The New 3.8% Investment Tax

On June 28, 2012, the US Supreme Court ruled, in a landmark decision, that the Patient Protection and Affordable Care Act (ACA) is constitutional. The ACA was signed into law in 2010 and among its many provisions is a 3.8% tax on some or all of the net income of higher income individuals.

The tax affects the net investment income of most joint filers with adjusted gross income of more than $250,000 ($200,000 for single filers). Adjusted Gross Income is defined as gross income minus adjustments to income such as IRA contributions, retirement plan contributions, the self-employed health insurance deduction and others.   Beginning on January 1, 2013, the tax rates on long-term capital gains and dividends for these earners will jump from their current low of 15% to 18.8% assuming Congress extends the current tax law.  However, if Congress allows the current tax rates to expire on December 31, 2012, the top rate on capital gains will rise to 23.8% and the top rate on dividends will nearly triple to 43.4%. Most experts believe that allowing the current rates to expire is an unlikely scenario.

The new tax calculations are complex, but in effect it is a flat tax on investment income above the $250,000/$200,000 threshold.  Although the tax applies only to investment income above the threshold, other income, such as wages, can raise adjusted income making investment income more vulnerable to the tax.  The tax does not include payouts from a regular or a Roth IRA, a 401(k) or pension plan, Social Security, or municipal bond investments.

An example may be helpful.  A married couple filing a joint tax return has $380,000 of adjusted gross income consisting of $240,000 of wages, and $140,000 of investment income.  Because they have $130,000 of investment income above the $250,000 threshold, they would owe an extra 3.8% of that amount, or $4,940.

We will provide additional information and develop planning strategies as the IRS releases more guidance on this complex tax.  Until then, consult with your tax advisor and consider strategies to reduce your Adjusted Gross Income.

About Mark Rioboli

Mark A. Rioboli, CFP®, CFS is Director of Wealth Management for Independence Advisors, bringing over 25 years of experience in the wealth management industry. Have a question for Mark? CLICK HERE TO ASK MARK

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