The three tax thresholds of the new tax regime

Abram Claude, Vice President, Columbia Management Learning Center | November 3, 2014

  • New tax rates and provisions became effective in 2013.
  • These taxes will impact many high income individuals, as well as certain estates and trusts.
  • The Columbia Management Learning Center is dedicating a series of blog articles to this important and timely “Navigating the New Tax Regime” topic.

In 2013, there were new tax rates and provisions that became effective as a result of the American Taxpayer Relief Act of 2012 and taxes associated with the Affordable Care Act (ACA) of 2010. Among them were three distinct income thresholds that investors could cross over, each with unique tax implications.

The first threshold triggers the two surtaxes related to the Affordable Care Act of 2010. Crossing the second threshold begins a phase-out of personal exemptions and itemized deductions for federal taxes. The third threshold is the gateway to the highest federal income tax bracket of 39.6% and the highest general long-term capital gains tax rate of 20%.

Affordable Care Act taxes

The income thresholds for an additional 0.9% Medicare hospital insurance payroll surtax and the net investment income tax of 3.8% are the same amounts according to the taxpayer’s filing status1 — but what the amount represents is different. If a taxpayer has wage and self-employment income over $200,000 filing single or $250,000 married filing jointly, he or she will face an additional 0.9% Medicare payroll surtax for every dollar of wage and self-employment income over the threshold.

Before 2013, the Medicare hospital insurance payroll tax was a set 1.45%. But starting in 2013, every dollar over the earned income threshold level has the additional 0.9% surtax, so the rate is 2.35% for dollars above the threshold. For dollars below the threshold, the standard 1.45% remains in place. This surtax only applies to the wage earner or the self-employed. The employer’s Medicare payroll tax rate remains at 1.45% regardless of the employee’s wage amount.

The same threshold number ($200,000 single/$250,000 joint) is used for the 3.8% net investment income tax. But in this case, the threshold is defined as modified adjusted gross income. For the purposes of the net investment income tax, modified adjusted gross income = adjusted gross income + certain excluded adjusted foreign earned income.

If a taxpayer crosses the threshold, then he or she must make a two-part calculation. The first is determining the amount in which you are over the threshold. The second is determining your net investment income amount. Whichever amount is the lesser is where the 3.8% net investment income tax is applied.

American Taxpayer Relief Act

Sometimes referred to as PEP and Pease, single filers and married filing jointly filers who exceed their respective thresholds of $254,200 single/$305,050 joint in adjusted gross income will experience a phase-out of their personal exemptions and their itemized deductions. Personal exemptions ($3,950 per exemptions for 2014) can be fully phased out and itemized deductions could phase out by as much as 80%.

Understanding Tax Thresholds for 2014

Understanding tax thresholds for 2014

At $406,751/$457,601 in taxable income, single and married filing jointly filers will move into the highest income tax bracket of 39.6%. Any ordinary income above the amount will be taxed at that rate. That is also the trigger for the highest long-term capital gains rate of 20%. The 20% rate applies to general long-term capital gains that otherwise would fall within the 39.6% bracket.

Listen to our Road Report Podcast

Hear members of our Columbia Management Learning Center National Speakers Bureau discuss more of the mechanics around the three tax thresholds of the new tax regime:

Download the podcast

Next week in this series: “What is Net Investment Income, and How is it Calculated?

This material is for educational purposes only. It cannot be used for the purposes of avoiding penalties and taxes. Columbia Management does not provide tax or legal advice. Consumers should consult with their tax advisor or attorney regarding their specific situation.