Investment Income and Wages

2013 Tax Increases on Investment Income and Wages

After a multitude of negotiations took place in Washington to avert a “fiscal cliff”, one certainty for 2013 is that there is a tax increase on investment income and wages for those income earners above a certain threshold.  The income thresholds are $250,000 for married taxpayers filing jointly, $125,000 for married taxpayers filing separately, and $200,000 for other filers.  Therefore, it will be imperative to engage in planning to keep income below these levels.  Some taxpayers and employers delayed in preparing for the new tax increases, waiting to see if the U.S. Supreme Court would uphold the 2010 health care legislation and/or if the GOP would win the White House.  However, with the Supreme Court upholding the legislation and President Obama’s re-election, it appears these tax increases will remain in place.

Taxpayers whose income will be above the amounts mentioned should become familiar with how the new tax increases will take effect.  Luckily, the IRS recently released guidance on the matter (I apologize in advance for the technical language to follow, but it does get quite complex)  Starting in 2013, a 3.8% Net Investment Income Tax (NIIT) will be imposed on the lesser of “net investment income” or the excess adjusted gross income (AGI) over the threshold amount.  At the heart of this tax is the definition of net investment income.  According to the rules and guidance, it consists of gross income from interest, dividends, annuities, royalties, rents, passive activity income, and gains on disposition of passive property less deductions allocable to the gross income or gain.  Net investment income does not include self-employment income or distributions from a qualified plan.  Please note that the 3.8% tax also applies to trusts and estates. 

Also effective in 2013 is the 0.9% Additional Medicare Tax on an employee’s share of Medicare tax on wages and compensation, as well as on self-employment income, that in total exceeds the threshold amounts mentioned above.  For this tax, instead of using AGI, the income thresholds only include wages, compensation, and self-employment income.  In addition, there is no “employer match” for the Additional Medicare Tax.  An employer is required to collect Additional Medicare Tax with respect to wages earned only to the extent an employer pays wages to employee in excess of $200,000.  Employees who expect to pay Additional Medicare tax but earn $200,000 or less from one employer may not request withholding of the Additional Medicare Tax from that employer but can instead ask for additional income tax withholding.  Those that did not request additional withholding, and the self-employed, may need to make estimated tax payments.  Finally, individuals will report Additional Medicare Tax and pay any shortfall on their Form 1040.

With proper planning it may be possible to keep income levels below the threshold that triggers the additional tax.  One such year-end planning technique may involve accelerating income that is otherwise subject to one or both of the new taxes.  If AGI cannot be lowered below the trigger levels, additional investment strategies and planning can be utilized to keep investment income at a minimum.  While 2013 indeed ushers in a level of uncertainty in many respects, there are definitive actions you can take to minimize your tax bite from the government.  Your CPA or other advisor can assist with these tax saving strategies.

Steve Levy is a Tax Manager at Donovan CPAs and Advisors.  He can be reached at slevy@cpadonovan.com or (317) 745-6411.

www.cpadonovan.com