President Trump scored a key victory in late 2017 when Congress passed a tax reform bill that reduced tax rates for both corporations and individual taxpayers. Many investors applauded the drop in the corporate tax rate from 35% to 21% because of its impact on business profits. And although changes to tax laws for individuals were a bit more of a mixed bag, a majority of taxpayers are likely to see both lower tax bills and greater simplicity when they file their returns in the next few months.
Even though the president reversed some of the tax increases that his immediate predecessor had put into place, he didn't succeed in getting rid of all of them. In particular, two relatively new taxes were left untouched by the tax reform package, which means that those who earn relatively high incomes will continue to pay those taxes indefinitely.
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A tax that hits you in the paycheck
High-income taxpayers started paying the Additional Medicare Tax in 2013. This 0.9% surtax applies only to earned income, which includes both regular wages and salaries that employees earn, as well as self-employment income that those who run their own businesses have to pay.
Only earned income above certain thresholds triggers the Additional Medicare Tax:
|
Filing Status |
Earned Income Threshold |
|---|---|
|
Single or head of household |
$200,000 |
|
Married filing jointly |
$250,000 |
|
Married filing separately |
$125,000 |
Data source: IRS.
So, for instance, if a single person has income from work of $210,000, then the Additional Medicare Tax will be 0.9% of the $10,000 over the earned income threshold, or $90.
For the most part, this tax typically is taken out of paychecks automatically by employers without a worker even necessarily noticing. But for joint filers, payroll withholding might not be accurate, because employers don't have any way of knowing how much an employee's spouse makes and therefore are unable to take it into account in determining whether total family earned income exceeds the $250,000 threshold. As a result, you might end up having to pay more in tax when you file your return, along with the special Form 8959 that's required if the Additional Medicare Tax applies.
However, because employers are directed to start withholding the tax when wages exceed $200,000 even if you are married, it's also possible that you'll get a refund of improperly withheld Additional Medicare Tax if the total wages for you and your spouse are less than the $250,000 threshold.
Taxing your portfolio
A second tax, also taking effect in 2013, applies to high-income taxpayers, but it aims in a different direction. The Net Investment Income Tax is also a surtax, but it's charged against interest and dividends on investments in your portfolio, as well as rental income from property, royalty income, and passive business income. Moreover, realized capital gains are also included in the calculation. At 3.8%, the tax rate for the Net Investment Income tax is much higher than the Additional Medicare Tax.
The same income thresholds apply as with the Additional Medicare Tax, but you have to take into account all of your adjusted gross income and compare it against the threshold. To the extent that you have net investment income that pushes you over the limit, you'll have to pay a fairly hefty 3.8% surtax on the excess.
There is some relief with the Net Investment Income Tax because, as its name suggests, it's determined on a net basis. Therefore, you're allowed to exclude some investment costs against your income for purposes of calculating the tax due. Also, if only a portion of your investment income is above the threshold, you'll pay tax only on that amount. For example, if you're single and have adjusted gross income of $210,000, $25,000 of which is investment income, then you'll pay the 3.8% tax only on the $10,000 over the $200,000 threshold, or $380.
Go again another day?
The White House and lawmakers have announced plans to pursue further tax legislation that could result in additional cuts for taxpayers, but for now, neither of these two taxes have gotten a lot of attention. Now that Republicans no longer control both houses of Congress, it'll be a lot harder to implement new tax initiatives.
High-income investors need to plan for these two taxes for the foreseeable future. Although they're relatively small compared with the regular income tax, they nevertheless add to the tax burden for those who make enough money to trigger them.
