New Tax in 2013 Affects Investment Income

Beginning in 2013, there will be a new 3.8% tax on investment income that exceeds certain limits. The tax came about to provide revenue for the 2010 Patient Protection and Affordable Care Act, which was upheld by the US Supreme Court earlier this year.1

This is the first time that investment income has been taxed to directly support health care spending. Given its wide scope, it’s important to understand who will be affected, and by how much. (The analysis in this article is based on information from Ed Slott’s “IRA Advisor,” August 2012 issue.)


Who Will Be Affected?

The tax is aimed at single taxpayers with income above $200,000 and married taxpayers with income above $250,000. The 3.8% tax is assessed on the lesser of (1) net investment income or (2) the amount of Modified Adjusted Gross Income (MAGI) that exceeds the taxpayer’s applicable threshold. The following table is an example of the 3.8% tax for two different married taxpayers.



Married Taxpayers in 2013
Example 1 Example 2
1 Net investment income2 20,000 52,000
2 Modified Adjusted Gross
Income (MAGI)
300,000 300,000
3 MAGI Threshold -250,000 -250,000
4 MAGI income above threshold 50,000 50,000
5 Net investment income
(from Line 1)
20,000 52,000
6 Lesser of lines 4 or 5 20,000 50,000
7 3.8% tax 760 1,900



What Actions Might Trigger the Tax?

A number of fairly common financial transactions could affect a taxpayers’ income sufficiently to make them subject to the new tax. These include:

  1. Sale of real estate, especially the sale of your principal residence if any of the proceeds are taxable
  2. Sale of stocks or other investments that have appreciated in value
  3. Dividend income
  4. Conversions (2013 and later) to Roth IRAs
  5. Taxable distributions from retirement accounts (examples: 401(k), 403(b), IRA) are not subject to the tax but may push other net investment income into the new tax’s range.



What Can Be Done to Decrease MAGI?

Some planning in 2012 is necessary.

  1. Defer more salary into 401(k) and 403(b) accounts.
  2. Make deductible contributions to Traditional IRAs or SEP-IRAs by business owners.
  3. Do Roth conversions in 2012 because qualifying distributions from Roth IRAs DO NOT increase MAGI.
  4. Make lifetime gifts in 2012. The combined limit (estate and lifetime gifts) is as high as $5.12 million and investment income from the gifts will be taxable to other persons or organizations.

It’s also worth noting that trusts and estates get hit hard by the tax. Because the tax brackets for trusts and estates rise much more rapidly than for individuals, it is possible that estates and trusts which earn (and do not distribute) more than $12,000 of investment income will be assessed the 3.8% tax.


Your BWFA advisor is prepared to help plan for the increased taxes. Please call your advisor to make an appointment.

1There will also be a new 0.9% tax on W2 and self-employment income that exceeds $200,000 (single) or $250,000 (married). However, this article concerns only the 3.8% tax on net investment income because this tax represents more tax planning opportunities.

2Net investment income is defined as interest, dividends, capital gains (long and short term), annuities (but not in IRAs or company plans), royalty income, passive rental income, other passive activity income. It DOES NOT include wages and self-employment income, business income from a trade or business (including interest and dividend income on the business’ account), excluded gains (from the sale of a principal residence), municipal bond interest, proceeds from life insurance policies, veteran’s benefits, social security benefits, and gains on the sale of an active interest in a partnership or S Corporation.