Great explanation of the ObamaCare taxes kicking in
Two new taxes which are part of the Patient Protection and Affordable Care Act of 2010 (PPA, also called ObamaCare) have taken effect as of January 1. The first is the new 3.8% Medicare “surtax” on investment income. Until recently, while investment income was subject to either ordinary income taxes or possibly favored income tax rates as qualified dividends or capital gains, only earned income (ie. wages, self-employment) was subject to Medicare taxes. That’s changed. Now, investment income is subject to medicare taxes to the extent that it exceeds certain high-income thresholds. This means that if you make enough, some or all of your investment income is now being taxed an additional 3.8%.
You’ll note that 3.8% is higher than the old Medicare rate which applied to all income, which was 2.9% split evenly between employer and employee. The reason for that higher rate is related to the second new tax which has taken effect. Until January 1, all earned income was subject to that flat 2.9% tax. Now, for individuals whose earned income exceeds those same “high-income” thresholds used for the investment tax are also subject to an additional 0.9% Medicare tax — paid by the employee, not the employer. So for an individual whose earned income is, say, $300,000 — which is $100,000 above the threshold — on that last $100,000 Medicare taxes are 2.35% rather than 1.45%.
The Vanguard article gives a bunch more details about what, exactly, is considered “investment income” and how the mechanics of this all work.
An important thing to note is that some investment income is not included here and some is. In particular, municipal bond interest, as well as distributions from IRAs and qualified plans like 401(k)s are not investment income for the sake of this computation. However, taxable distributions from non-qualified annuities is. So the tax math in favor of IRAs and 401(k)s has gotten stronger. So think twice if someone is pushing you towards a non-qualified annuity. And if you can, max out those retirement accounts!