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    Obamacare 3.8% Surtax and how to avoid it.

    Tom Marble I voted for ObamaCare

    3.8% Obamacare Surtax and how to avoid it.

    A surprise Birthday Party may be fun, and surprise tax bill is not.  Many people in Los Angeles are getting hit with a with the Obamacare surtax, with a little tax planning man could avoid getting surprised with a pesky tax bill.

    By David Rae Certified Financial Planner™, Accredited Investment Fiduciary™


    I’m a Financial Planner in LA where people tend to be more liberal compared to other parts of the county.  If you were to randomly pick people on the street and ask them if they support healthcare for everyone, you would probably get more responses of yes.  However, support of universal healthcare in SoCal creates a bit of a conundrum for pocketbooks.

    David Rae with Michelle Obama at the White House
    In case you wondered about my politics with this post, here I am with Michelle Obama at the Whitehouse.

    Why?  Income levels tend to be higher in the Golden State.  The higher the income, the more money those in support of healthcare for everyone will have to pay in taxes.  The 3.8% surtax on higher incomes seems to be the tax that surprise and annoy many people who find themselves getting hit with it for the first time.  The only good news about paying this surtax is that it means you are making more money than 90% plus of Americans.  Of course, I don’t think that will make it sting any less.


    Where did the Obamacare Surtax come from?

    To help fund the Affordable Care Act (also dubbed Obamacare) there was a 3.8% surtax levied against high incomes.  This specific tax took effect in 2013 and, according to the Tax Policy Center, is expected to bring in nearly $30 billion dollars of tax revenue.


    This surtax begins for those making just $200,000. Arguably a great income, but those making it don’t exactly scream rich here in La La Land.  The surtax was supposed to be a tax on the RICHEST Americans and for the most part it is. It is worth pointing out that there is difference between income and wealth.  Around three-fourths of the surtax revenue come from households earning more than $1 million per year.  According to the Wall Street Journal, these households will owe an average of $37,000 each.  While households earning between $200,000 and $500,000 will owe an average of $200 each.


    The surcharge may not hit you now but beware.  Statistics can often lie.  The averages above conceal wide variations in the tax bill.  The surtax trigger points are not adjusted for inflation.  Things like a big investment windfall, or stock option exercise, could increase your income subject to this tax.   There are likely many people earning just above $200,000 whose surtax bill will be minimal, artificially bringing down the “average” bill for those between $200,000 and $500,000.  To be clearer if you earned $500,000 you would owe $11,400 from just this surtax.

    Who Pays the Obamacare Surtax
    Who is actually paying the Obamacare Surtax? Many Californians I’d guess.

    How the Obamacare tax works

    There is a flat surtax of 3.8% on net investment income for married couples who earn more than $250,000 of adjusted gross income (AGI).  For single filers the threshold is just $200,000. Another example of the marriage penalty at work in our tax code.


    The levy is only investment income above the thresholds.  For example, if you make $100,000 you won’t owe any additional taxes.


    But let’s say you are a single earner making $180,000 of AGI each year and experience a one-time gain of $100,000 from selling long-held shares (this could also be a home sale or employer stock options.  This would increase your income to $280,000 making $80,000 of your total income subject to the 3.8% surtax. This would result in you owing roughly $3,040 in extra taxes.


    When I listed the above income ranges, I bet you just thought about your own paycheck.  Only considering their paychecks is why so many people are surprised when they get hit with this tax for the first time.


    What will be counted as investment income?

    Things like interest, dividends, capital gains, rental income, royalties and even some passive investment income will be counted.

    What is not counted as investment income?

    Generally speaking, you can exclude income from municipal bonds, partnership income and S Corporations if you are actively participating.  There are also certain types of rental income and some capital gains, for selling a business, that may be excluded as well.


    How to minimize the surtax sting


    You may not be able to completely avoid the ACA surtax, but with a little tax planning you should be able to minimize it.  Here are a few smart tax planning tips.

    1. Before you sell a highly appreciated home, consider your income and this tax. Many couples will have nothing to worry about as you can potentially exclude up to $500,000 ($250,000 for singles) profit on the sale of a primary residence. While $500,000 is a nice exemption, that doesn’t go as far around Los Angeles as it does in Arkansas.
    2. Don’t ignore tax harvesting. I’ve been doing this since 2004 for clients and it still amazes me how few advisors take the time to do this.  It is extra work but it can make a huge difference on net investor returns.  The 3.8% surtax is on net investment income.  If you are winning big on one holding, you may have losses you can realize on other holdings to help minimize you tax bill.  If I’m making your eyes cross don’t worry.  A good fiduciary financial planner can help take care of it for you.
    3. Look for ways to minimize your AGI. The lower your AGI (the number at the bottom of the FORM 1040) the lower amount of your income will be subject to the 3.8% surtax.
    4. Need another reason to contribute to your retirement plan? Making contributions to your 401k, 403b or pension will lower your AGI.  You can also make charitable contributions from you IRA assets if you are over 70 ½ (link to RMD strategies).


    How to deal with retirement income

    Income from retirement accounts like IRA’s, pensions and 401ks are not directly subject to the 3.8% surtax.  That being said, they may lift other forms of income into the surtax realm.  Let me give you an example.  Let’s say a couple did a great job saving for retirement and have $300,000 in retirement income from IRA’s, social security and Defined Benefit Pension plan.  In this case, they wouldn’t owe the surtax since all of this income came from retirement accounts.  Now, let’s say they also have $20,000 in capital gains on their stock portfolio.  They would owe the 3.8% Obamacare surtax on the full $20,000 since this amount would be on top of their retirement income.  Having a more tax efficient portfolio could help alleviate some of this extra OBAMACARE surtax burden.


    ROTH IRA to the rescue

    Payment from a ROTH IRA comes out tax free and doesn’t raise taxable income.  This can also help minimize the burden of the 3.8% surtax.  This is where diversification of your retirement account types can really pay off.  If you will have certain years with high investment income, you will want to adjust your withdrawal strategy to minimize overall taxes and the 3.8% surtax.

    You can escape the healthcare surtax with death

    Your heir or heirs receive a step up in basis when you pass away.  So, if you hold investments up until the time of your passing, there won’t be capital gains taxes or the ACA surtax on the earning prior to your passing.  Of course you have to die, so not always a great option.


    Now that we’ve covered death and taxes it is time to wrap this up.

    Financial Expert David Rae on the KTLA News Los Angeles
    How to Avoid the Obamacare surtax, Financial Expert David Rae discussed with KTLA news

    Live for Today, Plan for Tomorrow.

    DAVID RAE, CFP®, AIF® is a Los Angeles-based retirement planner with DRM Wealth Management. He has been helping friends of the LGBT community reach their financial goals for over a decade. He is a regular contributor to the Advocate Magazine, Investopedia and Huffington Post as well as the author of the Financial Planner Los Angeles BlogFollow him on Facebook, or via his website www.davidraefp.com


    The opinions voiced in this article are for general information only and in not intended to provide specific advice or recommendations for any individual.

    Connect With David Rae, Financial Planner LA

    David Rae, CFP® AIF®

    President / Founder DRM Wealth Management LLC

    1(323) 905-4380


    "Obamacare 3.8% Surtax and how to avoid it."

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