An Interesting Puzzle

Laurie Frederiksen on

Here's something you might find interesting. A club had asked me whether Arlington investments (AI) is a REIT and subject to the accounting complications they bring. The club had done its homework and checked the AI investor relations pages. They found this statement there:

"The Company is taxed as a C corporation for U.S. federal tax purposes. The Company's dividends are eligible for the 23.8% federal income rate on qualified dividend income, whereas dividends paid by a REIT are generally subject to tax at ordinary income rates (currently at a maximum federal rate of 43.4%)."

This was positive. AI is not a REIT. However the 23.8% tax rate confused me. I knew that the top rate on Qualified dividends had been raised for some people, but I thought it had only been raised to 20%. I checked and that is the case.

Does anyone know where the 23.8% rate is coming from?

The club was able to figure that out. If nobody can guess, I'll let you know what they found out tomorrow. It might be something you'll be faced with on your personal taxes this year.

Laurie Frederiksen
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Rich Zilinsky on

It is related to a 3.8% Medicare surcharge.

The Affordable Care Act imposes a Medicare surcharge of 3.8% on all net investment income (NII) once the taxpayer's adjusted gross income exceeds $200,000 (single) or $250,000 (married); while this tax is not part of the income tax, it has the same effect on investors as a higher tax rate. The NII tax begins to apply to individuals falling in the 33% tax bracket. Thus the top effective marginal tax rate is 23.8% on qualified dividends and long-term gains, 43.4% on ordinary investment income.

On Thu, Sep 26, 2013 at 1:04 PM, Laurie Frederiksen <laurie@bivio.biz> wrote:

Here's something you might find interesting. A club had asked me whether Arlington investments (AI) is a REIT and subject to the accounting complications they bring. The club had done its homework and checked the AI investor relations pages. They found this statement there:

"The Company is taxed as a C corporation for U.S. federal tax purposes. The Company's dividends are eligible for the 23.8% federal income rate on qualified dividend income, whereas dividends paid by a REIT are generally subject to tax at ordinary income rates (currently at a maximum federal rate of 43.4%)."

This was positive. AI is not a REIT. However the 23.8% tax rate confused me. I knew that the top rate on Qualified dividends had been raised for some people, but I thought it had only been raised to 20%. I checked and that is the case.

Does anyone know where the 23.8% rate is coming from?

The club was able to figure that out. If nobody can guess, I'll let you know what they found out tomorrow. It might be something you'll be faced with on your personal taxes this year.

Laurie Frederiksen
Invest with your friends!
www.bivio.com

Become our Facebook friend! www.facebook.com/bivio
Follow us on twitter! www.twitter.com/bivio
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Laurie Frederiksen on

Good job Rick! You get a gold star!

Actually, to get to 23.8% on qualified dividends is a even a little harder than just getting to the cutoff where the extra 3.8% applies. You have to be in the 39.6% tax bracket to have the rate on your qualified dividends increase from 15%-20%. As you can see from the chart below from Wikipedia shows that your taxable income will need to be above $400,000 or $450,000 for married filing jointly to pass that hurdle.

So many of us will probably be paying tax rates on qualified dividends that have not changed.

Yeah!

Laurie Frederiksen
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On Thu, Sep 26, 2013 at 1:42 PM, Rich Zilinsky <rzilinsky@gmail.com> wrote:

It is related to a 3.8% Medicare surcharge.

The Affordable Care Act imposes a Medicare surcharge of 3.8% on all net investment income (NII) once the taxpayer's adjusted gross income exceeds $200,000 (single) or $250,000 (married); while this tax is not part of the income tax, it has the same effect on investors as a higher tax rate. The NII tax begins to apply to individuals falling in the 33% tax bracket. Thus the top effective marginal tax rate is 23.8% on qualified dividends and long-term gains, 43.4% on ordinary investment income.

Linda Lee on

Laurie, your reply sounds like you are saying that for many of us our tax rates on capital gains will not change. If your income exceeds $250,000 for a married couple filing jointly, you will still have to pay 3.8% more in capital gains tax. That is higher than just 15%. This really hurts couples where one spouse is working and the other is trying to convert 401k money to Roth and needs to sell stocks to come up with the money to pay the taxes. I am thinking that it may be better to sell the stocks gradually before retiring in order to bring up the cost basis of the money being used to pay the taxes.

From: Laurie Frederiksen <laurie@bivio.biz>
To: The Club Cafe <club_cafe@bivio.com>
Sent: Thursday, September 26, 2013 12:31 PM
Subject: Re: [club_cafe] An Interesting Puzzle

Good job Rick! You get a gold star!

Actually, to get to 23.8% on qualified dividends is a even a little harder than just getting to the cutoff where the extra 3.8% applies. You have to be in the 39.6% tax bracket to have the rate on your qualified dividends increase from 15%-20%. As you can see from the chart below from Wikipedia shows that your taxable income will need to be above $400,000 or $450,000 for married filing jointly to pass that hurdle.

So many of us will probably be paying tax rates on qualified dividends that have not changed.

Yeah!

Laurie Frederiksen
Invest with your friends!
http://www.bivio.com/

Become our Facebook friend! www.facebook.com/bivio
Follow us on twitter! www.twitter.com/bivio
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On Thu, Sep 26, 2013 at 1:42 PM, Rich Zilinsky <rzilinsky@gmail.com> wrote:

It is related to a 3.8% Medicare surcharge.

The Affordable Care Act imposes a Medicare surcharge of 3.8% on all net investment income (NII) once the taxpayer's adjusted gross income exceeds $200,000 (single) or $250,000 (married); while this tax is not part of the income tax, it has the same effect on investors as a higher tax rate. The NII tax begins to apply to individuals falling in the 33% tax bracket. Thus the top effective marginal tax rate is 23.8% on qualified dividends and long-term gains, 43.4% on ordinary investment income.

Laurie Frederiksen on

Hi Linda,

The extra tax is aimed at those with a large amount of income from investments who do not have to pay the Social Security and Medicare taxes those of us with regular salary income do. Of course, there can be huge arguments about any tax. Not sure we want to get into those here, but it is important to be aware of the changes if you are in the vicinity of any of the thresholds.

Here is a description of who the 3.8% tax applies to:

Net Investment Income Tax FAQ's

I'm not sure your reasons for converting to a Roth, but it is usually better to do that in a year in which your tax rates are lower. You can always convert the 401K into a regular, rollover IRA without owing tax and make the Roth conversion (if you need to) at a time when your overall tax rate might be less, or in a year when the market is down and the total value of your 401K is lower and the gains on what you are taking out is less.

I'm not sure what you are referring to when you say you should "sell the stocks gradually before retiring in order to bring up the cost basis of the money being used to pay the taxes". The cost basis in your retirement account is the amount of pre-tax money you contributed, not the cost basis of the stocks you own in that account.

Laurie Frederiksen
Invest with your friends!
www.bivio.com

Become our Facebook friend! www.facebook.com/bivio
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On Fri, Sep 27, 2013 at 12:10 AM, Linda Lee <lindalee0@yahoo.com> wrote:

Laurie, your reply sounds like you are saying that for many of us our tax rates on capital gains will not change. If your income exceeds $250,000 for a married couple filing jointly, you will still have to pay 3.8% more in capital gains tax. That is higher than just 15%. This really hurts couples where one spouse is working and the other is trying to convert 401k money to Roth and needs to sell stocks to come up with the money to pay the taxes. I am thinking that it may be better to sell the stocks gradually before retiring in order to bring up the cost basis of the money being used to pay the taxes.