New Tax Increases

While the payroll tax hike in the New Year’s deal to avoid the fiscal cliff has received a lot of attention, investors may also want to pay attention to another lesser known federal tax increase that went into effect in early January.

The little known Obamacare provision – – known colloquially as the health care surtax — imposes a new 3.8% investment income surtax on individuals with modified adjusted gross income (MAGI) above a certain threshold ($250,000 for married taxpayers filing jointly and $200,000 for individual taxpayers). For those folks, the tax specifically hits the lesser of investment income or MAGI above the threshold amount.

I’ll be the first to admit that I try not to spend too much time with the Internal Revenue Code these days as it interferes with my recovery from being a tax attorney.  That said, as a tax geek myself, and taking a cue from Daniel Morillo and Matt Tucker’s recent calculation-heavy posts, I couldn’t help but do a little math to discover how this new surtax may impact investors differently depending on the tax status of their fixed income assets.  Here’s one example I computed:

Scenario 1 – Taxable bond interest income


Let’s say you have a married couple filing jointly who has $180,000 of MAGI from non-investment sources and another $90,000 of investment income. Let’s further assume that 60% of the investment income comes from dividends (qualified, of course) and capital gains. Then let’s assume the balance of the investment income comes from taxable bond sources, specifically the iShares Intermediate Credit Bond Fund (CIU). And finally, let’s assume that the principal amount is $1,139,241 (I backed into this amount using $36,000 and CIU’s 3.16% dividend yield).

This couple would pay a total of $18,180 in tax on their investment income.  The tax would consist of 15% tax rate on $54,000 (60% of the investment income), 28% on the $36,000 of interest income and a surtax of 3.8% on $20,000 (This represents the difference between the $250,000 threshold and the couple’s $270,000 of MAGI income).  That means on an after-tax basis, the couple keeps $71,820.

Scenario 2 – Tax-exempt bond interest income