New Taxes Arrive for Health Care

As I write this, serious talks are (hopefully) happening in Washington DC on a number issues collectively referred to as the "fiscal cliff." There are some important issues there, and a solution will not be easy. It will undoubtedly include both cuts in benefits (i.e., spending) and increases in taxes.

But we have a new tax increase about to take effect. The Affordable Health Care Act included a 3.8% tax on the "wealthy" to help pay for the expanded benefits. In general this is a Net Investment Income Tax (NIIT) on non-earned income over $200,000 for singles and $250,000 for couples. The issue is what is included in that list? While this is not an exhaustive list, it should give you a good feel:

• Interest and dividends
• Capital gains from the sale of stocks, bonds, and mutual funds (including capital gain distributions from mutual funds)
• Net income from rentals
• Gains from sale of interest in partnerships and S-Corporations if you were a passive owner
• Gain from the sale of investment real estate -- potentially including your residence!

The tax is 3.8% on the amount of gain that causes your taxable income to exceed the appropriate limit (e.g., $250,000). It is worth looking at that real close when we think about the sale of our homes.

First, it is only on gain. So if you purchased your house for $100,000 and sold it for $250,000 then you only have $150,000 of gain. The full $250,000 was never a consideration.

Second, under certain conditions, we are allowed to exclude from taxation a portion of the gain on the sale of our primary residence. For a single taxpayer that is $250,000, and for a married couple filing jointly that is $500,000. Since that gain exclusion is not taxable, it too is not subject to the 3.8% NIIT. The qualifiers are having owned and lived in the residence for 2 out of the last 5 years.

For example, if you paid $100,000 for that house 13 years ago and have lived in it the whole time, you sell it for $650,000, and you are filing a joint return, then $650,000 - $100,000 - $500,000 = $50,000. So it is possible that you could pay the tax on the $50,000 of excess income. But we still have not applied to total income test. So further assume that with the gain on the old house the total taxable income on the tax return comes to $260,000. That means the 3.8% NIIT will be applied to $10,000 only, or an additional $380 in income tax.

There are numerous fine points to the rules, and the list above is not all-inclusive. So it is important that each person seeks competent tax help. But this should give a general understanding for most situations.