Some of the 2013 tax law changes slated to take effect Jan. 1 could hit your portfolio if you aren't prepared – and some will go into effect regardless of the fiscal cliff resolution.
In fact, the Internal Revenue Service (IRS) has released 159 pages of rules that will apply to trusts, annuities and individual equity traders.
One tax that could affect you is a new 3.8% surtax on investment income – or as it's fondly called, the investment income Medicare tax. The new tax is part of the 2010 healthcare reform law passed by Congress, and represents the first surtax on capital gains and dividend income.
There's also a new 0.9% healthcare tax on wages for high-income individuals; it is called the earned income Medicare tax increase.
Combined, these two taxes could raise an estimated $317.7 billion over the next decade, reported Reuters, based on a June Joint Committee on Taxation analysis.
To find out if you qualify for these taxes – and how to avoid them – check out this look at the proposed changes.
2013 Tax Law Changes: Medicare Surtax
The 3.8% Medicare surtax is a big deal because it's the first time a Medicare tax will be assessed on investment income.
For the purposes of the rule, investment income includes the following:
- Interest, Dividends, Royalties, and Annuities
- Capital gains, including any profit you make on the sale of your residence if it exceeds the amount you are allowed to exclude
- Passive-activity income. This can defined as earnings that stem from rental property, limited partnerships or other business that an individual is not actively involved.
You'll be affected by the Medicare surtax if your modified adjusted gross income (MAGI) is more than $200,000 as an individual, or $250,000 for married couples filing jointly.
Your MAGI is the total of adjusted gross income plus any foreign income. So if you work in the United States, MAGI will equal AGI, which includes your net investment income (gains minus losses).
It's a bit tricky, though.
The 3.8% Medicare surtax only goes into effect if your MAGI is over the $200,000/$250,000 threshold. If it is, then the tax is applied to the lower of these two numbers: Your net investment income, or the amount by which your MAGI exceeds the threshold.
Let's say you're a taxpayer filing as a single individual. You make $180,000 in wage income and an additional $90,000 from investment income. Your modified adjusted gross income is $270,000.
By applying the 3.8% tax, it will apply to the $70,000 that is over the $200,000 mark. That would be $2,660.
Or, if you have $220,000 of net investment income and no other income, your MAGI would then equal $220,000. The 3.8% surtax would then apply to $20,000 (lesser of MAGI over threshold or net investment income).
For investors affected by the 3.8% tax, the IRS will release a new taxpayer's form to use for 2013 returns.
There are two strategies to avoid the tax, according to FOX Business. Either keep your MAGI under the threshold, or eliminate your investment income.
To stay under the threshold, you could implement buy-and-hold strategies to your portfolio, invest in municipal bonds or maximize contributions to your retirement plan.
2013 Taxes: The 0.9% Tax on Earnings
Even if you avoid the surtax on investments, you could still be subject to the new 0.9% healthcare tax on individuals' earned income (wages, compensation and self-employment income).
This will go into action based on your earned income. For single taxpayers, the threshold is $200,000 and for married joint filers, the number is $250,000.
Keep in mind, this 0.9% surtax is only applied to wages. This increase effectively goes from a current Medicare tax of 1.45% to 2.35%.
Maybe you haven't noticed this on your paycheck, but for years, wages have been liable to a 2.9% Medicare tax with an even split between the employee and employer at 1.45%.
Beginning with your first paycheck in 2013, if you annual earned income is greater than the threshold, you will now pay 2.35% (1.45% plus 0.09%) to Medicare on the wages above the threshold, while employers will only pay their share on the amount up to the threshold.
For those who are either retired as well as others who don't obtain income from a job, they won't have to worry about this tax regardless of income received from other ways.
Before the two rules become final, the IRS will accept public comments and conduct hearings in April.
Michael Grace, managing director at Milbank, Tweed, Hadley & McCloy LLP law firm in Washington, and a former IRS official, said to Reuters, "The proposed regulations surely will increase tax compliance burdens for individuals. There's clearly some drafting left to be done."
In the meantime, in addition to the steps above, investors can do things like shift some of the taxable investments into tax-sheltered and tax-exempt vehicles such as annuities, life insurance and municipal bonds, reduce your trust income exposure, and consider investments that offer deductions, like certain oil and gas and real estate picks.
But the best things to do are to keep updated on what 2013 tax law changes are likely to be implemented, and talk with your tax and investment advisor.
Related Articles and News:
- Money Morning:
The 2013 Tax Law Changes that Could Be Headed Your Way
- Money Morning:
How to Prepare for Taxmageddon 2013
IRS aims to clarify investment income tax under healthcare law
- FOX Business Network:
Financial Steps to Take Now to Prep for Looming Tax Increases
Affordable Care Act Tax Provisions
- Morgan Stanley:
New Year, New Medicare Taxes At a Glance