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Phantom Taxes on the "Wealthy"

While the American Taxpayer Relief Act increases the top tax rates on individuals with taxable income in excess of $400,000 ($450,000 for married taxpayers), there are also tax provisions in the Affordable Care Act, (Obamacare) that effect individuals with AGI (adjusted gross income) in excess of $200,000 ($250,000 for married taxpayers). Although this material is already covered elsewhere on our website, this article is intended to highlight only those changes that effect the wealthy.

Changes per the Affordability Care Act (Obamacare)

Medicare Tax Increase for High Income Earners

Starting in 2013, there is an additional 0.9% Medicare tax on wages above $200,000 for individuals ($250,000 married filing jointly). The tax will be withheld by your employer, only if your wages from that employer exceed $200,000 regardless of your marital status.

This means that for married taxpayers earning less than $200,000 individually but more than $250,000 when combining income with your spouse, you have a liability for which there was no withholding. The same would be true if you worked for multiple employers and exceeded $200,000 in total wages, but less than $200,000 from any one employer. In the case of a married individual whose wages exceed $200,000 but his or her spouse did not have wages, taxes would be withheld but not due.

Medicare Tax on Investment Income

There is a Medicare tax of 3.8% on investment (unearned) income for single taxpayers with modified adjusted gross income (MAGI) over $200,000 ($250,000 joint filers). Investment income includes dividends, interest, rents, royalties, gains from the disposition of property, and certain passive activity income. Estates, trusts and self-employed individuals are all liable for the new tax. Please note that this is based on modified adjusted gross income, not taxable income. This is basically your income prior to deducting personal exemptions and itemized deductions. To see if this may apply to you, just look at the bottom number on the first page of your most recent form 1040. If that number is higher the $200,000 ($250,000 joint filers) and you have any unearned income then you will probably owe an additional 3.8% tax on that income.

Changes per the American Taxpayer Relief Act

Top Tax Rate on Ordinary Income

Taxable income in excess of $400,000 ($450,000 for married taxpayers) will be taxed at 39.6%. Previously the top tax rate was 35%.

Capital gain and dividend rates rise for higher-income taxpayers

The top rate for capital gains and dividends is 20% for taxpayers with incomes exceeding $400,000 ($450,000 for married taxpayers). When combined with the Obamacare 3.8% surtax discussed above, the overall tax rate on capital gains and dividends will be 23.8%.

Personal Exemption Phase-out (PEP)

The Personal Exemption Phase-out (PEP), starting threshold for those making $300,000 for joint filers and a surviving spouse; $275,000 for heads of household; $250,000 for single filers; and $150,000 (one-half of the otherwise applicable amount for joint filers) for married taxpayers filing separately. Under the phase-out, the total amount of exemptions that can be claimed by a taxpayer subject to the limitation is reduced by 2% for each $2,500 (or portion thereof) by which the taxpayer's AGI exceeds the applicable threshold. These dollar amounts are inflation-adjusted for tax years after 2013.

Pease limitations on Itemized Deductions

The "Pease" limitation on itemized deductions starting threshold for those making $300,000 for joint filers and a surviving spouse, $275,000 for heads of household, $250,000 for single filers, and $150,000 (one-half of the otherwise applicable amount for joint filers) for married taxpayers filing separately. Thus, for taxpayers subject to the "Pease" limitation, the total amount of their itemized deductions is reduced by 3% of the amount by which the taxpayer's adjusted gross income (AGI) exceeds the threshold amount, with the reduction not to exceed 80% of the otherwise allowable itemized deductions. These dollar amounts are inflation-adjusted for tax years after 2013.

Estate and Gift Tax Rate Changes

The 2012 Taxpayer Relief Act is 40% for gifts made and decedents dying after 2012. Under the Act, transfers over $500,000 are taxed at 37%, transfers over $750,000 are taxed at 39% and transfers over $1,000,000 are taxed at 40%. More specifically, the tax on a transfer over $1 million is $345,800 plus 40% of the excess over $1,000,000. Thus, the $5,450,000 exemption for 2016 or, in technical terms, the basic exclusion amount for 2016, would offset $2,125,800 in tax ($345,800 + (.40 $4,450,000)). In other words, the unified credit for 2016 transfers is $2,125,800.

Updated: February 2016

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