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Medicare Taxes Set to Rise

Medicare surtaxes will be levied on high income earners. As it stands now, there will be 2 separate taxes for both earned income and unearned income.

The 3.8% Medicare surtax policy was passed in 2010 and is scheduled to take effect in 2013. This will affect those making over $200,000 per year ($250,000 if married). Currently, the top tax rate on dividends and capital gains is 15%. The surtax alone would increase this to 18.8%. Bear in mind that this does not take into account the expiring Bush tax cuts. That said, more increases for tax on investment income could be coming.

What effect will this have? It will make dividends worth less than what they are today. Because of the anticipation of higher dividends, many companies are currently paying special, lump sum dividends to avoid shareholders paying higher rates. Dividends you receive before the end of 2012 will still have a maximum tax rate of 15%.

The tax increase will have unintended consequences. If dividends are worth less in the future, companies will be more reluctant pay them. They will likely use other “tricks” like share repurchases. This increases earnings per share because it reduces the number of shares in the market.

Higher taxes for dividends will place downward pressure on stock prices. Because we are in a low yield environment, many investors have deployed more cash into dividend paying stocks. This is because interest rates are too low to provide a reasonable return.

If you plan on selling stocks in the near future, selling large gains before the end of 2012 will likely result in tax savings. This is especially true for high income earners.

The Medicare payroll tax will also increase for high income earners. An extra 0.9% will affect single filers with earned income over $200,000, married couples filing joint with income over $250,000, and married filing separate taxpayers with an income over $125,000. The top rate on Medicare overall will be a combined total of 2.35%.

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