Tax Planning Issues

Wednesday, August 8, 2012

Get Ready for These Five New Taxes on January 1, 2013

Now that the health care law has been declared constitutional, several significant provisions will become effective on January 1, 2013.


Tax #1: 3.8% Surtax on Investment Income

This new tax will be levied on net investment income if modified adjusted gross income is more than the “threshold amount” based on filing status. For married taxpayers filing jointly, the threshold amount is $250,000. For married filing separately, it is $125,000. For single taxpayers, the threshold is $200,000. The surtax also applies to trusts and estates if the net investment income is more than about $12,000 and is not paid out to the heirs/beneficiaries.


Assuming Congress extends the current tax rates that are set to expire on December 31, adding this surtax will increase the tax rate on long-term capital gains and dividends from 15% to 18.8%. If Congress does not extend the current rates, the top rate on January 1 for capital gains will be 23.8% and the top dividends rate will be a whopping 43.4%!


How the Tax is Determined

Modified adjusted gross income is adjusted gross income (the last line on page 1 of Form 1040) plus the net foreign income exclusion amount. Income includes interest, dividends, capital gains, wages, retirement income, and income from businesses and partnerships. No itemized deductions, which lower income for income tax purposes, are included for this calculation.


If modified adjusted gross income is less than or equal to the taxpayer’s threshold amount (see above), no surtax will be paid, regardless of the amount of investment income.


If modified adjusted gross income is more than the taxpayer’s threshold amount, the 3.8% surtax will be due on 1) the amount of adjusted gross income over the threshold amount OR 2) net investment income, whichever is less.


Net Investment Income Defined

Net investment income is total investment income less allocable expenses. Investment income includes interest, dividends, capital gains, annuities, rents, royalties, passive activity income, gain on the sale of a principal residence above the $250,000/$500,000 exclusion and gain from the sale of a second home.


It does not include active trade and/or business income; distributions from IRAs and other qualified retirement plans; Social Security income and veterans’ benefits; income from tax-exempt and tax-deferred vehicles like municipal bonds, tax-deferred nonqualified annuities, life insurance and nonqualified deferred compensation; or any income taken into account for self-employment tax purposes.

Plan Now to Minimize the Tax

Start now to reduce investment income and modified adjusted gross income for 2013 and beyond. Consider shifting investments, converting to a Roth IRA, deferring income, increasing contributions to tax-deferred plans, installment sales and charitable trusts.


Tax #2: Medicare Payroll Tax Increase for Higher Earners

This tax will increase .9%, from 1.45% to 2.35% on wages and self-employment income above $250,000 for married taxpayers filing jointly and above $200,000 for single taxpayers.


Tax #3: Medical Device Manufacturing Tax

This 2.3% tax will be levied on the gross sales of medical device makers, whether or not they make a profit.


Tax #4: High Medical Bills Tax

Currently, medical expenses that exceed 7.5% of adjusted gross income are deductible on Form 1040. On January 1, the threshold will increase from 7.5% to 10%.


Tax #5: Flexible Spending Account Cap

Flexible Spending Accounts are pre-tax accounts that 24 million Americans use to pay for all kinds of family medical expenses, including tuition for children with special needs. Currently, these accounts have no federal limit, but beginning January 1 they will have a $2,500 annual cap.


Planning Considerations in 2012

In addition to planning now to reduce or avoid the 3.8% surtax in 2013 and beyond, this is an exceptional year to do estate planning. The federal gift and estate tax exemption is $5.12 million, which allows a married couple to remove 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-era tax rates, including income and capital gain taxes, are set to expire at the end of 2012. With these new taxes becoming effective in January, 2013 is on track to have the highest tax rates we have seen in years.


As always, be sure to seek expert advice on all tax-planning issues. Now, more than ever, you need the assistance of experienced professionals to advise you and help you implement the best plan for you and your family.


*The content of this blog is adapted in part from information provided by the nationally recognized tax professionals at Keebler & Associates. For more information please visit their website at The full text of the Health Care Act is available here, with the relevant provisions of the surtax beginning at Section 1411 at page 946.

The Garner Law Firm assists clients in Arlington, Texas as well as Mansfield, Fort Worth, Hurst, Bedford, Euless, North Richland Hills, Colleyville, Southlake, Grapevine, Coppell, Irving, Grand Prairie, Dallas, Duncanville, Cedar Hill and other communities in Tarrant County, Dallas County, Denton County, and Collin County.

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