Since we are in the midst of “tax season” and the subject of tax is on my mind, I thought I would spend just a few moments this month touching base on a lesser talked about tax that will have an impact on many of my doctor clients this year.
When the Supreme Court upheld the 2010 health-care law, much of the focus was on the 3.8% Medicare surtax that will apply to some high-income investors beginning this year. Understandably this is a concern; especially when you consider that the top tax rate is being raised to 39.6%. Those in this bracket will pay an effective rate of as much as 43.4% on their investment income. Add to this to the tax you pay at your individual State level and the overall tax paid becomes a bit painful.
What seems to be overlooked, in much of the discussion, is the “other” surtax that is in effect this year. An extra 0.9% Medicare tax will be applied to those whose “earned income” exceeds an annual threshold - $200,000 for “single filing” taxpayers and $250,000 for joint filers. Unlike its 3.8% big brother, that is applied depending upon the amount of your investment income as well as your other overall earnings, the computation on this surtax is straightforward. And, it may seem like a small amount, but it still has an impact when you consider how much tax is already being paid over a career.
Let’s take look at an example with a married couple that earns $350,000 a year. Starting this year, this couple will have to pay an extra $900 in Medicare tax ($350,000 - $250,000 = $100,000 X 0.9% = $900). Compounded over ten years of work, this couple will contribute an additional $9,000 or more to the Medicare system. Keep in mind that withholding for this additional Medicare tax occurs once an individual is paid wages in excess of $200,000. In our example, here, if the couple each make $175,000 or some other combination where they both earn less than $200,000 they will not have any withholding out of their wages for the additional surtax.
In giving consideration to both surtax amounts and the higher tax rates being applied to your earnings, I would recommend two things:
1. Proactive Tax Planning – taking time during the year to plan for the taxes that you may need to pay is more important now than ever before. In addition to planning for the amounts you may need to pay, your planning should also give consideration to ways in which you may be able to limit the tax you pay. This may include examining how you receive your money in some cases or even how you invest the money you earn.
2. Save more money in your Retirement Plan – The new tax will not apply to income in tax-deferred retirement accounts such as 401(k) plans or distributions from such plans. Increasing your retirement plan contributions should be considered. And if you are already funding your 401(k) Profit Sharing Plan to the maximum, I would suggest that you give consideration to adding a Cash Balance Plan or review other retirement plan strategies that will assist you in saving for your future and help you keep more of the money you earn.