How the New 3.8% Tax Works

The 3.8% tax on net investment income beginning Jan. 1 applies to dividends, interest (except from municipal bonds), net capital gains, rents, royalties and investment annuities for most joint filers with adjusted gross income of $250,000 or more ($200,000 for singles).

Example: A couple has adjusted gross income of $240,000, not counting their investment income. If they have $2,000 of interest, $4,000 of dividends and $1,000 of net capital gains, the 3.8% tax won’t apply. But if they have the same interest and dividends plus a $10,000 net capital gain, then they’ll owe a new tax of $228 on $6,000, the amount of their investment income above $250,000.

Things get more complex for retirees. Defined-benefit pension payments and individual retirement account payouts aren’t themselves subject to the 3.8% tax, but they can raise adjusted gross income.

Example: A widow has $210,000 of adjusted gross income from pensions and IRA withdrawals, so she doesn’t owe the new tax even though that income is above $200,000.

But if instead she has $120,000 from pensions and IRA payouts, plus a $100,000 net taxable gain from the sale of her home—after subtracting her cost basis and the $250,000 exclusion—then she will owe $760 of new tax on $20,000.

“For people under the thresholds, the timing of investment income will become very important,” notes Sharon Kreider, a CPA in Sunnyvale, Calif., who has studied the new levy.

By: Laura Saunders, Wall Street Journal