Slammed by New Taxes: Why You’re Poorer Than You Think
Life + Money

Slammed by New Taxes: Why You’re Poorer Than You Think


Recent tax law changes will hit the wealthiest Americans harder than others when they file their taxes in the next few months, thanks to new Obamacare taxes and increases in overall tax rates and capital gains taxes. 

For most income groups, the United States still has historically low tax rates and lower wage earners don’t have as much sympathy for those at the other end of the income spectrum. That doesn’t mean the top tier isn’t feeling the pain. The tax rate increases begin to kick in for couples earning $250,000 or individuals making $200,000 per year.  

Related: The Myth of Being Rich at $250,000 

That is not rich,” says Phoenix-based CPA Donna Esposito, a senior director of tax services for a large consulting firm, who says changes in regulations have upset both her relatively affluent and her extremely wealthy clients. “The regulations are so complex, it’s overwhelming.” 

Several factors are making this year particularly painful: there are four major tax increases that went into effect this year, plus the end of Bush-era tax cuts reinstated phase-outs for itemized deductions and personal exemptions. Here are some of the new or higher taxes high-income earners will see this year: 

  • Additional Medicare tax regulations authorize an increase in Medicare tax by 0.9 percent, for married couples earning $250,000 or individuals at$ 200,000 
  • The new Net Investment Income Tax (NIIT) imposes a 3.8 percent increase to investment income of “individuals, estates and trusts” and is triggered at the $250,000 or $200,000 threshold. Both of these taxes are being levied to help pay for the new health care law.  The NIIT is not indexed for inflation. 
  • Tax on capital gains and dividends increased from 15 percent to 20 percent in 2013, for couples earning $450,000, or individuals earning $400,000 returning rates to Clinton-era levels. 

Related: 8 Smart Ways to Lower Your Taxes in Retirement 

  • The top income tax bracket increased to 39.6 percent (From 35 percent in 2012) for married Americans making $450,000 or individuals making $400,000. Those taxpayers are also ineligible for the personal $3,900 exemption. 
  • A phase-out on personal exemptions caps how much high earners can deduct on their taxes. The phase-out limits exemptions for taxpayers who earn more than $300,000 (married filing jointly) or $250,000 (single) by 2 percent for each $2,500 earned above the threshold. 

Benjamin Harris, a policy advisor at the Brookings Institution says the new taxes present a “series of tradeoffs” for both high-end taxpayers and the American economy. 

“Deficits don’t look as bad as they did in 2012 and there’s more confidence that we can pay our bills,” he says. “But one of the drawbacks could be that there is less incentive to undertake investment.” 

The increased capital gains tax could hit taxpayers particularly hard, given the record year seen by the stock market. U.S. mutual funds are disclosing capital gains distributions greater than many investors have seen since before the financial crisis. 

A Morgan Stanley analysis of a hypothetical couple earning $500,000 per year, and $315,000 in investment income found that the couple’s tax liability would increase from $183,000 in 2012 to $220,000 in 2013, a nearly 20 percent increase, some of which might be avoidable with additional tax planning. 

Related: You Won’t Believe Which State Taxes Its Poor the Most

There are strategies high-earners can use to reduce tax exposure but there are also limitations, says Andrew Rotter, a partner at Citrin Cooperman, a tax and consulting firm in New York. “We tell people not to let taxes get in the way of their investment strategy,” he says. “Don’t let the tax tail wag the investment dog.” 

One of Rotter’s wealthy clients, a retiree, amassed $4 million in stocks and bonds and other investment income in 2013.  He will owe an additional $400,000 in taxes this year because of the Net Investment Income Tax, and the increase in the capital gains tax, according to Rotter. 

Another of his clients strategically decided to minimize the effect of the NIIT by converting a proprietorship to an entity called an S corporation. The business income from an S Corporation isn’t subject to the 3.8 percent surtax or self-employment tax. 

Still, his clients are resigned to forking over the extra cash. “No one’s happy about all this, but no one’s talking about expatriating,” says Rotter. 

Since most of the new levies are straightforward taxes on income, there’s little most high-income earners can do to avoid them, although some taxpayers may be able to structure their compensation to total less than $250,000. 

The easiest way to reduce income to take advantage of as many deductions as possible. The most valuable deductions are: charitable donations, which can be deducted up to 50 percent of gross income; mortgage interest, available on the first $1 million of mortgage debt; and state, local, and property taxes

Related: 11 Surprising Things You Have to Pay Taxes on 

The tax laws contain “a lot of moving parts” and high earning taxpayers should expect a “multiyear impact,” says Greg Rosica, an Ernst & Young partner based in Tampa. He recommends that clients examine their investment portfolio and consider asset rebalancing and harvesting losses. This strategy means using taxable accounts to offset portfolio gains by taking capital losses in order to minimize capital gains taxes.  This can be especially important in 2013 when long-term capital gains will be taxed at 23.8 percent and short-term gains taxed at a top rate of 43.4 percent. 

Another strategy is focusing on ways to delay income and accelerate deductions.  This can work well if your income will be in a lower tax bracket this year, than it will be in 2014.  A third strategy is using asset location as a financial planning tactic that involves dividing assets between taxable and tax deferred accounts such as 401k, and Roth IRAs. 

“Each person has a unique set of deduction and there obviously have been significant changes in the tax laws,” says Rosica. “High earners especially need to look at planning opportunities now, because it will be too late in January.” 

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