Many US taxpayers recall the high income tax rates of the early 1980’s. In 1981, the top income tax bracket was 70%! This top bracket was one of sixteen different marginal tax brackets in that year. While today’s top marginal rate is only 39.6%, and there are only seven tax brackets, our tax system is no less confusing. Moreover, hidden taxes abound in today’s tax code. We will highlight several below.
Itemized Deduction and Personal Exemption Phase Outs
The ironically titled American Taxpayer Relief Act of 2012 re-enacted two previously repealed tax deduction limitations:
The Limitation on Itemized Deductions, or Pease Limitation (named after the congressman who sponsored it), limits deductions taxpayers can take once their income exceeds certain levels. For married couples filing jointly in 2015, this threshold is $309,900 ($258,250 for single filers). Pease reduces most itemized deductions by 3% of the amount that taxpayer’s adjusted gross income (AGI) exceeds these thresholds. Therefore, if a single taxpayer’s adjusted gross income equals $358,250, her itemized deductions would be reduced by $3,000—3% of the $100,000 overage. The cost to her is her effective tax rate times that $3,000.
The Personal Exemption Phase Out reduces personal exemptions ($4,000 in 2015) for taxpayers and their dependents by two percent for every $2,500 that their AGI exceeds their relevant filing status threshold. Phase outs begin at the same Pease thresholds above. Therefore, that same single taxpayer with $100,000 of income in excess of the threshold would lose 80% of her exemption or $3,200. The cost to her is her effective tax rate times that $3,200. Again, another hidden tax and effective income tax surcharge.
Capital Gains
While not necessarily hidden, capital gains tax increases should be noted by taxpayers in the highest marginal bracket—married couples with taxable income of $464,850, single filers with $413,200. To the extent a taxpayer’s income exceeds that threshold and capital gains make up a portion of their income, those gains are subject to the new 20% rate instead of the normal rate of 15%. Hence, another increase for top-bracket taxpayers.
Estates and Trusts
The tax on estates and trusts is an often overlooked tax. Estates and trusts, just like individuals, are subject to income and capital gains taxes. However, fiduciary taxpayers are subject to much lower taxable income thresholds. For example, a married couple doesn’t reach the top bracket until their taxable income exceeds $464,850. A trust enters the highest bracket after only $12,300 in taxable income. Per the preceding paragraph, note how capital gains are taxed once a taxpayer is in the highest bracket; capital gains are quickly subject to the 20% rate in trusts. Consequently, effective tax planning is a must for trusts. When appropriate, trustees should look to shift income to a beneficiary’s lower tax bracket, trust document permitting.
Net Investment Income Tax
Effective in 2013, the Net Investment Income Tax (NIIT) is a 3.8% surtax on unearned investment income such as dividends, interest, royalties, rent, and capital gains. Taxpayers immune to the highest tax brackets may find themselves affected by the NIIT because of its lower relative thresholds: $250,000 of modified adjusted gross income (MAGI) for married couples; $200,000 for single taxpayers. Moreover, unlike our marginal tax brackets, NIIT income thresholds are NOT indexed for inflation. Lastly, trustees should remember that the NIIT applies to estates and trusts, not just individuals.
Medicare Surtax and Medicare Premiums
The Medicare Surtax, a 0.9% surtax on earned income over the aforementioned thresholds, was included in the same legislation as the NIIT. This surtax is in addition to the existing 1.45% Employee Medicare Tax.
Taxpayers enrolled in Medicare should consider the hidden tax embedded in their Medicare premiums. Monthly Medicare Part B and Part D premiums increase in conjunction with a taxpayer’s income. Specifically, there are four income tiers above the base premium tier. Decisions made today impact future premiums, as your current Medicare Part B and Part D premiums are based on your AGI from two years prior. To the degree you are able, look to plan income accordingly.
In summary, good financial planning is more than investment management. Effective financial planning involves taking a comprehensive approach across all disciplines, including income-tax planning. We certainly do not expect you to remember the numerous income tax acronyms and thresholds contained in this article. Please leverage our experienced team of financial professionals. Our hope is that you will call or come by to discuss the most advantageous and appropriate approach for your specific situation. As always, thank you for choosing Bragg Financial Advisors for your financial planning and investment management.
This information is believed to be accurate but should not be used as specific investment or tax advice. You should always consult your tax professional or other advisors before acting on the ideas presented here.
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July 28, 2015Many US taxpayers recall the high income tax rates of the early 1980’s. In 1981, the top income tax bracket was 70%! This top bracket was one of sixteen different marginal tax brackets in that year. While today’s top marginal rate is only 39.6%, and there are only seven tax brackets, our tax system is no less confusing. Moreover, hidden taxes abound in today’s tax code. We will highlight several below.
Itemized Deduction and Personal Exemption Phase Outs
The ironically titled American Taxpayer Relief Act of 2012 re-enacted two previously repealed tax deduction limitations:
The Limitation on Itemized Deductions, or Pease Limitation (named after the congressman who sponsored it), limits deductions taxpayers can take once their income exceeds certain levels. For married couples filing jointly in 2015, this threshold is $309,900 ($258,250 for single filers). Pease reduces most itemized deductions by 3% of the amount that taxpayer’s adjusted gross income (AGI) exceeds these thresholds. Therefore, if a single taxpayer’s adjusted gross income equals $358,250, her itemized deductions would be reduced by $3,000—3% of the $100,000 overage. The cost to her is her effective tax rate times that $3,000.
The Personal Exemption Phase Out reduces personal exemptions ($4,000 in 2015) for taxpayers and their dependents by two percent for every $2,500 that their AGI exceeds their relevant filing status threshold. Phase outs begin at the same Pease thresholds above. Therefore, that same single taxpayer with $100,000 of income in excess of the threshold would lose 80% of her exemption or $3,200. The cost to her is her effective tax rate times that $3,200. Again, another hidden tax and effective income tax surcharge.
Capital Gains
While not necessarily hidden, capital gains tax increases should be noted by taxpayers in the highest marginal bracket—married couples with taxable income of $464,850, single filers with $413,200. To the extent a taxpayer’s income exceeds that threshold and capital gains make up a portion of their income, those gains are subject to the new 20% rate instead of the normal rate of 15%. Hence, another increase for top-bracket taxpayers.
Estates and Trusts
The tax on estates and trusts is an often overlooked tax. Estates and trusts, just like individuals, are subject to income and capital gains taxes. However, fiduciary taxpayers are subject to much lower taxable income thresholds. For example, a married couple doesn’t reach the top bracket until their taxable income exceeds $464,850. A trust enters the highest bracket after only $12,300 in taxable income. Per the preceding paragraph, note how capital gains are taxed once a taxpayer is in the highest bracket; capital gains are quickly subject to the 20% rate in trusts. Consequently, effective tax planning is a must for trusts. When appropriate, trustees should look to shift income to a beneficiary’s lower tax bracket, trust document permitting.
Net Investment Income Tax
Effective in 2013, the Net Investment Income Tax (NIIT) is a 3.8% surtax on unearned investment income such as dividends, interest, royalties, rent, and capital gains. Taxpayers immune to the highest tax brackets may find themselves affected by the NIIT because of its lower relative thresholds: $250,000 of modified adjusted gross income (MAGI) for married couples; $200,000 for single taxpayers. Moreover, unlike our marginal tax brackets, NIIT income thresholds are NOT indexed for inflation. Lastly, trustees should remember that the NIIT applies to estates and trusts, not just individuals.
Medicare Surtax and Medicare Premiums
The Medicare Surtax, a 0.9% surtax on earned income over the aforementioned thresholds, was included in the same legislation as the NIIT. This surtax is in addition to the existing 1.45% Employee Medicare Tax.
Taxpayers enrolled in Medicare should consider the hidden tax embedded in their Medicare premiums. Monthly Medicare Part B and Part D premiums increase in conjunction with a taxpayer’s income. Specifically, there are four income tiers above the base premium tier. Decisions made today impact future premiums, as your current Medicare Part B and Part D premiums are based on your AGI from two years prior. To the degree you are able, look to plan income accordingly.
In summary, good financial planning is more than investment management. Effective financial planning involves taking a comprehensive approach across all disciplines, including income-tax planning. We certainly do not expect you to remember the numerous income tax acronyms and thresholds contained in this article. Please leverage our experienced team of financial professionals. Our hope is that you will call or come by to discuss the most advantageous and appropriate approach for your specific situation. As always, thank you for choosing Bragg Financial Advisors for your financial planning and investment management.
This information is believed to be accurate but should not be used as specific investment or tax advice. You should always consult your tax professional or other advisors before acting on the ideas presented here.
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