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Here is the best article that I've read so far that explains the new math for taxpayers making more than $250,000: link

This has been a pretty confusing topic for people, so I thought I would post the article here and hope that it'll help answer some questions. To the extent that it does not, I would propose using this thread to discuss and figure out the impact of the new phase-out rules and to see if there are ways around it (or if they are unnnecessary because of the AMT).

Please note that at the bottom of the article there is a link to the Tax Policy Center online calculator, which will also help you run a couple of different comparisons.

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by "total" I meant MAGI, at least as I read the intrawebs.

psychtobe (Jan. 06, 2013 @ 4:16p) |

I am just starting to look into this, but, so far, am finding this example helpful (although I haven't yet tried to conf... (more)

geo123 (Jan. 07, 2013 @ 4:58p) |

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SangioveseW (Jan. 09, 2013 @ 10:25a) |

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Let me try this again.

CA married couple with AGI $450k, of which $20k is investment income.

39.6% federal
11.3% state
5% investment tax, as each dollar of earned income pushes investment income above the $450k cap, which causes the investment tax rate to rise from 15% to 20%
2.35% medicare tax (1.45% up to $250k of earned income, 2.35% above that)
=

58.25%

Second scenario:

CA married couple with AGI $250k, of which $20k is investment income.

33% federal
9.3% state
3.8% (Medicare tax on investment income > $250k, since each dollar of earned income pushes a dollar of investment income above the $250k mark)
=

46.1%

What do you think of that?

psychtobe said:   0.9% medicareIt's worse than that. The regular Medicare tax rate is 1.45% (if you are an employee; if you are self-employed, it is 2.9%) and the additional Affordable Care Act Medicare tax on individuals earning more than $200K/year and married couples earning over $250K/year is 0.9%. So, your hypothetical couple's marginal dollars would be taxed at 2.35% or 3.8% if you are self-employed.

13.9% state (California)Is that the tax rate for California residents with incomes over $1MM? I thought that it was slightly lower if you are under $500K but I'm not in California and haven't been following it very closely.

Remember that state income taxes are deductible for federal income tax purposes, so, your federal income tax liability is reduced as a result. Now, state income taxes are not tax deductible under the AMT and, while the new 39.6% bracket will push more people out of the AMT early, those making just slightly above the $450K threshold are still almost certain to continue paying the AMT. This means that their state income taxes won't be deductible but the AMT tax is 28%.

psychtobe said:   A California taxpayer couple right at $450k AGI of which, say, $20,000 is investment income could see each marginal dollar of earned income taxed as follows:

39.6% federal
0.9% medicare
13.9% state (California)
5% additional increase in investment income tax (as investment income is pushed from the <$450k 15% rate to the >$450k 20% rate)
3.8% medicare investment tax (over income > $250k

=

63.2%

I am not an accountant or lawyer, so someone please correct me if I am wrong.


Which dollar does that apply to, a capital gain dollar or an income dollar?
You're mixing up capital gains dollars and income dollars, I don't think that's right.

I found the OP's linked article readable only when I was falling-down drunk!

So here is a different, new tax article that is readable for when I am cold-sober:
link

psychtobe said:   A California taxpayer couple right at $450k AGI of which, say, $20,000 is investment income could see each marginal dollar of earned income taxed as follows:

39.6% federal
0.9% medicare
13.9% state (California)
5% additional increase in investment income tax (as investment income is pushed from the <$450k 15% rate to the >$450k 20% rate)
3.8% medicare investment tax (over income > $250k

=

63.2%

I am not an accountant or lawyer, so someone please correct me if I am wrong.

You're wrong

You don't just add capital gains tax (now called investment tax) to earned income tax - it's one or the other

psychtobe said:   A California taxpayer couple right at $450k AGI of which, say, $20,000 is investment income could see each marginal dollar of earned income taxed as follows:

39.6% federal
0.9% medicare
13.9% state (California)
5% additional increase in investment income tax (as investment income is pushed from the <$450k 15% rate to the >$450k 20% rate)
3.8% medicare investment tax (over income > $250k

=

63.2%

I am not an accountant or lawyer, so someone please correct me if I am wrong.

Why are you adding investment income tax to the normal income tax rate? They're taxed at two different rates.

EDIT: Crap, glahhg and SiS beat me to it.

geo123 said:   
13.9% state (California)Is that the tax rate for California residents with incomes over $1MM? I thought that it was slightly lower if you are under $500K but I'm not in California and haven't been following it very closely.


Right. New $300-500k bracket in CA is now 11.3% not 13.9%

That's for Schedule X (Single). The example should use Schedule Y (MFJ), still 9.3% for 450k taxable or no increase.

Published Numbers

PMonkeyDishwasher said:   psychtobe said:   A California taxpayer couple right at $450k AGI of which, say, $20,000 is investment income could see each marginal dollar of earned income taxed as follows:

39.6% federal
0.9% medicare
13.9% state (California)
5% additional increase in investment income tax (as investment income is pushed from the <$450k 15% rate to the >$450k 20% rate)
3.8% medicare investment tax (over income > $250k

=

63.2%

I am not an accountant or lawyer, so someone please correct me if I am wrong.

Why are you adding investment income tax to the normal income tax rate? They're taxed at two different rates.

EDIT: Crap, glahhg and SiS beat me to it.


No, the new law requires not only higher marginal rates on > $450k of total income, it simultaneously causes the capital gains and dividend tax rate on income above that level to rise from 15% to 20%. So if you are at exactly $450k, and you earn one more dollar, it displaces a dollar of investment income above $450k, increasing its tax rate from 15% to 20%. That is why I added the 5% to the marginal income tax rate.

I have corrected the other rates per replies.

You don't pay the 39.6% on the investment income. You will either pay 39.6%, or 20+3.8%, depending on the kind of investment.
It's one or the other, never both. Then add 2.35% medicare, and your state tax (11.3% in the CA example, up to $500k)

That leads to 53.25% on wages/some investments and 37.45% for the other investments. Add 2% if you are over the $1M mark. And be happy that you make as much in one year as many people make in their entire career.

Oh and one other thing - your state taxes are deductible on the federal side, so the actual rate is less than this rough calculation.

I still don't think that is right. The dollar of earned income pushes a dollar of investment income into a higher tax bracket.

Example:

$250k of AGI, $20k of it investment.

Earn $10k of additional earned income. Total AGI now $260k. Pushes $10k of investment income > $250k.

The $10k of earned income is taxed at 33%+9.3% = $4230
The $10k of investment income which was previously taxed at 15% is now taxed at 18.8% = 3.8% additional tax or $380.

$380+$4230 = $4610 of additional tax for your $10,000 income. That is 46.1%.

Same for the $450k example.

i wish I had this problem to figure out when filing my taxes this year

The two rates are calculated separately. You don't have $250k of AGI, $20k in investment. Instead, you have $230k of non-investment income and $20k of investment income.
They are two different buckets, and the marginal tax rate for each amount would come separately. That is the case in present law - none of your 15% cap-gains income affects your tier of tax rate.

Talk with your tax accountant if you actually think this is a scenario that affects you, but as an academic matter you should never bundle the two together when calculating tiers on tax rates.

fine, call it $230k earned and $20k investment income. it doesn't matter. When you have investment income and your AGI is over $250k, the investment income is taxed at 18.8% rather than 15%. That is effectively a 3.8% additional tax on the earned earned income itself, if every earned dollar pushes an investment dollar above $250k.

If you make $250k in earned and $250k in investment income, you do not use $500k in determining the marginal rate. The marginal rate for one type of income has nothing to do with the other.

I'll give you a few examples.

Example 1:
$250k investment income
$10k salary

15 + 3.8% paid on every investment earning above $200k. ($400k is where the 15% jumps to 20%)
10% paid on earned income above $10k (up until you hit the 15% tax).
1.45% paid in Medicare on all earned income above $10k. No 0.9% Medicare surcharge here.
6.2% Social security paid on all earned income above $10k (up until you hit the $113k cap)
California tax for any additional earnings will be 10.3% (assuming you are single)

Your next $5k in earned income would be charged 10+1.45+6.2+10.3=27.95% tax rate.
Your next $5k in investment income would be charged 15+3.8+10.3=29.1% tax rate.


Example 2:
$250k salary income
$10k investment income

15% paid on every investment earning up to $250k.
33% paid on earned income between $178k-388k
2.35% paid in Medicare on all earned income above $200k.
0% Social security paid on all earned income above the $113k cap.
California tax for any additional earnings will be 10.3% (assuming you are single)

Your next $5k in earned income would be charged 33+2.35+10.3=45.65% tax rate.
Your next $5k in investment income would be charged 15+10.3=25.3% tax rate.

In both cases, the state tax counts as a deduction on the federal tax, so the actual rate is lower.

The only time where the AGI is relevant is on the CA state tax where both numbers are taxed identically.

ducky51 said:   i wish I had this problem to figure out when filing my taxes this year
You mean to let your accountant handle? Unless you value your time at a very low rate (which you shouldn't if you're at $250k+ annually), it makes more sense to have an accountant do it.


mrunge said:   

Example 2:
$250k salary income
$10k investment income

15% paid on every investment earning up to $250k.
33% paid on earned income between $178k-388k
2.35% paid in Medicare on all earned income above $200k.
0% Social security paid on all earned income above the $113k cap.
California tax for any additional earnings will be 10.3% (assuming you are single)
Your next $5k in earned income would be charged 33+2.35+10.3=45.65% tax rate.
Your next $5k in investment income would be charged 15+10.3=25.3% tax rate.


Bolded portion is exactly what I said. Except you have a conflated example of combining the numbers for a single and married taxpayer, as highlighted in the two underlined portions. That's why our rates and conclusions differ. And it's 3.8% in this example, not 2.35%.

In this link:

https://www.fidelity.com/viewpoints/personal-finance/new-medicar...

"In other words, youll owe the 3.8% tax on the amount by which your investment income exceeds the income thresholds, or, if your wages alone already are higher than the income thresholds, you'll owe tax on the lesser of net investment income or MAGI that exceeds the thresholds."

The 2% payroll tax holiday will be sorely missed by the workers.

edit: Comment deleted. This conversation is a waste of time.

I addition to the private message, you may want to read this post from Bogleheads, in which the poster describes a "triple play zone" of hitting every phased in additional tax.

http://www.bogleheads.org/forum/viewtopic.php?f=10&t=107999&star...

PMonkeyDishwasher said:   ducky51 said:   i wish I had this problem to figure out when filing my taxes this year
You mean to let your accountant handle? Unless you value your time at a very low rate (which you shouldn't if you're at $250k+ annually), it makes more sense to have an accountant do it.
There is tremendous value associated with knowing how these things work and not relying on an accountant's final product to just blindly remit your tax payment without understanding why and how various actions that you take throughout the year impact your tax liability.

By the way, plenty of people with incomes above this threshold are W2'd, so their tax situations are relatively simple and can be pretty easily handled by inexpensive tax software, like TurboTax, etc... This is all the more reason to learn the mechanics of these new phase-out rules.

geo123 said:   PMonkeyDishwasher said:   ducky51 said:   i wish I had this problem to figure out when filing my taxes this year
You mean to let your accountant handle? Unless you value your time at a very low rate (which you shouldn't if you're at $250k+ annually), it makes more sense to have an accountant do it.
There is tremendous value associated with knowing how these things work and not relying on an accountant's final product to just blindly remit your tax payment without understanding why and how various actions that you take throughout the year impact your tax liability.

By the way, plenty of people with incomes above this threshold are W2'd, so their tax situations are relatively simple and can be pretty easily handled by inexpensive tax software, like TurboTax, etc... This is all the more reason to learn the mechanics of these new phase-out rules.

Well now I feel silly for arguing that one should be completely ignorant of the tax code and blindly submit taxes while unfailingly trusting an accountant. Oh wait, that's not what I did.

PMonkeyDishwasher said:   geo123 said:   PMonkeyDishwasher said:   ducky51 said:   i wish I had this problem to figure out when filing my taxes this year
You mean to let your accountant handle? Unless you value your time at a very low rate (which you shouldn't if you're at $250k+ annually), it makes more sense to have an accountant do it.
There is tremendous value associated with knowing how these things work and not relying on an accountant's final product to just blindly remit your tax payment without understanding why and how various actions that you take throughout the year impact your tax liability.

By the way, plenty of people with incomes above this threshold are W2'd, so their tax situations are relatively simple and can be pretty easily handled by inexpensive tax software, like TurboTax, etc... This is all the more reason to learn the mechanics of these new phase-out rules.

Well now I feel silly for arguing that one should be completely ignorant of the tax code and blindly submit taxes while unfailingly trusting an accountant. Oh wait, that's not what I did.
I didn't mean to suggest that you did and am sorry if my response conveyed that impression.

geo123 said:   PMonkeyDishwasher said:   geo123 said:   PMonkeyDishwasher said:   ducky51 said:   i wish I had this problem to figure out when filing my taxes this year
You mean to let your accountant handle? Unless you value your time at a very low rate (which you shouldn't if you're at $250k+ annually), it makes more sense to have an accountant do it.
There is tremendous value associated with knowing how these things work and not relying on an accountant's final product to just blindly remit your tax payment without understanding why and how various actions that you take throughout the year impact your tax liability.

By the way, plenty of people with incomes above this threshold are W2'd, so their tax situations are relatively simple and can be pretty easily handled by inexpensive tax software, like TurboTax, etc... This is all the more reason to learn the mechanics of these new phase-out rules.

Well now I feel silly for arguing that one should be completely ignorant of the tax code and blindly submit taxes while unfailingly trusting an accountant. Oh wait, that's not what I did.
I didn't mean to suggest that you did and am sorry if my response conveyed that impression.

My apologies for misinterpreting your comment. I do agree with what you said, of course; knowledge of the tax code is useful for any taxpayer.

Knowledge of the tax code would also be useful for congress. They basically created a new 39.6% tax bracket at 400K, which is just barely above where the 35% tax bracket will start in 2013 (likely around 397K or 398K depending on how the IRS calculates inflation). They should have just made the 35% bracket be 39.6% and save the hassle of a new bracket.

armus said:   Knowledge of the tax code would also be useful for congress. They basically created a new 39.6% tax bracket at 400K, which is just barely above where the 35% tax bracket will start in 2013 (likely around 397K or 398K depending on how the IRS calculates inflation). They should have just made the 35% bracket be 39.6% and save the hassle of a new bracket.This is certainly true for single taxpayers. For married filing jointly, the new 39.6% tax bracket starts at $450,000, so there is more of a distance there.

psychtobe said:   PMonkeyDishwasher said:   psychtobe said:   A California taxpayer couple right at $450k AGI of which, say, $20,000 is investment income could see each marginal dollar of earned income taxed as follows:

39.6% federal
0.9% medicare
13.9% state (California)
5% additional increase in investment income tax (as investment income is pushed from the <$450k 15% rate to the >$450k 20% rate)
3.8% medicare investment tax (over income > $250k

=

63.2%

I am not an accountant or lawyer, so someone please correct me if I am wrong.

Why are you adding investment income tax to the normal income tax rate? They're taxed at two different rates.

EDIT: Crap, glahhg and SiS beat me to it.


No, the new law requires not only higher marginal rates on > $450k of total income, it simultaneously causes the capital gains and dividend tax rate on income above that level to rise from 15% to 20%. So if you are at exactly $450k, and you earn one more dollar, it displaces a dollar of investment income above $450k, increasing its tax rate from 15% to 20%. That is why I added the 5% to the marginal income tax rate.

I have corrected the other rates per replies.


Is it total income or taxable income?

by "total" I meant MAGI, at least as I read the intrawebs.

psychtobe said:   I addition to the private message, you may want to read this post from Bogleheads, in which the poster describes a "triple play zone" of hitting every phased in additional tax.

http://www.bogleheads.org/forum/viewtopic.php?f=10&t=107999&star...
I am just starting to look into this, but, so far, am finding this example helpful (although I haven't yet tried to confirm its accuracy): Forbes' contributor's analysis.

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