Tax Hikes All Around
Married California couples in the top 4 Federal brackets (25%+) are looking at combined marginal tax rates of 33%, 42.3%, 44.3%, & 48.9%. Couples in the highest bracket will also be exposed to higher dividend and long‐term capital gains rates. The combined minimum long‐term capital gains rate for Californians in the highest bracket will be 29.3%‐‐and that’s before we add in the Medicare surtax on investment income (see next section).
Medicare Tax Impact
People who earn more than $200,000 (single) or $250,000 (MFJ) will face an additional surtax on investment income of 3.8%. This means that dividend and long term capital gains rates for California earners above these thresholds would be 28.1%. If you happen to fall into the highest bracket ($400k/$450k+) then you could be looking at a tax of 33.1%. Those workers earning more than $200,000 will also face a greater Medicare hospital insurance tax on earning above this threshold. The normal hospital insurance portion of the payroll tax is 1.45%. This is increased to 3.25% on earning above the $200k threshold. There can be a complication for couples since employers (who account for payroll tax withholding) do not know if the couple exceeds the $200k in household income even though the individual may not. You should consult your tax advisor to help you adjust withholding if you are above this threshold as a household.
Asset Location
Because of these hidden tax drags on invested assets, the decision of how to “locate” your capital becomes ever more important. Tax‐deferral can be a great tool for lowering taxable income now (as in the case of retirement plans), but it also shields the asset’s growth from being taxed as the money is growing. This could allow you to grow interest on the money you would have paid in taxes along the way. Other investment vehicles that could provide tax deferral may also provide this kind of compounding. Municipal securities are also exempt from the Medicare surtax, meaning that an allocation to this asset class may make some sense on a case by case basis.
What is assured is that if you have annual household income approaching $200,000, it will make sense to re‐assess your investment plan on assets outside of your retirement plan. You may want to adjust your financial plan in favor of increasing savings into retirement plans (if you are not already maxing these out). The time to revisit this is now, since these are the new rules for 2013.
