In a last-ditch "fiscal cliff" compromise on Tuesday, lawmakers in the Senate and House of Representatives passed a bill that will raise some taxes for well-heeled investors.
Part of the tax increases will be on investment income for the top 2 percent of earners. Individuals earning more than $400,000 per year or couples making more than $450,000 will pay an increased rate on capital gains and qualified dividends, up from 15 percent to 20 percent.
Those same taxpayers are already facing a new tax on net investment income in 2013 as a result of health care reform and the new Medicare surtax. As a result of the Affordable Care Act, individuals earning more than $200,000 and joint-filing couples making more than $250,000 face a tax of 3.8 percent on the lesser of net investment income for the year or the amount that their modified adjusted gross income exceeds those income thresholds. Together with the increase in dividends and capital gains rates, investors now potentially face an 8.8 percent increase altogether.
"Investors who are subject to the increased taxes will have to evaluate their investments in 2013 to make sure that their after-tax rate of return is satisfactory," says CFP professional Michael E. Goodman, who is also a CPA and member of the American Institute of Certified Public Accountants' National Financial Literacy Commission.
It may not make sense to hold some types of investments this year if owning them could lead to an inflated tax bill.
"For example, in 2012 in the search for yield, a lot of people were overweighting dividend-paying stocks. Now, is this 8.8 percent tax on those dividend-paying stocks going to make them continue to be worthwhile?" says Goodman.
That's not all. The Bush-era tax cuts got rid of phaseouts on personal exemptions and itemized deductions, but they're back this year for some people. Specifically, joint-filers earning more than $300,000, heads of household earning $275,000, or individuals with incomes of $250,000 or more will be limited in the amount of exemptions they can claim or itemized deductions they can take.
"This will increase the net taxable income to portfolios such that there will be even a higher rate of tax on generic portfolio income -- perhaps not capital gains or qualified dividends, just interest income will be taxed at a higher rate now," Goodman says.
What do you think of the deal reached in Congress this week?