Sep 26, 201211:27 AMFinancial Perspectives
with Michael Dubis, CFP
Planning for the Medicare tax
It’s still uncertain who will win the election in November, but at the start of next year, America's entire tax structure is set to change as the Bush-era tax rates expire and we see higher income, capital gains, and dividend tax rates. The estate tax rates are also scheduled to rise, and the exclusion amounts will go down.
Of course, Congress may intercede between now and then, but in an election year, uncertainty reigns.
Unless there’s a radical restructuring of current legislation, the recent Supreme Court ruling on the 2010 Patient Protection and Affordable Care Act (aka "Obamacare") has taken one uncertainty off the table: We now know that a new tax will have to be planned for as of Jan. 1, 2013.
There’s a ton of misunderstanding out there with regard to what the Medicare tax means. I’m pretty tired of reading the confusing rhetoric, so here’s a summary:
Individuals whose current taxable income exceeds $200,000, or couples with a joint income above $250,000, will pay the 3.8% tax on the lesser of two calculations. There is no tax for those whose income does not exceed these thresholds.
You would first calculate your modified adjusted gross income (MAGI) minus the threshold amount (i.e., $200,000 or $250,000); the amount above this would be subject to taxation if it happens to be lower than the second calculation. Note: MAGI is generally calculated as follows:
- Adjusted gross income
- Minus Roth IRA conversions and rollovers
- Minus required IRA minimum distributions
- Plus traditional IRA contributions that were deducted
- Plus student loan interest that was deducted
- Plus tuition and fees deducted
- Plus domestic production activities deduction taken
The second amount is your net investment income – that is, how much you made, in aggregate, on taxable (but not muni bond) interest, plus dividends, distributions from annuities, royalties, net rental income (after deducting for expenses, property taxes, interest expense from debt service, and property depreciation), income from passive investments like partnerships, from actively trading financial instruments and commodities, plus the gain from selling non-business property. Of course, you get to subtract out losses and expenses related to those investments.
Whatever is lower is the amount you pay tax on.
You might have read that this tax will be imposed on the gains from the sale of your house, but that is highly unlikely to happen to most homeowners, at least in the Wisconsin area. If your income is above the threshold limit, you and your spouse would still have to make a profit of more than $500,000 ($250,000 for singles) on the sale of your house before the tax becomes applicable due to the existing capital gains tax exclusion limit on the sale of a personal residence.
The investment calculation does not include payouts from a regular or Roth IRA, 401(k) plan, Social Security or veterans' benefits, or any income from a business on which you are paying self-employment tax. It also doesn't apply to the appreciation of your stocks or mutual funds until or unless they're sold and gains are taken.
However, IRA and qualified plan distributions do raise your MAGI, and this, of course, can put you over the threshold. In years when you have little investment income, this income amount above the threshold may become the applicable tax base – so you could end up paying taxes on these amounts.
Taxes are only one component of your total financial picture. A strategy that simply tries to lower your payments to Uncle Sam may not be the best one for your personal needs, or for building retirement income. Call your tax advisor. If you have a financial planner, bring him or her in as well, but make sure whoever is giving you advice is a fiduciary and not trying to sell you something as a “tax strategy.”
I hope this is helpful as we think through the coming changes in tax law.
Cory Myers, CPA KMA Accounting Madison, Wisconsin, www.kmaaccounting.com.
Michael Dubis is a fee-only certified financial planner and president of Michael A. Dubis Financial Planning, LLC. He is also an adjunct lecturer at the University of Wisconsin Business School James A. Graaskamp Center for Real Estate. Mike can be reached at firstname.lastname@example.org.
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