Now that the Supreme Court has upheld most of the provisions in the Patient Protection and Affordable Care Act (otherwise known as Obamacare) high income investors can expect to pay higher taxes on most investments.
Legislative changes of this magnitude certainly come at a cost and in order to pay for Obamacare, investors must now share more of the burden in the form of a 3.8% surtax on investment income. This will be in addition to any future rollback of the Bush tax cuts already proposed for the wealthy.
This new tax that was passed in 2010 when Democrats controlled the House, Senate and Executive branches and affects joint filers with adjusted gross income of more than $250,000 and single filers with income above $200,000. Earned income amounts above these thresholds will be subject to the new tax, but income below will remain at current levels.
The tax is slated to begin January 1, 2013 assuming Congress upholds the legislation and barring no significant changes to the political landscape in the November 2012 elections.
In a nutshell, certain investment and income taxes will increase by 3.8% from their current levels assuming no other legislative changes or expiration of current tax rates. Capital gains for high earners will jump from 15% to 18.8% on long term holdings.
In addition, there are also changes to the payroll tax. What once was a flat tax is now a means adjusted, progressive tax that will raise the Medicare payroll tax for joint filers with income above $250k and singles above $200k.
The Medicare tax will increase 0.9% to 2.35% from the current 1.45% on wages and self employment income. The Medicare tax is uncapped, so this new tax will apply to all income and wages above the aforementioned thresholds. High earning self employed persons will pay this amount twice.
Most tax experts believe that ordinary dividends and income, interest income, short and long term capital gains, rents, royalties, taxable annuity income, sales of primary residences above the $250,000/$500,000 exclusion, gains from sales on second homes and passive income will all be counted and subjected to the 3.8% surtax.
That is to say that almost all investments, save for a few, will now be subjected to these higher rates. Primary residence sales that result in large capital gains will not avoid this new tax. Joint filers are afforded a $500,000 exemption on the sale of a primary residence and single filers are allowed $250,000.
However a couple with $200,000 in adjusted gross income who has a $100,000 capital gain above the $500,000 primary residence exclusion amount would have to pay an additional 3.8% on the extra $50,000 above the joint $250,000 limit. Income and capital gains tax are combined and not mutually exclusive.
Investment properties and second homes are offered no exclusion upon sale and capital gains above the $250k joint and $200k single amounts would be subject to the 3.8% tax increase. This can be problematic for those with significant real estate holdings, but read on.
For those who are selling investment properties and residences that will result in significant capital gains, one such strategy may be a structured sale. With a structured sale annuity, the owner can defer constructive receipt of the capital gains and defer them over several years.
At present, structured sales have been accepted by the I.R.S when setup and executed properly by qualified tax professionals along side annuity insurance agents. By taking payments over several years, the capital gains can be spread out and in many cases help to keep investors below the new tax thresholds.
When considering investments with tax advantages, there are two insurance products that can be helpful for many investors.
The first is a simple and straightforward investment account known as a tax deferred annuity.
When compared to bank certificates of deposit, mutual funds, and dividend paying stocks (among others), a non-qualified tax deferred annuity can shelter income for the life of the owner. There are no forced distributions with a non-qualified annuity and the deferred income tax can be spread out over several years during the owner’s lifetime or amongst the annuity beneficiaries at settlement.
Perhaps even a better investment is life insurance. Life insurance policies grow tax deferred, but in contrast to an annuity, the proceeds are payable income tax free to the named beneficiaries. There is really no better investment when it comes to wealth transfer than a whole or universal life insurance policy.
Converting your traditional IRA to a Roth IRA can be beneficial when done properly. Considering that time is running out in 2012 before the new investment tax takes hold, now is a good time to consider a Roth IRA conversion.
It goes without saying that you would want to speak with your tax advisor before converting any qualified account, but it should be noted that distributions from a Roth IRA are considered income tax free by the I.R.S. and thus would not be counted towards your adjusted gross income.
Those with sizable IRA accounts might consider a total or partial Roth IRA conversion now in order to potentially reduce taxable required minimum distributions at age 70 1/2 and beyond.
Hyers and Associates Inc. is a full service, independent life and annuity insurance agency. We specialize in wealth transfer and tax avoidance strategies for those in higher income tax brackets.