| 04 August 2010
Under the new health care legislation that was signed into law this spring, 2013 becomes an important year for many people. Starting in 2013, there will be a new 3.8% Medicare tax on unearned income (IRC Section 1411). It would be easy to just wait and see how this affects you but there may be some planning opportunities to discuss with your advisor. But first, let me define the issue.
In 2013 the law assesses a new 3.8% tax to the lesser of: a) net investment income; or b) the excess of modified adjust gross income (MAGI) over the applicable threshold amount ($200,000 for those filing single and $250,000 for those filing jointly). I am not going to get into a definition of what net investment income is but for purposes of this article, it includes everything from dividends to rental income to capital gains (municipal bond interest is excluded from this computation). There is more to it than that so as we always say, see your accountant before making any decisions for your own situation.
Let me point out who is not affected by this. If you do not have unearned income, this new tax does not apply; and if your MAGI is not above the threshold limits ($200,000/$250,000), then you do not have to worry about this tax. But equally important, do not dismiss this quickly if you are under the threshold since many things can push you over, and that is where planning comes in.
This new tax might apply more to the following people: Those with significant ongoing income – this is tricky because many retirees with large IRAs might have to start taking Required Minimum Distributions (RMDs) which could push their income too high; those with unearned income which could include distributions from mutual funds or interest/dividends from funds/stocks/bonds – asset location is going to become a much bigger issue going forward since starting in 2013, you might want to put higher turnover investments inside retirement plans and keep more of your index funds and municipal bonds in your taxable portfolio; those who can time income – you might want to accelerate income into 2012 (this could include capital gains as well) or even lump income into certain years beyond that.
As with all planning ideas, I would like to also temper my comments by pointing out that sometimes focusing on avoiding one issue brings up a whole host of other issues that can have more detrimental effects. It might be worth paying this new tax if you accomplish a goal, especially if it just barely pushes you over the threshold limits ($200,000/$250,000); keep in mind that the 3.8% is due only on the income over those limits that is unearned income.
Now is the time to start working with your advisor on this since sometimes it can take a year or more to reposition portfolios without detracting from performance. And of course, congress or the IRS can still tweak the rules around this new law, but starting the conversation now will help you avoid surprises later.