger. But, in historical terms, it’s not a particularly big tax.”

“This [3.8%] tax alone makes accelerating investment income into 2012 profitable for many taxpayers,” Robert Gordon of Twenty-First Securities, a tax-strategy firm in New York, said to SmartMoney.

The Takeaway

The new Medicare surtax, which Congress passed in 2010, affects the net investment income of most joint filers with adjusted gross income of more than a quarter of a million dollars. Starting on January 1, 2013, the tax rates on long-term capital gains and dividends for these earners will jump, assuming Congress extends the current law. How can you best prepare for this tax? AmOne can help you find the best financial solution for you. Our knowledgable associates are ready to answer your questions on investing, retirement, financial planning, and more. AmOne offers solutions; your call to us is free and we won’t try to sell you anything. Find out how to reach us and learn more about how AmOne can help you today.

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