The Affordable Care Act (ACA), aka Obamacare according
to Title I of the act claims to be the “largest middle
class tax cut for health care in history.” Despite a
very messy and disappointing start, Obamacare is in
motion and so are the new taxes that became effective
January 1, of 2013. Higher income earners will be
subject to increased capital gains tax rates in 2013 and
the imbedded capital loss carry forwards from 2008-2009
that everyone has benefitted from are evaporating faster
than a rain drop in the Sahara. It’s going to be a
banner tax collection year for the Federal Government
and it’s important you’re prepared.
The ACA created two new taxes. The first is an
additional 3.8% NIIT (Net Investment Income Tax) and the
second is the Additional Medicare tax of 0.9% on earned
income. TITLE IX of ACA details REVENUE PROVISIONS and
revised tax rates that became effective on January 1,
2013. If you’re Modified Adjusted Gross Income (MAGI)
found on line 37 of 1040, is greater than the following
amounts, $250,000 for Married Filing Jointly and
Qualifying Widower, $200,000 for Single and Head of
Household, and $125,000 for Married Filing Separately,
you are at risk.
ACA taxes are in addition
to the revised tax rates effective in 2013 which moves
most people subject to NIIT and Additional Medicare into
the 33% tax bracket with the highest rate of 39.6%.
Earners making above $400,000 will be subject to the
increased capital gains and dividend rates of 20%. ACA
taxes are also added on top of the capital gains.
Let’s define investment income according to the IRS:
dividends, capital gains, rental and royalty, and income
from non qualified annuities.
from trading activities that is passive to the taxpayer.
from the sale of stocks, bonds, and mutual funds and
capital gains distributions from mutual funds.
from sale of investment real estate and second homes
that are not your primary residence.
gain on the sale of interests in partnerships and S
Corporations for passive owners is also subject to NIIT.
to minimize NIIT Taxes.
you plan year round for taxes you’ll develop a better
understanding of how certain financial transactions and
decisions impact you. Be sure to maximize all qualified
plans such as 401(k), 403(b), including catch up
provisions for people over 50 and take full advantage of
all deferred compensation options and defined benefit if
you are a highly compensated employee. The IRS limit for
defined contribution plans in 2013 is $17,500 or $23,000
over age 50. Defined benefit plans allow you to defer up
to $210,000 for 2014. If you had passive activity losses
from past investments, they can be harvested to offset
passive income. An easy way of remembering is “PAL’s can
be used to offset PIG’s.” Loss carry forwards from “at
risk” prior activities can also be used to offset new
taxes. Be sure to take all your deductions from
investment related activities. Some examples are
expenses from investments, interest, advisory fees, tax
prep fees, legal fees associated with profit seeking
activities, and fiduciary expenses related to estates
and trusts. If you are self employed, keep track of all
business related expenses and if you are an employee
keep track of non reimbursed expenses. Increasing your
gifts to charitable organizations always helps. The 0.9%
additional Medicare tax on wages that is not
automatically held from payroll but you can request a
modest adjustment using IRS forms W-4. Finally, be
careful of tax schemes involving foreign trusts or
international business corporations. If it doesn’t smell
right, the milk is probably spoiled.
The Alternative Minimum Tax is a topic for another
conversation could phase out some of your deductions if
you claim a high number of personal exemptions, have
incentive stock options, or have high state and local
taxes. If you live in New York City, this means you. AMT
and its impact are rarely discussed in national debates
on tax fairness but it does impact your effective tax
If you own a large stake of highly appreciated assets
that will create an estate tax liability, consider a
Charitable Remainder Trust. Aside from the highly
beneficial charitable deduction, assets sold inside a
CRT are not subject to capital gains but you must take
an annuity stream of income each year. The annuity
income stream from a CRT is not subject to NIIT. I will
cover more specifics in a future article. Incomes from
Grantor Trusts are also typically exempt from NIIT but
you pay them as income flows through to your personal
tax return. However, Estates and Trusts which are
normally subject to taxes on undistributed net
investment income above $11,950 for 2013 threshold are
subject to NIIT. In such cases your tax professional can
spread out the distribution among multiple beneficiaries
to reduce the tax impact.
Consider tax managed investments whose stated goals are
after tax return versus absolute returns before capital
gains. These funds limit taxes by continuously
offsetting gains and losses and avoid managers who focus
on short term trading. You should seek to shelter as
much income as possible from taxable events unless it’s
more economic to take a profit. At that point feel
fortunate and keep good track of your cost basis.
In closing, managing your tax liabilities is an ongoing
process and waiting until December of a given tax year
with the hopes your advisor can tax harvest your
brokerage accounts or simply handing everything to your
accountant isn’t the most optimal approach. A more
proactive approach is to manage your liabilities year
round by working closely with your tax professional and
financial advisors on a more regular basis to develop a
strategy. If you treat tax liabilities as part of your
overall financial plan and invest accordingly with tax
efficiency and after tax returns as one of your
objectives you will have a better chance of lowering the
taxes you pay to Government and increase the amount of
money to charitable causes you want to support. Tax year
2013 as it pertains to NIIT and The Additional Medicare
Tax will be a learning experience.
Start planning for 2014 today.
Mark Pappa is an account executive with
Financial Resources, Inc.