OBAMA’S HEALTHCARE REFORM JUST PASSED: INVESTMENT AND TAX IMPLICATIONS
President Obama’s newly passed healthcare reform package will result in higher taxes for individuals making more than $200,000 and couples earning more than $250,000. Fortunately, these new tax laws don’t kick in until 2013.
MEDICARE PAYROLL TAX HIKE
The current Medicare payroll tax is 2.9% of all wages, with the worker and the employer each paying half. Starting in 2013, high income workers will pay an extra.9% of income above $200,000 for individuals and over $250,000 for couples. These extra tax and income limits apply to wage income only. Thus, a couple making $500,000 in wage income would pay an extra $2,250 in Medicare taxes in 2013. A couple making $1 million would pay an extra $6,750 in taxes.
NEW MEDICARE TAX ON INVESTMENT INCOME
High income families will also be subject to a new 3.8% tax on investment income starting in 2013. This applies to capital gains, dividends, interest, annuities, etc. This tax will apply to people with total income (wages plus investment income) in excess of $200,000 for individuals and $250,000 for couples. This new 3.8% tax applies to whichever is less-your total investment income or the excess of your modifi ed adjusted gross income (AGI) over the high-income limit of $200,000 or $250,000. Thus, if a couple has total income of $300,000 and investment income of $100,000, they would only owe the 3.8% tax on $50,000 (their total income of $300,000 less the high income threshold of $250,000). Tax exempt investment income (such as municipal bonds) is not subject to this new tax!
COMBINED IMPACT OF BOTH NEW TAXES
Adding both of these new taxes together, a couple with wage income of $500,000 and investment income of $100,000 would owe an extra $6,050 in Medicare taxes in 2013. A couple with wage income of $1 million and investment income of $200,000 would owe an extra $14,350 in Medicare taxes.
ANOTHER CAPITAL GAINS AND DIVIDEND TAX RATE HIKE COMING IN 2011
Independent of these new Medicare tax hikes, the tax rates on dividends and capital gains are likely to go up from the current low 15% level to 20% (or higher) next year. If Congress does nothing, the Bush tax cuts will expire and these tax rates will automatically go up. Thus, combined with the new extra 3.8% Medicare tax on investment income (including capital gains) in 2013 means taxes on investment income are defi nitely going up over the next several years. Based on the quote above and the experience in Massachusetts, this may be just the start of new higher taxes on “the rich.”
INVESTMENT IMPLICATIONS AND STRATEGIES FOR INVESTORS
• Since the new Medicare tax on investment income does not apply to tax-exempt income, this is a positive for investing in tax-free municipal bonds relative to regular taxable bonds. Muni bonds are more attractive going forward.
• This is another reminder to try to manage your reported income to under $200,000 for individuals and $250,000 for couples, if you can. There are many ways to manage your reported income down: saving more in tax-deferred vehicles such as 401K plans, profi t sharing plans, SEP’s, deferred compensation plans, investing in muni bonds, offsetting capital gains with capital losses, and investing in stocks that pay little or no dividends. Investing for capital appreciation will be taxed less than investing for current income.
• The rising tax rates on investment income make strategies around tax location even more important. Smart tax location means putting your tax ineffi cient investments (like bonds) in your tax deferred accounts and your tax effi cient assets (like growth equities) in taxable accounts.
• If you have investments with large capital gains (your business, real estate, securities, etc.) that you are thinking about selling soon anyway, you may want to consider selling them now (or part of them) at the current low 15% capital gains rate. Tax rates are going up.