Signed into law on January 2, 2013

Who is Wealthy?

ATRA combined with the 2010 healthcare tax acts now create three different income thresholds that high income clients need to plan around. To make matters even more confusing, there are four different ways income is calculated to compare against the three threshold amounts that can possibly impact a client.

For ordinary income tax purposes, joint filers whose taxable income exceeds $450,000 and single filers whose taxable income exceeds $400,000 will face a new top tax bracket of 39.6% and a top long-term capital gain and dividend tax rate of 20% (which actually becomes 23.8% after adding the 3.8% surtax on net investment income).

Itemized deductions of joint filers with AGI in excess of $300,000 and single filers with AGI in excess of $250,000 will begin to phase-out, up to a maximum of 80%. Personal exemption phase-outs will also affect the same filers at the same income thresholds.

For the net investment income surtax, joint filers with MAGI in excess of $250,000 and single filers with MAGI in excess of $200,000 will begin to have their net investment income hit with an additional 3.8% surtax. Additionally, married couples with earned income in excess of $250,000 and single filers with earned income in excess of $200,000 will face an additional 0.9% Medicare surtax on any excess.

Planning will be especially challenging for those clients with income between $250,000 and $450,000. Their income is high enough to trigger the investment surtaxes and perhaps itemized deduction and exemption phase-outs, but not high enough to reach the top tax income tax rates for the wealthy.

When looking at planning strategies that generate income, such as Roth conversions or selling appreciated stock, advisors will have to carefully analyze any tax impacts. It won’t simply be enough to make sure a client does not jump into the next bracket, as meaningful amounts of additional tax could be owed by a client within the same bracket through the loss of other tax benefits.

2013 Long-Term Capital Gain

Clients who fall into the new 39.6% top federal income tax rate will face a new 20% long-term capital gains rate. However, while this 20% rate is the percentage stated under the law, it’s not the real long-term capital gains rate that nearly all of these clients will be paying. In fact, thanks to the 3.8% surtax, the 20% rate is somewhat of an illusion for virtually everyone. Almost no one will actually pay a 20% rate on long-term capital gains or dividends.

Here’s why. A married couple, for example, gets hit with the 39.6% bracket at over one $450,000 of taxable income. Taxable income not only includes deductions to arrive at AGI, or so-called above-the-line deductions, but also a client’s standard or itemized deductions (below-the-line deductions). On the other hand, the $250,000 MAGI threshold (for the 3.8% investment income tax) for joint filers does not include a client’s standard or itemized deductions. Since this threshold is both a lower amount and takes into consideration fewer ways to reduce a client’s income, if the client is over their $450,000 taxable income threshold, they’ll be over their $250,000 MAGI threshold as well. A similar situation exists for single filers who reach the highest tax bracket at $400,000 of taxable income but the 3.8% surtax at just $200,000 of MAGI.

There are a few different ways clients can generate income taxed at long-term capital gains rates that’s exempt from the 3.8% surtax on net investment income that could, in theory produce a true 20% rate. However, these situations are rare exceptions rather than the norm and as result, nearly all clients who supposedly face a 20% long-term capital gains tax will pay 23.8% instead.

Bottom Line: The 20% rate is actually 23.8% for pretty much all your
clients, but you won’t find 23.8% anywhere in the law. In addition, the 15% rate for those subject to the 3.8 %, is actually 18.8% and you won’t find that
rate in the law either.


This is for informational purposes only and should not be construed as tax advise. Please consult a qualified tax advisor regarding your individual situation.