Obamatax Costs Some Taxpayers Thousands

During the most recent tax season, we saw the first effects of the American Taxpayer Relief Act of 2012, and for high-income clients they weren’t pretty.

The act, which was passed by Congress and was designed to address the “fiscal cliff” (remember that?), had its first full effect on taxpayers last year. Although the act made permanent “lower” tax brackets for middle-income taxpayers, there were many nasty surprises for those in the higher brackets.

We’ll use a real-client example to illustrate just how costly this legislation was:

Taxpayer and spouse are retired. They worked hard and saved all their lives and have accumulated about $2.6 million in taxable accounts and $812,000 in IRAs. They own a commercial building that they lease.

  • Due to their high adjusted gross income (AGI), they paid Alternative Minimum Tax (AMT) of $8,586.
  • Their personal exemptions were reduced by $4,992, again due to their high AGI.
  • They lost $2,397 of itemized deductions.
  • They paid $4,937 of Net Investment Income Tax (NIIT). This is the new 3.8% Obamatax on investment income, to fund Medicare. It applies to married taxpayers whose AGI exceeds $250,000.
  • They paid $6,834 in taxes on their Social Security benefits.
  • Mutual fund distributions in their taxable accounts boosted their tax liability.
  • Their sale to their son of a second home resulted in a taxable capital gain.

Client paid $72,693 in federal income taxes on $379,915 of income, for an effective rate of 19.13%.

In the current tax environment, income tax planning is more important than ever for those with high income or high net worth, or both

The following concepts work today just like they have in the past: Keep your AGI down. You can do this by putting off the recognition of capital gains and continuing to invest tax-efficiently. Donating appreciated assets instead of cash to charities, and making gifts of such assets to children or grandchildren, who may be in lower tax brackets, is a good strategy as well.

Defer income and accelerate deductions. Use tax-efficient investments like exchange-traded funds. Consider municipal bonds for fixed-income portion of your taxable portfolio.

Beyond that, all you can do is grin and bear it.