There are a lot of strong emotions circling the new health-care law, and regardless of how you feel, there are changes coming that may need to be considered regarding your investments and taxes. The new tax hikes related to the health-care bill are directly intended for high-net worth individuals. These may be what are referred to as “unintended consequences” for some individuals.
Individuals with adjusted gross income above the magical number of $200,000 for singles, and $250,000 for married couples, a 3.8% Medicare tax will be applied to investment income such as capital gains, dividends, interest, rental and annuity income – mostly known as “unearned income”. This is a significant tax hike for some. Along with the new Medicare tax, there are proposed increases in capital gains and income taxes going forward when the Bush tax cuts are due to expire.
The same 3.8% tax will apply to unearned income from assets held inside a trust. This is new territory for trusts. The Medicare tax will apply the same way it does assets held outside trust, except the income threshold is much lower. Instead of the $250,000 threshold, it will be triggered if trust unearned income exceeds $11,200. If the investment income is paid out to the beneficiaries, it is not subject to the tax. But if it remains inside the trust, it may be subject to the additional 3.8% tax.
Investors may consider reevaluating their plans. Here are some suggestions from the conversations we are having with clients. Municipal bond interest will remain tax-free under the new rules so that may be something to revisit. Using cash-value life insurance and overfunding the policy so loans may be used to fund retirement (loans are not considered income, so are not subject to tax) might be a discussion you should be having with an advisor. If you have large capital gains in an investment, consideration may be given to taking the gains this year and re-buying the position. This will raise your cost basis and may help with the exposure to the added tax later on. Be careful when considering IRA conversions as this may trigger higher income in the year of the conversion.
