New Obamacare Investment Tax
Written By: Peter S. Muffoletto, C.P.A.
The Patient Protection and Affordable Care Act (ACA) affirmed by The Supreme Court includes certain income tax provisions to help pay for what has become known as Obamacare.
With the Supreme Court upholding the ACA as constitutional all the provisions within the law now come into affect, one being the 3.8 percentage surtax on investment income. No guidance has been issued by the Internal Revenue Service as to the implementation of the new tax.
The increased tax which Congress passed in 2010 ACA act affects the net investment income of those filing joint tax returns with adjusted gross income (AGI) of more than $250,000, and $200,000 for single filers.
Starting January 1, 2013 the tax rates on long-term capital gains and dividends will increase from 15% to 18.8%, assuming Congress extends the current law. Should Congress fail to extend by year end the so called Bush Tax rates the capital gains tax rate will rise to 23.8%, and the top rate on dividends will nearly triple to 43.4%.
Adjusted gross income (AGI) is computed to include interest, dividends, capital gains, wages, retirement income, Social Security Income, net rental income, income from partnerships and small businesses, and all other income but does not include subtractions for itemized deductions such as mortgage interest and charitable gifts, or personal exemptions.
For those that have called for a flat tax on the wealthy, it has arrived. The new levy is complex but in effect it is a flat tax on investment income above the $250,000/$200,000 threshold. While the tax applies only to investment income above the threshold, other income such as wages or Social Security benefits can raise adjusted gross income, making investment income more vulnerable to the tax.
Definition of "investment income"
The IRS has yet to provide any guidance and will need to do so soon as to how net investment income is to be defined for the purposes of this new provision in the tax law and how it will be implemented but based upon existing tax law it would appear that the tax applies to dividends; rents; royalties; interest, except municipal-bond interest; short and long term capital gains; the taxable portion of annuity payments; income from the sale of a principal home above the $250,000/$500,000 exclusion; a net gain from the sale of a second home; and passive income from real estate and investments in which a taxpayer does not materially participate, such as a partnership.
The tax does not appear to include payouts from a regular or Roth IRA, 401(k) plan or pension; Social Security income; or annuities that are part of a retirement plan. Also appearing to be excluded are life insurance proceeds; municipal-bond interest; veterans' benefits; Schedule C income from businesses; or income from a business on which you are paying self-employment tax, such as a Subchapter S firm or a partnership.
Application of the 3.8% tax to the sale of a principal residence
The new tax would apply at the rate of an additional 3.8% above the capital gains rate if the net gain on the sale of personal residence exceeds the $500,000 exclusion for joint filers, $250,000 for singles, and the taxpayer's income also exceeds the adjusted gross income threshold.
The 3.8% tax applies to trusts and estates
The tax applies to net investment income of more than about $12,000 that is not paid out to heirs or beneficiaries.
Higher payroll tax for high income earners
The new law is a true change from prior law in that it adds a progressive element to what has always been a flat payroll tax. The change raises the Medicare tax by 0.9% (from 1.45% to 2.35%) on wages and self-employment income above $250,000 ($200,000, single).
Unlike Social Security taxes, the Medicare tax is uncapped. The new levy has no deductible component for self-employed taxpayers.
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