New Taxes for Higher Income Taxpayers

Question: I am in a fairly high income bracket and am worried about the new taxes I might have to pay this year.  Can you tell me more about them?

Answer:  Congress passed two new tax laws, one in 2010 and one at the beginning of this year, that both contain provisions to increase income taxes on higher income taxpayers starting in 2013.  The 2012 American Taxpayer Relief Act (Relief?  Really?) increases tax rates on earned income and capital gains, reduces personal exemptions, and  reduces itemized deductions.  The 2010 Health Care Reform Act (sometimes referred to as ObamaCare) adds a surtax on investment income and increases the Medicare earned income tax.  Here is how they work:

Long-term Capital Gains

For single taxpayers with taxable income of more than $400,000 ($450,000 if filing Married Filing Jointly (MFJ)) the tax rate on long-term capital gains increases from 15% to 20%.

Qualified Dividends

Same tax treatment as long-term capital gains.

Income Tax Bracket

Taxpayers with taxable income above $400,000 if filing as single or $450,000 if filing as MFJ will see their top tax bracket increase from 35% to 39.6%.  

Itemized Deduction Phase-out

Taxpayers with adjusted gross income (AGI) above $250,000 if filing single or $300,000 if filing MFJ will have to reduce their otherwise allowable itemized deductions by 3% of the amount by which the AGI exceeds the $250,000 or $300,000 threshold.

Personal Exemption Phase-out

Taxpayers with AGI above $250,000 if filing single or $300,000 if filing MFJ will lose 2% of their personal exemption for every $2,500 of income in excess of the threshold amounts. The personal exemption amount in 2013 is $3,900.

Medicare Earned Income Tax

Wage earners pay a 1.45% Medicare tax on all their earned income and self-employed individuals pay 2.9%.  Unlike the Social Security tax, which is capped at $113,700 of earnings in 2013, the Medicare tax applies to all earned income.  Starting this year, workers with AGIs above $200,000 if filing single or $250,000 if filing MFJ will pay an additional 0.9% Medicare tax on earned income above the applicable thresholds.

Medicare Investment Income Tax

This new tax adds a 3.8% additional tax to all investment income for taxpayers with modified adjusted gross incomes (MAGI) above $200,000 if filing single or $250,000 if filing MFJ. Investment income includes taxable interest, dividends, capital gains, most rent and royalty income, and income from nonqualified annuities.

If any of these new taxes apply to you, you should do some tax planning now to avoid a big surprise next spring when tax time rolls around.  I suspect that the majority of higher income individuals are simply not aware of just how much bigger Uncle Sam’s bite will be.

Kenneth B. Petersen CFP®, EA, MBA, AIFA® is an investment manager and Principal of Monterey Private Wealth, Inc., a Wealth Management Firm in Monterey.   He welcomes questions that you may have concerning investing, taxes, retirement, or estate planning.  Send your questions to: Ken Petersen, 2340 Garden Road Suite 202, Monterey, CA  93940 or email them to ken@montereypw.com.