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New tax increase on unearned income expected

Posted by Cheryl Costa  June 21, 2010 09:51 AM

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On March 30, 2010 President Obama signed the Health Care and Education Reconciliation Act of 2010. A lot has been written about the changes that are expected in healthcare, but what is less well understood is how the costs of the new program will be offset.

One of the big revenue raisers will be a new Medicare tax on unearned income. This new tax will consist of a 3.8% surcharge on the lesser of a taxpayer's net investment income or the amount that modified adjusted gross income exceeds $200,000 for singles, $125,000 for married taxpayers filing separately or $250,000 for those filing jointly. (And to add insult to injury, these limits are not adjusted upwards for inflation, so more and more people will find themselves impacted each year.)

This new tax, which will take effect on January 1, 2013, will apply to the following types of unearned income: interest, dividends, annuities, and rental income. In addition, if you sell your home and have a gain that exceeds the exclusion thresholds, that gain will be subject to the surtax as well.

As you may have guessed this tax increase is not very popular and people are already looking at strategies to minimize the bite of this new tax. How might you avoid some or all of this tax? First, try to keep your income below the threshold limits. You may find that you can squeak in under the limits if you take steps to minimize or reduce your income. One method would be to contribute the maximum amount permitted to your 401(k) or 403(b) plan. In addition, if you will be hit hard by this new tax, you might want to alter your investments to include more tax free investements like muni bonds or stocks which don't pay much in the way of dividends (be careful though not to make knee-jerk investment decisions based on one factor -- it is never wise to let the tax tail wag the dog). In addition, if you are thinking about selling your home and might face a high tax burden, you might want to consider selling before December 31, 2012. A sale before that date would avoid the surcharge.

This blog is not written or edited by Boston.com or the Boston Globe.
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D. Abraham Ringer is a CERTIFIED FINANCIAL PLANNER practitioner and a Financial Adviser with Morgan Stanley Global Wealth Management in Boston. He is registered in MA, NH, NY and several other states to which his articles are directed. For more information please visit www.morganstanleyfa.com/ringer
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