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Investors Beware: Medicare Surtax in Obamacare Tied to Capital Gains

Investors Beware: Medicare Surtax in Obamacare Tied to Capital Gains

Between the melodramatic gamesmanship on Capitol Hill and the eerily empty offices of federal buildings around the country, there is the Affordable Care Act (otherwise known as Obamacare) at the center of a bitter political battle. As the last phases of the law become reality, what many investors may not realize is that capital gains on investments are actually part of the tax structure within the Affordable Care Act and are in effect for 2013. After the Washington sideshow is over, it the surtax provision that will become the particular focus of investing taxpayers and their tax professionals. The law includes a Medicare surtax of 3.8 percent that applies to investment income for those with an adjusted gross income of more than $200,000 for single filers and $250,000 for married joint filers. However, there is an additional component to the tax that makes it even more important to lower the capital gains from your investments. The tax applies to either the normal income or the net income from investments, whichever is lowest.

The second half of the Medicare tax is an additional .9 percent. This number applies to the earned income over those same amounts of $200,000 for single and $250,000 for joint whereas the first tax applied to the lesser of gross income or investment income. So if Mr. Smith files a single return with a $210,000 income and a net investment income of $45,000, the total amount is $255,000. The tax on investment income will be on the lesser of two – either gross income or investment income. The amount Mr. Smith has exceeded the $200,000 threshold by is $10,000. Compared to the investment income of $45,000, the 3.8 percent tax will apply to the lower amount of $10,000 instead and total $380. The second half of the tax at .9 percent applies to the $10,000 that Mr. Smith exceeded over the $200,000 income limit and totals $90. This brings the total surtax provision for the health care law to $470.

Reducing gains on your stock investments not only lowers your capital gains tax but a portion of the Medicare surtax as well. One way to sell a stock to your advantage can be as simple as choosing the right sales methodology. Most people don’t realize it but the default methods used by most brokerage firms are not always the optimal choice for them, particularly when it comes to the tax consequences of the sale.

There are a variety of sales method options available to the investor when a stock is sold. For example, choosing the right tax lots from several different purchases of the same stock can make a tremendous difference in calculating the loss or gain from the investment. Sales method options include FIFO (First In, First Out), LIFO (Last In, First Out) and so forth. The results can be significant using tax optimization strategies. There are some very effective tools online to help you make the best sales methodology decisions. You have 72 hours from the time of sale to declare the preferred sales methodology. Choose carefully. Strategically managing your capital gains just became more important than ever.

Here’s an example of what a difference it can make.


This example illustrates how the sales methodology chosen at the time of sale can make a significant dollar difference on the declared gains or losses. In the example above, for a long-term transaction, HIFO (highest in, first out) offers the greatest advantage, potentially providing a large loss for tax purposes. Compare that to the other options where over $46,000 shows as a gain and you begin to get the picture.

For the short-term transaction, LIFO (last in, first out) and LGUT (loss gain utilization method) provides almost the same advantage by showing a loss to declare.  Evaluating your sales method selection prior to selling your stock can make a significant difference in your tax responsibility

So why are the numbers so different depending on which tax lots you choose to sell? It’s all about the cost basis of your securities. Cost basis, in the simplest definition, refers to the original purchase price of the stock plus the expenses incurred on the cost. However, it doesn’t end there. Over time, companies issue dividends or undergo various corporate actions such as mergers, spin-offs and splits, among other things. Those all affect the cost basis value of your securities. In an application like the one used for the example, all of those corporate actions are taken into account in order to calculate the true value of the security. When you choose a particular tax lot, the price and cost basis of the security at that time is what is used to calculate those gains and losses on that group of shares in the tax lot.

Ultimately, it’s all about strategy when you sell your stock. Maximize your gains and minimize your losses. That includes how much you keep after taxes – both capital gains taxes and the new Medicare surtax. However the drama in Washington plays out, the Affordable Care Act and the tax provisions will remain law. Be prepared. With the right planning, you can minimize the impact on your gains.

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