Trying to make business or investment decisions based on whether the Bush tax cuts will expire on Dec. 31 is like rolling the dice. But there is little or no speculation required when it comes to the taxes needed to fund President Obama’s health care overhaul. Regardless of who wins the presidential election, new taxes on investment income and a boost in payroll tax are slated for 2013. The new taxes are expected to yield $210 billion over a decade to help fund the health care law, which aims to expand insurance coverage to more than 32 million Americans. Here’s an overview of how the new levies will be imposed as of Jan. 1, 2013. It is estimated that about 4 percent of the tax-paying population will be affected by the new health care law levies:
- A 0.9 percent boost in payroll taxes for individuals earning more than $200,000 a year or households earning more than $250,000;
- A 3.8 percent tax increase on investment income for individuals earning more than $200,000 a year or households earning more than $250,000.
Higher-income taxpayers and business owners would be wise to have strategies in place to shelter their investment and other types of incomes – as much as the law permits – well before year-end.
Bearing in mind the complexity of the 70,000-page tax code and the specific considerations of individual taxpayers, there is no one-size-fits-all strategy. However, there are some basic tips that might alleviate the blow and some information on gray areas. As always, your tax strategy should be developed in consultation with a qualified professional tax advisor.
Timing a Sale
If you are in the midst of selling a business, finish the deal by year-end to pre-empt the additional tax hit. Likewise, if you are already planning to offload a large single stock position in the next five years to free up some cash, try to do it before Dec. 31. Real estate sales are also subject to the new investment income levy, but bear in mind there’s no change to the tax exemptions allowed on primary residences.
Depending on the individual taxpayer’s circumstances, other avenues should be explored, including cashing in gains in 2012 rather than next year and moving business profits into capital expenditures not subject to taxation.
As it stands now, the 3.8 percent tax will be levied in addition to the existing 15 percent rate on income from capital gains, dividends and other investments for those in the $200,000-plus salary bracket. The law does make an exception to the new 3.8 percent tax on investment if the income is earned in the ordinary course of a trade or business. Whether the income is classified as wages or investment income hinges on how the new law characterizes the provider of the service. This is where the law gets into a gray area, which tax professionals don’t expect to see clarified until after the election. This issue affects business partnerships involving, for example, real estate, law and private equity management firms (like Bain Capital, the firm co-founded by Mitt Romney) – businesses where profits are dispensed as distributions to partners and not as wages.
Deferred compensation plans are another area needing further clarification. So far, more input from the Internal Revenue Service is required to determine if the investment built up in such plans will be subject to the new 3.8 percent investment tax.
Tax professionals will be hard at work devising appropriate strategies as soon as the IRS spells out exactly how the new taxes will be applied. Be sure to consult your tax professional to determine how these new health care taxes will affect you.