CPA Q&A on the New Healthcare Surtax

Actors, athletes, politicians, chefs and even some interior designers are household names these days, but what about certified public accountants (“CPAs”)?  Meet Robert S. Keebler, a well-known and respected CPA who just might become a household name thanks to his webinar series on the new healthcare surtax which will be implemented in 2013.

Here are the answers to questions that Mr. Keebler has been addressing in his webinars:

Why does the new health care law affect my taxes?

Now that the new health care reform law has been declared constitutional, the remaining provisions will be going into effect. One little known provision is a 3.8% investment income surtax, also called the health care surtax or the Medicare tax; it will go into effect on January 1, 2013.

Who is affected by this new surtax on investments?

Not surprisingly, the calculations for the surtax are tricky: the tax applies to either your investment income or to the amount of your modified adjusted gross income exceeding the threshold upon which the tax is levied, whichever is less.

Specifically, the investment income surtax will apply to taxpayers who have a modified adjusted gross income of $200,000 or more for individual taxpayers.  The investment surtax threshold is $250,000 for married tax payers filing jointly and $125,000 for married taxpayers filing separately.  For trusts and estates, the threshold affects those with income which exceeds the top income tax bracket ($11,650 in 2012).

Stated another way: If your modified adjusted gross income (MAGI) is less than or equal to the threshold amount that applies to you, you will not pay this tax.  If your modified adjusted gross income (MAGI) is greater than the threshold amount that applies to you, you will pay the 3.8% tax on the lesser of your net investment income or the amount of your MAGI exceeds the threshold amount.

Is my liability for this investment surtax calculated before or after my tax deductions?

The surtax liability is determined on income before any tax deductions are considered. That means your deductions could put you in the lowest income tax bracket, yet your investment income could still be subject to the surtax.

Also, the capital gain rate is scheduled to increase for high-income taxpayers to 20% in 2013, so the total tax on capital gains (with the surtax) could be 23.8% in 2013 and beyond.

What kinds of investments will be taxed?

People in the income tax brackets mentioned above will be subject to a 3.8% surtax on certain kinds of investment income, such as interest, dividends, capital gains, rent and royalties (though interest on tax-exempt municipal bonds doesn’t count).

This new surtax will be assessed on the lesser of your a) net investment income or b) modified adjusted gross income (MAGI) which exceeds the “threshold amount.”

Does this new tax apply to home sales?

It does apply to home-sale profits, but few people should be affected. Up to $250,000 of the profit from the sale of your home is tax-free if you’re single and have owned and lived in the home for at least two of the five years leading up to the sale.  For married couples filing jointly, the exclusion rises to $500,000 of profit from the sale of a home.  These profits are not subject to capital-gains taxes or the new 3.8% surtax.

If your profit on the home sale is more than the exclusion amount, or if you lived in the house for less than two out of the past five years, your investment profit will be subject to this additional tax if your MAGI exceeds the tax threshold. This tax exclusion does not apply to second homes or vacation homes, so the entire profit on the sale of a second home or vacation home could be subject to the surtax.

Is there anything I can do to avoid or reduce the amount of this new surtax?

The good news is that there are some steps you can take this year to help you avoid or reduce the amount of surtax beginning in 2013.  Anything you can do to keep your income below the $200,000/$250,000 MAGI threshold in 2013 — such as contributing to a 401(k) or flexible spending account — can help you avoid the tax.  Also consider buying investments that aren’t subject to the surtax, such as tax-exempt municipal bonds.

Remember that 2012 is an exceptional year for estate planning in general. The federal estate tax exemption is $5.12 million, which allows a married couple to transfer as much as $10.24 million from their estate with no estate tax. Under current law, this exemption is scheduled to shrink to $1 million in 2013. Other Bush tax cuts, including income and capital gain taxes, are set to expire at the end of 2012. With the new 3.8% surtax becoming effective in January, 2013 we are set to have the highest tax rates we have seen in years.

If you believe you may become subject to the 3.8% tax next year and want to learn about ways to mitigate or even prevent its application to you, speak with a qualified certified public accountant or estate planning attorney to learn more about the options that may be available to you, based upon your particular situation.

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