Three Big Reasons to Not Overreact to Taxes
Some people want to pay long term rates before they go up. After all, this is a 5/20 or 25% tax increase!
However, you may not be one of those people who would benefit by selling your equities and realizing those gains this year. Talk to your financial advisor at AIFS before making that decision. There are three big reasons not to realize too much in taxes in 2021.
If you are currently receiving Medicare, then you may know that the amount you pay for Medicare premiums depends upon your income reported on your tax returns. You might not know the details.
This increase in premiums is called IRMAA: Income Related Monthly Adjustment Amount.
If you report a large capital gain, then that increases your income for Medicare purposes, and that might force you to pay more for Medicare premiums for two years!
Here are the details. Medicare looks at your tax return from two years ago. They look at the Modified Adjusted Gross Income—MAGI. MAGI is a gotcha because most of us do not know what that is. MAGI does not appear on the tax return. You have to take your Adjusted Gross Income and add back the long-term capital gains, deductions you took for taxable Social Security payments, losses from a partnership, passive income/loss, rental losses, and a few more items!
If your MAGI is above one of the following numbers, then you pay more for Medicare for two years. Why two years? Because the government looks at your tax return from two years ago. Let’s look at what this means for a married couple filing a joint return.
Remember, this is based on 2020 Tax Returns.
Income up to … Medicare Premium per Month in 2022
< $182,000 … $170.10
$284,000 … $340.20
$340,000 … $442.30
$750,000 … $544.30
> $750,000 … $578.30
For example. A modest married couple with an adjusted gross income of $85,000. They realized a $200,000 long term capital gain in 2020. They look back in January, 2022, and find that their MAGI was $285,000. This means their 2022 Medicare premium doubles from $170.10 per month to $340.20 per month, for 24 months, per person.
For the IRMAA calculations for a single person, visit www.gotaxfreebook.com
Net Investment Income Surtax
If your long-term capital gains get high enough, then you have to pay an additional 3.8% tax. If you are already paying this tax, you know about it. If you are not paying it, then by selling a bunch of your investments in a single year, you might force yourself to pay more in taxes than you have to.
Finally, it is worth noting that the IRS will make you pay a penalty tax for under-paying your taxes. In a year where you have a large windfall, it is easy to under-report. There are only two ways around this tax. First, you could pay 110% of the previous year’s taxes. Or, you could pay 90% of the estimated tax burden for this year. If you have a large windfall, then consider making that tax payment in the same year. Regardless of when in the year you realize the gain, you do not have to make it until the end of the year, however. The IRS counts any payment during the year equally.
1 Complete list of MAGI items: https://www.investopedia.com/terms/m/magi.asp