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The 3.8% Obamacare Tax-What You Need to Know

Posted by Shalimar Albanese on Dec 6, 2012 11:17:00 AM

Guest Blog Post by Judith Hetherman, CPA

What you need to knowDespite the need for economic reform and lower taxes, in January 2013, a new tax will come into effect. The reason for this new tax? To fund the Patient Protection and Affordable Care Act, or, more commonly known as Obamacare. How this new tax is applied may affect your tax planning.

This new 3.8% tax will affect anything that is deemed “unearned net investment income”. For tax planning purposes, you need to know what this is comprised of: dividends, annuities, bonds, mutual funds, royalties, rents (less any expenses), capital gains (less capital losses), income earned from stocks, as well as income from loans – essentially, anything earned from a passive income stream. 

Additionally, this tax applies to trusts and estates, with certain caveats.

But that’s not all. This tax will also affect those who actively earn a higher income. It targets people who, in 2013, have an AGI more than $250,000 for those who are married, $200,000 for those who are single, or $125,000 for married couples who are filing separately.

If you have both passive income and are a high income earner, then this tax applies to the lesser of your net investment income and your AGI. When tax planning, consider the examples below:

Example 1: Zach, who is single, has a net investment income of $50,000 and an AGI of $235,000. The tax applies to the lesser of the two amounts over the threshold for a single person ($235,000 – $200,000 = $35,000), or $50,000. Therefore, Zach would have to pay 3.8 percent of $35,000 = $1330.

Gains from selling property that was not used in an active business plus income from investing working capital are also considered investment income.

However, primary residence rules still apply – assume someone sells their primary residence the first $250,000 (if single) or $500,000 (if married) – because it is a primary residence sales, only those with gains over this limit, who make over the income limits, will be affected. If the property is an investment (rental) property, then this exclusion doesn't apply and they would only be taxed if their AGI is over the limits stated above.

Example 2: Capital Gains: If Jack and Jill sell their primary residence and realize a gain of $525,000. (first 500,000 gain on their primary residence is tax free), and they also have $325,000 AGI (before adding taxable gain from the sale of the property), then the tax would be calculated as such: 

  • AGI before any taxable gains: $325,000
  • Gain on the sale of primary property: $525,000
  • Taxable gain calculation ($525,000 – $500,000): $25,000 
  • Revised AGI amount ($325,000 + $25,000 taxable gain): $350,000 
  • Excess of AGI amount over threshold for married couples ($300,000 – $200,000): $100,000 
  • Lesser of the taxable amounts: $25,000 (taxable gain)
  • Amount owing ($25,000 x 0.038): $950

However, if Jack and Jill had a gain of less than $500,000 when they sold their home, none of that gain would be subject to the 3.8% tax.

Also, owners of a second home that was not being rented (or not rented for more than 14 days) are not subject to this tax.

Example 3: Vacation Home: Jack and Jill are fortunate enough to own a vacation residence that they purchased for $270,000 and they have never rented it to anyone else. They are able to sell it for $335,000. The year that they sold it, they also earned income of $225,000 from other sources. The tax would be calculated as such: 
  • Gain on sale of vacation residence ($335,000 – $275,000): $60,000
  • Income from other sources $225,000
  • Revised AGI ($60,000 + $225,000): $285,000 
  • Excess AGI over threshold for married couples ($285,000 - $250,000): $35,000 
  • Capital gain: $60,000
  • Lesser of the taxable amounts: $35,000 (excess AGI)
  • Amount owing ($35,000 x 3.8%): $1,330

Thankfully, some exceptions do apply to this upcoming tax. For example, non-taxable income, such as 401(K) plans, veterans’ benefits, distributions from qualified plans, tax-sheltered annuities, eligible 457 plans, proceeds from life insurance, to name only a few, are not subject to the new 3.8 % tax. Charitable trusts are also exempt.

There are ways you can protect yourself from this tax. Seeking shelter in those assets and structures that are exempt is one thought, but there are others to consider. Although this tax doesn’t come into effect until 2013, it is best to determine your best financial strategy as soon as possible. Always make sure you talk to your financial advisor or accountant to get advice about tax planning, to review your financial plan, or to get more information before making any decisions.

Please contact Judith Hetherman, CPAs or your Accountant for help in implementing these or other year-end planning strategies that might be suitable to your particular situation.**

Judith Hetherman is a Certified Public Accountant specializing in personal and business income tax preparation and business consulting. She assists her clients in maximizing their income and minimizing their taxes. Client retention and outstanding service led Judy to be recognized by RI Monthly as a Five Star Wealth Manager in 2012. She is a member of the RI Estate Planning Council, the RI Society of CPAs, and the National Institute of Certified Healthcare Business Consultants. As a business liaison for the RI Secretary of State office, she assists individuals who are looking to start a new business with their accounting questions, entity choices, and provides them with the information needed to get started in business.

**This blog post is intended to provide generalized information that is appropriate in certain situations. It is not intended or written to be used, and it cannot be used by the recipient, for the purpose of avoiding federal tax penalties that may be imposed on any taxpayer. The contents of this blog post should not be acted upon without specific professional guidance.

Topics: quick tips, 3.8% tax, obamacare tax, tax planning

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