The ghosts and ghouls, the witches and zombies have vanished as surely as your candy jar emptied. The Halloween decorations are stored in the closet until next year. However, not all the blood sucking vampires disappeared. The income tax provisions of the Affordable Care Act still wait to drain your bank account by year end. Worst of all, a number of the provisions may combine in unexpected ways to cost you thousands in additional taxes. Careful planning before year end might save you some financial hemoglobin.
The new income tax provisions feed on varying measures of income. For instance, the new 0.9% Medicare surcharge on earned income sinks in its fangs when your wages and self-employment income exceed $250K ($200K for single taxpayers). The painful 3.8% Medicare surcharge on investment income bleeds you when your adjusted gross income exceeds $250K ($200K for single taxpayers). You can't even count on the 15% long term capital gains tax rate any more. The new long term capital gains rate of 20% will bite you if your taxable income exceeds $450K ($400K for single tax payers). The new tax rate of 39.6% starting for taxable income above $450K ($400K for single taxpayers) is another painful pint for Count Dracula.
Worse yet is how these provisions combine for even more serious financial blood letting. For example, let's say you want to sell a piece of commercial real estate where you have a modest gain of $200K. If your taxable income, as a result of the sale, exceeds $450K, your capital gains tax rate goes up from 15% to 20%. But's that's not enough blood loss. To the extent that the gain drives your adjusted gross income above $250K, you'll get bitten for the 3.8% Medicare surcharge on your investment income over the $250K. That includes the real estate gain. If your income would have otherwise been below $250K, not only does the federal capital gains tax rate go from 15% to 20%, but you get to pay the additional 3.8% Medicare tax for a total tax bite of 23.8%. But the bite goes even deeper. The gain can subject any of your other investment income to the same 3.8% fang marks.
Another painful bite from the gain on your property comes from the return of the phase out of itemized deductions based on income. Your capital gain substantially increases your income and will thus reduce your itemized deductions such as mortgage interest and real estate taxes. Your actual federal tax rate on the property sale could come close to 30% after taking into account all of the interactions between facets of the new law, which is a never satisfied vampire.
If you own a company that annually pays you a bonus to reduce company taxes, the vampire wants a bite out of this as well. If your bonus takes you above $250K in earned income, you'll pay 0.9% on the excess with the Medicare surcharge on earned income. Not only that, but the income from the bonus may expose your financial neck to the new 39.6% tax rate and subject your investment investment income to the 3.8% Medicare tax.
How can you wave a financial cross or eat enough garlic to avoid the vicious bites of the new law? First, pay close attention to the timing of your income. Spread your income out over multiple years, if possible.
If you are selling a property for a substantial gain, consider selling other assets, where you may have unrealized losses. If you're holding on to a worthless stock, consider taking the loss in the same tax year as the property sale gain.
Offsetting the two allows you to get more than just a $3K deduction in the current year for a lone stock loss. You can potentially offset all of the stock loss against the gain from the property sale. By reducing the net gain, you reduce or eliminate the chance of getting bitten by the 3.8% Medicare surcharge, and you keep the vampire from feeding on your itemized deductions as well.
When considering a year end bonus, look at both the corporate tax rate and your effective personal tax rate after the bonus. If the corporation is paying 34% and you have no plans to distribute dividends, you may find that not taking the bonus reduces your total tax bloodletting by keeping you below the 39.6% upper personal tax rate.
If you own an S corporation, reconsider your level of participation in the company. If you receive income classified as passive from the company, you'll get a 3.8% tax bite from the Medicare surcharge on net investment income. Participating sufficiently to become active in the business is like blowing a breath full of garlic at the surcharge. It will fly back to its cave and wait to feed until you have passive income.
S corporations waive the cross at the tax act vampires in another way. Consider an S corporation election for your business if you currently operate as a sole proprietorship or a partnership. If you actively participate in an S corporation, only your wage income is subject to the 0.9% Medicare tax. With a sole proprietorship or partnership, all of your profits are potentially subject to the 0.9% Medicare tax. Dividends from active participation in S corporations are also not considered investment income for the 3.8% tax on net investment income. S corporations are your Van Helsing, chasing away the new tax act vampires almost entirely.
Tax planning is more crucial than at any time since Ronald Reagan was President. Eyeballing your 2013 situation against 2012 won't do. The tax vampires will visit most affluent small business owners in 2013. But with a little planning, they won't bleed you dry.
Thanks for reading! As always, for real tax and accounting advice, please visit our main S&K web site at www.skcpas.com. Also, please like the "How to Screw Up Your Small Business" Facebook page.
Until next time, let's do it to them before they do it to us.
