We’ve started a new year, and that means that there are a few new tax changes for investors. The passage of a tax deal for the so-called fiscal cliff has brought some changes to taxes, and 2013 also marks the first year of the Medicare surtax on investments.

As you prepare your finances for this new year, don’t forget that you might have higher taxes to pay on your investments.

Medicare Surtax for High Income Earners

One of the first things that you should understand that “high earners” are subject to a tax on certain investment income, thanks to the Patient Protection and Affordable Care Act or ACA┬ápassed in 2010. With the Supreme Court upholding almost all aspects of the law in 2012, the provisions continue to be put into place, including a Medicare surtax that is designed to help pay for some of the costs associated with the law.

The Medicare surtax is levied on unearned income for those who make more than $250,000 when married filing jointly (and more than $200,000 if filing as a single taxpayer). The surtax is 3.8% of the net investment income in question. There are ways you can reduce your tax liability in this area in order to reduce what you owe on investment income:

  • Use tax-exempt bonds. You don’t pay the Medicare surtax on any investments that the federal government doesn’t collect taxes on.
  • Reduce your income. If you want to avoid paying the Medicare surtax, you can try to keep below the threshold. You can sell some of your losers to offset gains, or you can look into deductions that reduce your income.
  • Participate in real estate and business activities: Part of the investment income in question is the income you receive from a business you own, or real estate income. If you aren’t an “active” participant, that income is unearned and subject to the surtax. However, if you participate “materially,” you might be able to have that income classed as earned rather than unearned, and you can avoid paying the surtax on it.

Carefully consider your situation, and think of what you can do to reduce your tax liability with regard to the 3.8% Medicare surtax on unearned investment income. For more information, check with the IRS web site about what qualifies, and what to expect.

New Capital Gains Tax for Higher Income Earners

investment taxesEven though there are still fiscal cliff spending issues to work out, a tax deal was agreed upon. Those who make more than $450,000 (married) or $400,000 (single) find themselves in a new tax bracket with the fiscal cliff deal. But it’s not just a new tax bracket for income; long-term capital gains taxes are on the rise.

The deal left the long-term capital gains rate at 0% for those who earn less than $72,500 a year filing jointly ($36,350 a year filing as single), but some are seeing an increase. For those who make between $72,500 and $450,000 a year (married) or between $36,250 and $400,000 a year (single), the long-term capital gains rate is 15%. However, for those who make more than $450,000 a year married, or more than $400,000 single, the new capital gains tax rate is 20%.

This new rate means that if you decide to sell your investments at a gain, the long-term rate will be 20% if your income is above the threshold. The same rates also apply to dividend income. It still retains its favored tax status, but if you make more than $450,000 a year or $400,000 a year, you will pay 20% on your dividend income, instead of 15%. For the most part, if you want to avoid these higher taxes on your investment income, your best bet is to try to manage your income so that it remains below the threshold.

And, of course, if you have short-term capital gains, and fall in the new higher tax bracket, you will pay more, since you will be taxed at a higher ordinary income rate.

Planning Ahead

Even with the new taxes on investment income, it’s still probably better (in most cases) than having your income taxed as ordinary income. Long-term capital gains and dividend income still receive favorable treatment, and you will still probably be able to see plenty of profits with your savvy investing moves — even if the government is taking a bigger chunk moving forward.



Miranda is freelance journalist. She specializes in topics related to money, especially personal finance, small business, and investing. You can read more of my writing at Planting Money Seeds.