When the US Supreme Court ruled in favor of the Patient Protection and Affordable Care Act, it instituted a new 3.8% investment tax on taxpayers beginning on January 1, 2013. Note that the Supreme Court did not create this tax; it is one of the ways we are going to pay for the new healthcare system. So what is this new tax and will it affect you?
ObamaCare Tax (Investment Tax)
The 3.8% tax is assessed to any net investment income that you have if your adjusted gross income is greater than $200,000 for individual filers or $250,000 for joint filers. Your adjusted gross income is calculated as your gross income minus adjustments to income such as IRA contributions, retirement plan contributions, the self-employed health insurance deduction and others.
If Congress elects to keep the current Bush Tax Cut rates intact, the tax rate on long term capital gains and dividends come January 1, 2013 will rise from 15% to 18.8%. But, if Congress chooses not to extend the Bush Tax Cuts, the tax rate on capital gains will rise to 23.8% and the tax rate on dividends will be 43.4% as projected by an internet tax estimator. Realize that these are just for those with adjusted gross incomes over $200,000 (or $250,000 if you file jointly).
For example, say a couple filing jointly has $380,000 in adjusted gross income for the year. Of this amount, $240,000 is from wages and $140,000 is investment income. Because they have $130,000 of investment income over the $250,000 threshold (in this case, $380,000 adjusted gross income minus the $250,000 limit equals $130,000), they owe 3.8% tax on this $130,000. This comes to roughly $5,000.
Ways To Avoid ObamaCare Tax
If you earn more than the $200,000/$250,000 limit, you will want to begin looking at ways to avoid this new tax. Some possibilities are to look past dividend paying stocks and focus more on long term capital gain appreciation. This option is only a deferral technique as you can still be hit with the tax through capital gains. But, since the capital gains tax may only be 23.8% compared to 43.4% for dividends, you will be better off going this route.
Another option is to look into tax exempt interest from municipal bonds since this investment income will not count against you. One last strategy is to max out your retirement plan contributions since anything you save in your IRA or 401(k) reduces your adjusted gross income.
Ideally however, you should seek the advice of your financial planner and accountant to determine the best strategy for your situation. This post only touches the surface of a complex new tax that has various exceptions.