Tax Planning

The 3.8% investment income tax, which is being used to help pay for health care reform, took effect January 1, 2013. The tax applies to “net investment income” for those with > $250,000 of income (joint return); $200,000 for singles. Only investment income, such as dividends, interest, and capital gains, above these dollar thresholds are taxed. The tax is a flat 3.8% in addition to other taxes owed.

There are tax strategies to ease the burden for any of the following events: marriage, divorce, birth and adoption, change in employment, starting a new business, disasters, change of household, medical expenses, retirement, and death.

Tax Advice For Major Events In Life

Two in five U.S. households own an IRA. In 2006 and 2007, the Treasury Inspector General for Tax Administration estimated that $286 million in taxes were uncollected due to missed IRA withdrawals and excess contributions.

For tax years beginning in 2013, the 20% long-term capital gains rate applies to taxable incomes > $400,000 ($450K joint return). With an increase tied to limiting the effect of itemized deductions, known as the Pease limitation, a taxpayer’s rate increases by ~1%. There is also a new 3.8% flat tax on net investment income, resulting in a total equivalent capital gains rate of ~25%.

To defray the costs of the Civil War, Congress passed a temporary income tax in 1861, 3% on income > $800 ($20,000 in today’s dollars). The very next year, the tax was expanded and made progressive, with higher rates on higher incomes. The income tax did not become permanent until 1913, after the ratification of the 16th Amendment. At the beginning of WWI, Congress expanded the tax and raised rates to as high as 77%. Still, by 1918, only one in six families paid income taxes.

The 0% long-term capital gains rate applies to individuals with taxable income of < $35,350 ($70,700 joint return); the dollar figures include capital gains. For example, a sole proprietor with taxable income of just $10,000 would not qualify for the 0% rate if his capital gains were $26,000.

On February 13, 1913, passage of the Sixteenth Amendment authorized a federal income tax. The first time an income tax was used was to raise money during the Civil War; the tax was repealed in 1872 because money from the tax was no longer needed.

One way for the federal government to either raise revenue or lower tax rates is to limit taxpayer deductions. The three biggest tax breaks for taxpayers are the following: employer-provided health insurance, mortgage interest deduction, and retirement plan contributions. According to the Tax Policy Center in Washington, only ~ 12% of taxpayers making < $63,000 itemize versus 90% of those taxpayers with earnings > $150,000. The top 5% of taxpayers (those earning $200K+) have itemized deductions representing ~ 13% of their income.