Rules for new health care investment surtax

Q: I understand that the health care reform law imposes a new tax on investments. To whom does the tax apply, and when does it take effect?

A: Starting this year, taxpayers who have a modified adjusted gross income of $200,000 or more ($250,000 for joint filers) will pay a 3.8 percent surtax on certain kinds of investment income, such as interest, dividends, capital gains, rent and royalties. (Interest on tax-exempt municipal bonds doesn’t count.)

The calculation is tricky; the surtax applies either to the investment income or to the amount of modified AGI exceeding the threshold, whichever is less. For example, if your joint income is $300,000 and you have $5,000 of investment income, you’ll pay the tax on the $5,000. But if your investment income is $50,000 and your joint modified AGI is $260,000, you’ll pay the tax on $10,000 of the investment income.

There’s also a 0.9 percent Medicare surtax on any salary or self-employment income that exceeds the modified AGI threshold.

Q: Does this new tax apply to home sales?

A: It does apply to home-sale profits, but it might not hit very many people. When you sell your home, up to $250,000 of the profit is tax-free if you’re single and have owned and lived in the home for at least two of the five years leading up to the sale; the exclusion rises to $500,000 for married couples filing a joint return. That part of the profit is not subject to capital-gains taxes, and it also avoids the new 3.8 percent surtax. So a married couple who bought a home more than two years ago for $300,000 (and has lived in it since then) can sell it for up to $800,000 without having to pay taxes on the sale — no matter how high their income.

If your profit on the home sale is more than the tax-free amount, or if you lived in the house for less than two out of the past five years, your investment profit will be subject to this extra tax if your modified AGI is more than $200,000 if you’re single and $250,000 if you’re married filing jointly. The tax exclusion does not apply to second homes or vacation homes, so the entire profit on the sale of a second home or vacation home could be subject to the surtax. For more information, see New Tax on Windfall Home-Sale Profits.

Q: What can I do to minimize the new tax?

A: Any steps you can take to keep your income below the $200,000/$250,000 modified AGI threshold in 2013 — such as contributing to a 401(k) or flexible spending account — can help you avoid the tax. Also consider buying investments that aren’t subject to the surtax, such as tax-exempt municipal bonds. See Plan for New Tax on Investment Income for strategies to help minimize the tax bite. source: JWR



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