Article by Investment U
When the Supreme Court was weighing arguments regarding the constitutionality of the Affordable Care Act, many phrases were being tossed around:
- “Individual mandate”
- “Pre-existing conditions”
- “Parent’s insurance until age 26”
- “Health insurance co-ops”
And when it came down to the end, Chief Justice John Roberts said that there will be a mandate that everyone must get health insurance by 2014 or get taxed. The tax would allow for subsidies or Medicaid to take over for those who can’t afford it.
Everyone was all up in arms over the mandate being a tax. But that’s not the tax we should all be worried about. The healthcare ruling means that a 3.8% surtax on investment income is almost certain. If it doesn’t come to pass, it means something uglier may be thrown upon us.
Either Way, It’s Going to Hurt
This new investment tax was originally passed by Congress in 2010. I’m about to get all “IRS” on you, so bear with me. It affects the net investment income of the majority of joint filers with adjusted gross income of more than $250,000 ($200,000 for single filers). January 1 of next year, the tax rates on long-term capital gains and dividends for these same earners bumps up from the lows of the Bush era ushered in at 15% to 18.8%. This will happen if Congress extends the current tax law.
But if they don’t…
If Congress – in their present state of dysfunction – allows the Bush era tax rates set in 2001 and 2003 to expire at the end of this year, the top rate on capital gains will jump to 23.8% and the top rate on dividends goes up nearly triple to 43.4%.
A lot of pundits and analysts got this wrong believing that Obamacare would be overturned. Now no matter what the case at the end of the year, people need to make moves to soften the blow of a new round of taxation.
Tax Will Affect a Lot of People
You may be asking yourself, “What is investment income? Does any of this political drama affect me?”
That’s a good question. Most experts will tell you that the following qualifies as investment income:
- Dividends
- Rents
- Royalties
- Interest (interest from munis doesn’t count)
- Short- and long-term capital gains
- The taxable portion of annuity payments
- Income from the sale of a primary home above the $250,000/$500,000 exclusion
- Any profit you would make from the sale of a second home
- Any passive income received from such things as real estate and/or investments (such as partnerships)
That’s a lot of categories for you to fall into.
Now here are cases were the tax doesn’t apply:
- Payouts from a regular or Roth IRA
- 401(k) plan or pension
- Social Security income
- Annuities that are part of a retirement plan
- Life insurance proceeds
- Municipal-bond interest
- Veterans’ benefits
- Schedule C income from businesses
- Subchapter S firm or a partnership income – a business were you are paying self-employment tax
The game has changed. From 2013 on, many investors will have to vigilantly watch how they manage not only their reported adjusted gross income but also their investment income so that this tax will not eat them up.
“Gimme Shelter”
A classic Rolling Stone’s song just seemed like the perfect segue… You can see the list above of the types of investment income that are immune to the new tax. We are going to see many investors in the next six months running for shelter in these types of assets and vehicles. Robert Gordon of Twenty-First Securities, a tax-strategy firm in New York stated, “This [3.8%] tax alone makes accelerating investment income into 2012 profitable for many taxpayers.”
Here are three major trends to look for or to take advantage of over the rest of 2012:
- You may see a growth outbreak in municipal bond investing soon. Municipal-bond income gets two thumbs up because not only does it not count against your adjusted gross income, it’s also not applicable to the 3.8% tax.
- Roth IRAs once again will find a sweet spot in the hearts of retirement investors – because unlike traditional IRAs – their withdrawals are tax-free.
- The self-employed may be more willing to turn to traditional defined-benefit pension plans. If you’re able and eligible to establish one of these, you may have the means to reasonably reduce adjusted gross income. But watch out. One the other side, withdrawals from these plans could increase your adjusted gross income to make you subject to the 3.8% tax for other investment income.
Here’s some food for thought. If you’re betting on a new President next year that will repeal all this legislation, good luck. That’s a gamble. If you bet wrong, it’s going to hurt you during filing season. You’ve been warned.
Good Investing,
Jason
Article by Investment U
