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Dividend and Long-Term Capital Gain Tax Rates

As a result of the Affordable Care Act of 2010 and the American Taxpayer Relief Act of 2012, the tax treatment for qualified dividends and long-term capital gains will be somewhat different for 2013 (and future years) than it was for 2012.

0%, 15%, and 20% Tax Rates

Just like before, any qualified dividends and long-term capital gains that fall in the 15% tax bracket or below will not be taxed.

And, just like before, any qualified dividends and long-term capital gains that fall in the 25%-35% tax brackets will be taxed at a 15% rate.

What’s new is that any qualified dividends and long-term capital gains that fall in the new 39.6% tax bracket (which kicks in when your taxable income is above $400,000 if single and $450,000 if married filing jointly) will be taxed at a 20% rate.

New 3.8% Medicare Surtax

The other big change is that the 3.8% Medicare surtax created by the Affordable Care Act goes into effect this year. This 3.8% tax applies to the lesser of:

  • Your “net investment income,” or
  • The amount by which your modified adjusted gross income exceeds $200,000 ($250,000 if married filing jointly).

For these purposes, net investment income includes both qualified dividends and capital gains, as well as other types of income such as interest, royalties, and rents.

An important distinction to make is that the calculation of this 3.8% tax depends on your modified adjusted gross income rather than your taxable income. (In contrast, where you fall in terms of having a 0%, 15%, or 20% income tax rate for qualified dividends and long-term capital gains depends on your taxable income.) For these purposes “modified adjusted gross income” means your adjusted gross income (i.e., the bottom line of the first page of your Form 1040) increased by any foreign earned income that was excluded from your gross income.

Total Tax Rates

The long and short of all of the above is that:

  • If your modified adjusted gross income is below $200,000 ($250,000 if married filing jointly), there’s probably no change in the rate at which your qualified dividends and long-term capital gains will be taxed, and
  • If your modified adjusted gross income is above $200,000 ($250,000 if married filing jointly), your total marginal tax rate for qualified dividends and long-term capital gains is probably 18.8%, or 23.8% rather than just 15%, as it has been for the last several years.

The reason that I say “probably” in each of the above statements is that, as always, different parts of the tax code interact with each other. So it’s possible that your actual tax rate on dividends and capital gains would be greater than what’s indicated above if your dividend and capital gain income is pushing you out of the range in which you would be eligible for some other tax break.

Impact on Asset Location Strategies

For the last several years, conventional wisdom has been that, if you have to hold something in a taxable account (as opposed to in tax-sheltered retirement accounts), it’s best to keep stocks in the taxable account given that dividends and long-term capital gains are taxed at lower rates than interest income from taxable bonds. The tax changes from 2012 to 2013 don’t have much impact in that regard given that:

  • Most taxpayers will not be experiencing a change in their tax rate for dividends and long-term capital gains, and
  • Taxpayers who will be experiencing an increase in dividend and LTCG tax rates will be experiencing an increase in tax rates on interest income as well.

That said, as fellow blogger The Finance Buff has noted, the currently-low yields on bonds (and the resultant fact that they put out a relatively low amount of taxable income) could by itself be enough to turn the conventional wisdom on its head.

Tax-Gain Harvesting: Still Makes Sense

For investors in the 15% tax bracket or below (for whom long-term capital gains will continue to be taxed at a 0% rate), tax-gain harvesting continues to be a worthwhile endeavor. It still provides a way to bump up your cost basis (and thereby reduce the gain upon which you might have to pay taxes later) without having to pay any additional tax costs now.

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  1. John Caldeira says:

    It’s unclear to me from reading today’s article whether the New 3.8% Medicare Surtax applies to everyone’s “net investment income,” or whether there is a threshold.


  2. John,

    It applies to everyone. But the amount of the tax is calculated based on the lesser of:
    1) Your net investment income, or
    2) The amount by which your MAGI exceeds the threshold mentioned above ($200,000 if single, $250,000 if married filing jointly).

    So, for most people, it will be calculated based on #2 in that list (which will work out to zero, because most taxpayers’ MAGI doesn’t exceed those threshold amounts).

  3. Hi Mike,

    I’m still a little puzzled: if the amount of tax is calculated on the “lesser” of net investment income or the MAGI threshold, then almost everyone would pay this new Medicare surtax if they have dividends from mutual funds in a taxable account.

    For example:
    If a couple, filing Jointly, has a MAGI of $150,000 and have dividend income of $10,000 during 2013 in a taxable account. Then, wouldn’t this couple have to pay the new 3.8% Medicare Surtax tax on the “lesser,” which is $10,000. Which would be $380. Right?

    Sorry Mike, but I guess I am seeing this the same way as John did. Maybe you can clarify it be using my example:

    Can you explain?

  4. Forrest,

    The tax is not on the lesser of net investment income or the MAGI threshold. It is on the lesser of net investment income or the amount by which MAGI exceeds the threshold.

    In other words, in your example, if a couple has MAGI of $150,000, the excess of their MAGI over $250,000 would be zero. So there would be no 3.8% Medicare surtax.

    Please let me know if that makes sense.

  5. thanks Mike, I was thinking along the same lines as John and Forrest. your last comment and example cleared it up.

  6. Never mind Mike, I dont think I read your #2 point in the comment on January 7, 2013 at 12:34 pm, closely enough. Now it makes sense. thanks

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