Welcome to the Ready Set Retirement Blog, my name is Derrick Glencer I am a CERTIFIED FINANCIAL PLANNER™ Practitioner. The Ready, Set…Retirement Blog focuses on the financial planning questions and concerns of Gen X Execs and Soon to Be Retirees.

In today’s post we are going to discuss one your favorite subjects….Taxes and how a dollar can add up to more when it comes to taxes.

It seems silly how one measly dollar can have impact, but it’s more than you think—especially during tax season and on your taxes.

Not only can an extra dollar of income push you into the next highest tax bracket (thankfully, with a progressive tax system, only those excess dollars will be subject to the higher incremental tax).

For those of you who aren’t really familiar with how ordinary income tax is paid there are two ways of looking at it.

1. What is my average tax rate. For example if your Adjusted Gross income is $200,000 and you paid $50,000 in Federal Income Tax, your average rate is 25%.
2. Your marginal rate is something completely different. Whether Single or Married filling Jointly, Married Filing Separately and Head of Household. Each has a series of backets. For example if you are Single and your AGI is $147,000. You pay 10% on the first $9,950, you pay 12% from $9,951 to $40,525, 22% from $40,256 to $87,375, and 24% on $87,376 to $147,000. So your top marginal rate is 24%. This is final bracket in which your last dollar was earned.

That dollar can mean you’re paying more taxes in other ways. Let’s take a look at two of them.

Medicare tax

If your wage or compensation exceed certain thresholds ($200,000 for those filing single or head of household in 2021 and $250,000 for those married filing jointly) by even $1, you’ll be subject to the 0.9% additional Medicare surtax on the excess.

While $1 over only means you’ll pay an extra cent or so, it can add up quickly the further you are over the limit. Your employer will withhold the tax for you, but here is the rub, you will have to file and additional tax Form.

Here is a hot tip:

Form 8959 is used to report the excess income that is subject to this tax. Please note that the calculations are a little more complicated if you have self-employment income in the mix, so and I can’t stress this enough be sure to discuss this with a qualified tax professional. A lot of folks like to go it their own on taxes and that is a reasonable thing if your taxes are straightforward, however when you start getting into the Medicare Tax and Net Investment Income Tax it might be time to seek out a qualified tax professional.

Hot Tip #2:

This is important for those of you who are retired and enrolled in Medicare so listen closely. You will have to pay an income-related adjustment in addition to your standard Medicare Part B premium if you made even a dollar over the applicable threshold, which is based on your income from two years ago. For example, those who made $91,000 or less (single) or $182,000 or less (married filing jointly) in 2020 paid $170.10 per month for this coverage in 2022. But those who made $91,001 (single) or $182,001 (joint) paid $238.10 per month, an extra $816 over the course of the year.

The next tax that could be triggered by just one dollar is Net investment income tax (NIIT).

Certain individuals, trusts and estates may be subject to an additional 3.8% net investment income tax (NIIT) on the lesser of their net investment income or the amount by which their modified adjusted gross income exceeds the threshold based on their filing status. (Again, that’s $200,000 for those filing single or head of household in 2022 and $250,000 for those married filing jointly.)

net investment income generally includes interest, dividends, capital gains not offset by capital losses, rental and royalty income, and nonqualified annuities; it excludes wages, unemployment compensation, Social Security benefits, alimony, and most self-employment income. So it is possible to be subject to this tax and/or the Medicare surtax since they apply to different income pools.

Another difference is that your employer doesn’t withhold anything for this tax. You may request that additional income tax be withheld if you think you’ll owe come April.

Hot tip #3:

To determine if you are liable for NIIT, you will use Form 8960 to compute the tax, and will report and pay the tax on the appropriate income tax return form.

Let’s look at an example. Say we have a single female and we will call her Debra, she files as head of household with $180,000 in wages. She is not subject to the Medicare surtax based on her wage compensation, however let’s say she received $90,000 from a passive partnership interest, and the IRS considers this net investment income.

Now her modified adjusted gross income is $270,000, this exceeds the threshold by $70,000. NIIT is based on the lesser of the amount that exceeds her modified gross income threshold or the actual net income.

So in this example the AGI threshold is $200,000 she exceeded that by $70,000. The passive income or was $90,000, she is allowed to calculate NIIT based on the lower of the two between $70,000 and $90,000.

So she will owe an additional $2,660 in NIIT this year, which is ($70,000 x 3.8%).

Here is the final hot tip:

Note: The real estate market is competitive in many areas of the country. If you’ve decided to sell your primary residence, please note that up to $250,000 in capital gains from the sale may be excluded from your gross income for regular income tax purposes (if you meet IRS qualifications) and, as a result, is also exempt from the net investment income tax. Again you should be sure to discuss this with a qualified tax professional to see if you qualify.

Estates and trusts are liable for the tax if they have undistributed net investment income and adjusted gross income over the threshold. As with most tax-related calculations, professional help can be invaluable as computations get complicated for different types of trusts.

Sources: irs.gov; Centers for Medicare & Medicaid Services; Raymond James research

Again, my name is Derrick Glencer I am a CERTIFIED FINANCIAL PLANNER™ Practitioner and this has been another episode of Ready, Set…Retirement If you enjoyed this content you can book a complimentary consultation via Calendly at: https://calendly.com/djgcfp

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derrick.glencer@raymondjames.com

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Thank you very much and go make it a great day!

Any opinions are those of Derrick Glencer and not necessarily those of Raymond James. Expressions of opinion are as of this date and are subject to change without notice Investing involves risk and you may incur a profit or loss regardless of strategy selected. Every investor's situation is unique and you should consider your investment goals, risk tolerance and time horizon before making any investment. Prior to making an investment decision, please consult with your financial advisor about your individual situation. Investment advisory services offered through Raymond James Financial Services Advisors, Inc. Securities offered through Raymond James Financial Services, Inc., member FINRA/ SIPC.

Certified Financial Planner Board of Standards Inc. owns the certification marks CFP^®, CERTIFIED FINANCIAL PLANNER™, CFP^® (Plaque design) and CFP^® (with flame design) in the U.S., which awards to individuals who successfully complete the CFP Board’s Initial and ongoing certification requirements.

Diversification does not guarantee a profit nor protect against loss. While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we are not qualified to render advice on tax or legal matters. You should discuss tax or legal matters with the appropriate professional.

The examples are case studies for illustrative purposes only. Individual cases will vary.