SOURCE: Detroit Free Press
Some well-to-do taxpayers won't be thrilled when they're hit with extra tax increase — which can add several hundred or several thousand dollars to the bill.
We're talking about higher tax rates for upper-income taxpayers, as well as a higher capital-gains tax rate and a new investment surtax that was included in the Affordable Care Act.
MORE TAX HELP:
See Form 8960 for the 3.8 percent tax that could apply to net investment income. The tax can apply to individuals, estates and trusts. You'd pay an additional 3.8 percent tax on the lesser of your net investment income, or the excess of modified adjusted gross income over $200,000 ($250,000 married filing jointly, $125,000 married filing separately).
- Some new tax strategies can apply because of that extra 3.8 percent surtax. For example, tax experts warn that someone in a higher-income household might think twice about making a large conversion from a traditional IRA into a Roth IRA. That's because the required inclusion of income from that conversion would drive up your adjusted gross income. Better planning over a few years could avoid triggering the tax.
- Financial planners are suggesting that investors review some strategies to help avoid or mitigate the 3.8 percent surtax. Some might ideas include reducing taxable income by contributing to 401(k) plans and IRAs; and looking into life insurance and charitable remainder trusts.
"Between the increased tax brackets that went into effect in 2013, and the new 3.8 percent Medicare surtax on net investment income, many upper-income taxpayers are seeing a significant bump in their taxes," said Patricia Bojanic, certified public accountant and tax partner at Gordon Advisors in Troy, Mich.
"It's made tax and investment planning that much more important," Bojanic said.
Some higher-income households, she said, could end up seeing an increase of 24 percent or more in the taxes on their investment income.
First, let's look at the new, little-understood 3.8 percent surtax that took effect in 2013.
Now, some taxpayers could be subject to an extra tax on net investment income. Investment income includes interest, dividends, royalties, rents, capital gains and passive activity income.
More people could be talking about the 3.8 percent surtax this season because of the relatively lower income threshold, said Bernie Kent, chairman of Schechter Investment Advisors in Birmingham, Mich.
"This is the one new tax that applies to the most people," said Kent, who has worked more than 40 years with high-net worth individuals and families.
The 3.8 percent surtax would apply to married couples when modified adjusted gross income exceeds $250,000 if filing jointly, and singles when modified adjusted gross income exceeds $200,000. The surtax would apply to married couples filing separately who individually earn more than $125,000.
On top of that, an added Medicare tax of 0.9 percent on gross income from wages and self-employment would be imposed on taxpayers earning more than $200,000 single or $250,000 for joint filers, too.
Alan Semonian, certified public accountant at Ameritax Plus in Berkley, Mich., said he has seen some higher-income households this season getting hit by the 3.8 percent surtax after receiving significant capital gains distributions from mutual funds.
One married couple, both physicians, had to report $50,000 in capital gains distributions from their mutual funds, he said. For that particular couple, the gains helped to trigger about $5,000 in extra taxes relating to the surcharge.
Mutual funds that aren't in tax-sheltered accounts, such as IRAs or 401(k)s, are required to pass profits from capital gains, interest or dividends to individual investors. You'd owe tax on that distribution, even if you did not sell off your shares in the fund.
The 3.8 percent tax does not apply to money taken out of a qualified retirement plan or IRA. It also does not apply to interest income from municipal bonds. Net investment income would not include wages, jobless benefits, Social Security benefits and alimony, either.
Though there are not many ways to reduce this 3.8 percent tax hit in 2013, a few options can exist for some people who are slightly above the $200,000 or $250,000 thresholds, Kent said.
Kent noted that someone who works for an employer who doesn't provide a 401(k) plan or other type of retirement plan, such as a traditional pension, still could contribute now through April 15 for the 2013 tax year to a deductible IRA, which would reduce taxable income. For 2013, a taxpayer could contribute up to $5,500. Or someone age 50 or older last year could contribute up to $6,500.
Someone who is self-employed could consider contributions to a Simplified Employee Pension IRA, and that could reduce 2013 taxable income.
The way the 3.8 percent surtax is calculated can be a bit confusing. For example, a single person with $225,000 in modified adjusted gross income could face an extra tax of $950 if wages were $100,000 and net investment income was $125,000. The surtax in that case is applied to $25,000 of net investment income.
For those with even higher incomes, more tax hits are taking place this year.
The highest tax rate jumps back to 39.6 percent for taxable income more than $400,000 for singles and more than $450,000 for married couples. That's up from 35 percent.
Investors in the top bracket now must pay 20 percent on long-term capital gains and dividends, instead of the 15 percent that most other taxpayers pay.
Higher-income taxpayers also face a potential phase-out of itemized deductions and personal exemptions, if their adjusted gross income is $250,000 or more if single or $300,000 or more for married couples.
James Jenkins, president of Jenkins accounting firm in Southfield, Mich., said self-employed business people are doing more planning. Many of these upper-income people, he said, "aren't accidentally rich" and they are not likely to just stand still as rates climb higher.
The real tax rate is closer to 44 percent, not 39.6 percent, for some higher-income taxpayers who have taxable income above the $450,000 threshold, Jenkins said.
"You know what a phase-out is? It's called higher tax rates," Jenkins said.
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