There is an old saying that there are only two things for certain in life – Death and Taxes. For high income earners, tax season each year can be a painful reminder of this. While there is a perception that those in higher income brackets have the ability to dodge taxes, the sad reality is that individuals who earn more often have fewer options when it comes to tax breaks and are unable to take some of the common deductions available to individuals in lower tax brackets.
Unlike a traditional IRA, if your income exceeds a certain amount you are not eligible to contribute to a Roth IRA. This can be particularly problematic if your income grows beyond the contribution eligibility limits after opening a Roth IRA. Contribution levels to a Roth are reduced if you are married and filing jointly earn $184,000. After $194,000 the ability to contribute is completely eliminated.
Net Investment Income Tax and .9% Medicare tax
When the modified adjusted gross income (MAGI) exceeds $200,000 ($250,000 for married persons filing jointly) a Net Investment Income Tax (NIIT) and an additional Medicare tax comes into play. The NIIT consists of a 3.8% surtax applied to investment returns such as dividends, interest ,capital gains, rental income, nonqualified annuities to name a few. The additional Medicare tax also starts at these same income levels. Additionally, the income where the NIIT and additional Medicare tax becomes effective is not adjusted for inflation. There is a “marriage penalty” with these taxes as a single can earn up to $200,000 but a married couple filing separately will start to pay after $125,000.
Social Security Benefits
In the past, social security benefits were tax-free. In recent years, however, the government has added an additional tax to some benefits in an effort to save social security for future generations. This plan creates the possibility of up to 85% taxation on social security benefits. While nearly three-quarters of those who receive benefits are still safe from taxation, those who earn higher social security benefits are not so lucky. In a nutshell, this means, individuals filing jointly who have a combined social security tax benefit between $32,000 and $44,000 may be required to pay income tax on up to 50% of their social security benefits. Furthermore, those who earn over $44,000 in benefits (filing jointly) could be taxed up to 85% on their benefits.
Alternative Minimum Tax (AMT)
An AMT is a supplemental income tax required in addition to baseline income tax for certain individuals. For 2016 the exemption is $83,800 for married joint-filing couples and $53,900 for unmarried individuals. Unfortunately, the exemption is phased out if your AMT income is too high. And, if your AMT bill exceeds your regular tax bill, you must pay the higher AMT amount.
These are just a few of the tax considerations for high income earners. At Financial Fiduciaries, not only do we manage our client’s investments, we also oversee their tax liability. Paying attention to tax implications is an important part of ensuring that our clients are able to make wise investment decisions that will allow them to realize the highest possible benefits. Contact our team to learn more!