The new Medicare surtaxes are the culprits behind the tax increases.  The law was enacted in 2010 to help cover the cost of health care reform.  However, the new tax is effective for tax years beginning in 2013.

First Levy - A special 3.8% Medicare surtax on unearned income for single filers with modified adjusted gross income over $200,000 and joint filers above $250,000.  Modified AGI is AGI plus any excluded foreign earned income.  The surtax is imposed on the smaller of the taxpayer’s net investment income or the excess of modified AGI over the thresholds.

Investment income includes interest, dividends, capital gains, annuities, royalties and passive rental income, but not tax-free interest or payouts from retirement plans such as 401(k)s, IRAs, Roths, profit sharing plans and defined benefit plans.  In other words, annuity payouts from retirement plans are exempt from the Medicare surtax.

For example, a couple with $80,000 of investment income and AGI of $280,000 will pay a surtax of $1,140 (calculated by multiplying the 3.8% surtax by the $30,000 excess over $250,000).   A single taxpayer with AGI of $400,000 and $100,000 of investment income will pay an additional $3,800 (calculated by multiplying 3.8% by $100,000).

The surtax boosts the top rate on capital gains and dividends to 18.8% (the 15% nominal maximum rate expected to be in effect for 2013 plus 3.8%).  The full profit on sales of rental properties and second homes can be hit by the surtax.  Also, large taxable gains may push your income over the surtax thresholds.

Planning Ideas - consider selling highly appreciated assets in 2012 instead of 2013.  Tax-exempt bonds will become more popular with high-income investors.  Tax-free interest is exempt from the 3.8% surtax and does not affect the owner’s AGI.  Converting to a Roth this year instead of next may be advantageous.  Although payouts from IRAs are exempt from the surtax, they are taxable, therefore causing your AGI to raise and possibly triggering the surtax on your investment income after 2012.

Second Levy - A 0.9% surtax on earned income (i.e. wages and income from self-employment).  Single taxpayers will owe the extra 0.9% Medicare tax once total earnings are more than $200,000.  The threshold for married couples is over $250,000.  So the effective Medicare tax rate on earnings over the thresholds will be 3.8% (the usual 2.9% Medicare rate plus an extra 0.9%).

Navigating the constantly changing internal revenue tax code can be difficult and frustrating.  The new Medicare surtax may cause a tax consequence that can be avoided with proper planning, making 2012 an important year to make wise tax planning moves.  The professionals at Wallace Neumann & Verville, LLP are available to help you plan for the new Medicare surtax laws.

Disclaimer

The “Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010,” includes an extension of the 100% exclusion from income on gains resulting from the sale of qualifying small business stock.

The Job Creation Act of 2010 contains a provision that amends Section 1202 of the Internal Revenue Code of 1986.  The amendment temporarily permits the exclusion of 100 percent of the gain from the sale of certain “qualified small business stock” acquired after September 27, 2010 and before January 1, 2012.  The stock must be held for more than five years by a non-corporate taxpayer.

Qualifying small business stock must be acquired from a C corporation.  Gross corporate assets must not exceed $50 million.  Gains eligible for the exclusion are limited to the greater of ten times the taxpayer’s basis in the stock or $10 million of gain from stock in that corporation.

Before you purchase Qualified Small Business Stock, you may want to ask your CPA about the tax consequences regarding the investment.  As always, feel free to contact a professional at  Wallace Neumann & Verville, LLP  for guidance regarding the tax consequences of investing in Qualified Small Business Stock.

Molly, a client of mine, just sent me a great Wall Street Journal article called “Exteme Tax Frustration” and it discusses tax consequences of commodity investing specifically “exchange-traded-funds” or ETFs.  As commodity prices soar, investors are rushing into the trendy ETF investment strategies (specializing in commodities like oil, currencies and gold).

ETFs can carry potential tax pitfalls such as higher tax prep fees, different tax rates and reporting requirements in various states.  A popular ETF that I have seen on clients’ tax returns, SPDR Gold Shares, is discussed in the Wall Street Journal article:

SPDR Gold Shares, for example, holds gold bullion in a “grantor trust.” As such, profits and losses aren’t claimed by the trust but “flow through” to holders and are taxed at their income-tax rates.

There is a big difference at tax time:  While holders of gold stocks in a mutual fund would pay tax on long-term capital gains (those held longer than a year) of 15%, long-term gains for Gold Shares holders are taxed at 28% because physical gold is a “collectible.”

Most ETFs are organized as partnerships and they issue a reporting statement called a K-1.  The K-1 is like a 1099 from a traditional brokerage account received at the end of the year but much longer and complex.  CPAs interviewed by the Wall Street Journal said each K-1 from an ETF can take up to an hour to input into a tax return.  The additional time necessary to understand and report an ETF investment adds to the tax preparation bill.

The article’s advice is:

For investors in commodity ETFs, tax surprises can dent or even erase the gains you thought you got. With these new products, the old adage “know what you own” may not be enough. You also need to know what you’ll owe.

Before you invest in ETFs, you may want to ask your broker or CPA about the tax consequences and estimated tax preparation fees regarding the investment.  As always, feel free to contact a professional at  Wallace Neumann & Verville, LLP and they can help determine the tax consequence of an ETF investment.