If you are one of the millions of Americans that invest in the stock market, you need to be aware that new taxes are looming on investment income. In 2013, there are three different capital gains rates. The three rates are comprised of 0 percent, 15 percent, and 20 percent. These are all based on your income tax bracket. Higher income individuals are the ones that will suffer the most with the new tax structure for investment income.
Individuals with adjusted gross income of $400,000.00 for individuals and $450,000.00 for married couples filing jointly are required to pay 20 percent in capital gains tax on any investments that are held for one year and one day. These investments van be stocks, bonds, mutual funds, or depreciable property such as rental properties. The new capital gains rate is just the tip of the iceberg when it comes to the new taxes that are looming in 2013.
The Affordable Care Act, which was made into law in 2010, requires individuals with incomes of $200,000.00 for individuals and $250,000.00 for couples, to pay a net tax. The Net Investment Income Tax (NIIT), is a 3.8 percent surtax on investment income.
IRC §1411 (c)(1)(A)(i), defines investment income as “gross income from interest, dividends, annuities, royalties, and rents, other than such income which is derived in the ordinary course of trade or business not described in paragraph (2). Let’s explore the definition of what is and is not investment income. The definition of net investment income as described with in the Code includes interest, dividends, annuities, royalties, and rents “other than such income which is derived in the ordinary course of a trade or business…”
The Internal Revenue Service has elaborated on the definition of interest, dividends, annuities, royalties, and rents. The definition of dividends includes corporate dividends, as well as any amounts treated as dividends under other provisions of the Code. The Internal Revenue Service further clarified net investment income also would include distributions of previously taxed earnings and profits.
The definition of net investment income includes gross income from annuities. Annuity income includes an assortment of payments made under the umbrella of annuities. These payments include: endowment or life insurance contract that are includable in the definition of gross income under IRC §72(a), 72(b), or 72(c). Interestingly enough, the Code does not define the term annuity , however Treasury Regs that have proposed that annuity income would include the gain from the sale of an annuity contract.
The next group of income that is subject to NIIT is royalties and rents. Royalty income would include amounts received from mineral, oil and gas royalties. Payments for the uses of patents, copyrights, goodwill, trademarks, franchises, and similar property would be included in the definition of royalty income. Rents would include amounts that are paid for the use of tangible property. This would include amounts that are paid by tenants to landlords.
The trade or business exception to net investment income on interest, dividends, and other category income is not included in net investment income if they meet the ordinary course of a trade or business exception. The exception to net investment income is determined a complicated test. Basically, the Code states that net investment income that is “derived in” the ordinary course of business is exempt from NIIT.
Wages and other compensation are not subject to NIIT, but may be subject to additional Medicare Tax of 0.9 percent on incomes of $200,000.00 for individuals and $250,000.00 for couples.
The Code goes on to talk about “other gross income” from trade or business in one of the categories for net investment income (passive income or trading financial instruments or commodities), as being subject to NIIT. Passive income would include income derived from an activity in which you do not materially participate. An example would be if you were invested in publically traded partnerships, which is common for some investors.
For the trading of financial instruments or commodities, other gross income would include gain from the property held in trade or business. For example, if you are self-employed and sold a piece of property for a gain, the gain would be subject to NIIT if you met the income requirements. The good news is that any losses that you incur in the sale of business property would be able to be deducted for the purposes of calculating NIIT.
If you sell your home, you may be subject to NIIT. If your gain on the sale of your main home includes a profit of $250,000.00 for an individual or $500,000.00 for a couple, then the proceeds may be subject to both the new capital gains tax and/or NIIT. ANY proceeds from the sale of rental property would result in capital gains tax and possibly NIIT.
Some tax planning ideas for both the NIIT and new capital gains rules would be to revisit passive activity rules. These rules are critical to avoidance of these new taxes. Consider maxing out IRA and 401(k) plans. The incomes derived from these investment vehicles are sheltered from these new taxes. Consider investing in municipal bonds. The interest earned from this investment is not subject to NIIT. Annuities and life insurance plans that are structured correctly will provide deferred earnings. Properly structured oil and gas investments are sheltered from NIIT, as well as income derived from charitable remainder trusts.
To sum everything up, you need to be aware that the additional 3.8 percent net investment income tax and new capital gains tax can really put a damper on investing. Now more than ever you need to consult your ta advisor.
For more information visit www.smalleynco.com
If you have any questions you can email Craig W. Smalley E.A.
Author of the books: It Starts With an Idea – Tax Tips for Small Businesses available on Nook and Kindle, The Ultimate Real Estate Investor Tax Guide, available on Nook and Kindle, The Complete Guide to the New Tax Law – American Taxpayer Relief Act of 2012 available on Nook and Kindle, Everything You Wanted to Know about the IRS – Audits, Appeals and Collections available on Nook and Kindle, Tax Avoidance is Legal! The Complete Guide to Individual Income Tax available on Nook and Kindle, The Complete Guide to the Affordable Care Act’s Tax Provisions available on Nook and Kindle, The Complete Guide to Retirement Plans for Small Businesses available on Nook and Kindle, The Complete Guide to Estate, Gift and Trust Taxation, available on Nook and Kindle, and The Complete Guide to Hiring an Accountant, available on Nook and Kindle.