There are few certainties for year-end tax planning this year, but if you’re a wealthy investor there is one sure thing: the new Medicare tax, slated to begin in 2013.
Part of the 2010 health care reform law, it is a 3.8 percent tax on investment income for individuals with adjusted gross income above $200,000, or $250,000 for married couples filing jointly.
The same high-income taxpayers also face an additional Medicare tax of 0.9 percent on wages and self-employment income, on top of the Medicare tax they currently pay.
Workers already pay 1.45 percent of their pay in Medicare taxes. Employers also pay 1.45 percent, but won’t be required to pay half of the new 0.9 percent additional tax.
The new Medicare tax is structured as a surcharge on net investment income including capital gains, dividends, interest, royalties, partnerships, and trusts. The tax does not apply to tax-exempt income, such as interest from municipal bonds or distributions from retirement plans.
The rules are complex; the Internal Revenue Service has issued 159 pages to clarify the tax. Depending on how much you make from wages and investments, the surcharge may apply to all of your investment income or to part of it.
These new Medicare taxes, coupled with the scheduled expiration of the Bush-era tax cuts, have accountants preparing for a flurry of activity.
For high earners, the combination of the Medicare tax and an expected higher capital gains rate could result in an effective long-term capital gains rate of 23.8 percent, versus today’s low rate of 15 percent.
Here’s what to consider:
■ Taking taxable gains: If you expect to be above the Medicare tax threshold and think your capital-gains rate will be higher in 2013, that turns traditional tax-loss harvesting on its head. Instead of the typical strategy of taking capital losses at year’s end, you’ll want to take gains and defer losses — you can lock in the gains at 15 percent this year, versus potentially paying 23.8 percent next year.
If you have stocks with substantial gains in your taxable portfolio, you could choose to lock in the 15 percent tax on those gains, then buy back the same stock over the coming months in order to reset your cost basis for tax purposes before rates go up. (The so-called wash sale rule, which prohibits immediately buying the same shares back when you take a loss, doesn’t apply to gains.) Ideally, pay for the tax outside of the investment you sold, so as to keep the amount invested the same.
■ Trusts could pay more: Medicare surcharge strategies get more complex for those who have trusts. Trusts are subject to the Medicare tax on the lesser of their undistributed net investment income for the year or the excess of their adjusted gross income over a threshold, currently $11,650. The result is that most trusts — with the exception of charitable trusts, which are exempt — will be affected. One possible strategy: Trusts may be able to reduce or eliminate the Medicare tax by distributing income to beneficiaries.
■ Intra-family loans get costlier: Interest payments on such loans, popular among the affluent at a time of low rates, could be subject to the Medicare tax for those receiving the loan repayment. Parents who have used intra-family loans to help their kids without paying gift taxes may want to revisit those arrangements.