July, 2012

New Additional 3.8% Investment Tax


Because of the Supreme Court’s ruling on Obama’s health care law, starting January 1, 2013, there will be a new additional investment income tax of 3.8% for couples with adjusted gross income of more than $250,000 ($200,000 for single tax filers). Although the IRS has not yet come out with guidance, the additional tax will probably affect the following investment returns:

  1. Dividends
  2. Rents
  3. Royalties
  4. Interest (but not municipal-bond interest)
  5. Short- and long-term capital gains
  6. Taxable portion of annuity payments
  7. Income from the sale of a principal home above the $250,000/$500,000 exclusion
  8. Net gain from the sale of a second home
  9. Passive income from real estate and investments in which a taxpayer doesn't materially participate, such as a partnership

There are a few strategies to help minimize the effect of the new tax. Investing in municipal bonds provides investors double benefits. First, the income from municipal bonds does not increase the adjusted gross income, which will trigger the additional tax if it is too high. Second, the income from municipal bonds is not subject to the 3.8% tax. Another strategy is investing in a Roth IRA, wherein withdrawals aren’t taxed once you qualify to make distributions. If you were thinking about converting an IRA to a Roth, you may want to consider converting now, before the additional tax applies. Certain pension plans may also be beneficial for investors with high business income because they can reduce their adjusted gross income through deductible pension contributions. Also, payouts from such plans are not subject to the 3.8% tax.

Source: Get Ready for the New Investment Tax, Wall Street Journal, June 30, 2012.