Question

In 2016 Mary earned $400,000 as a VP of Tax at ABC corp. She also sold 10,000 of her stock options at a gain of $250,000. Please discuss Mary's tax ramifications under special rules for high-income taxpayers

Answer 1

Last year, with the passage of Taxpayer Relief Act of 2012, anumber of tax changes were enacted. In addition, a few Obamacaretaxes went into force. Although most taxpayers and Americans willbe affected by these changes over time, most of the tax changes forthis filing season target the highest income earners.

The most notable changes for taxpayers this filing season:

• A new 39.6 percent income tax bracket for those making over$400,000
• Phase-out of the personal exemption and itemized deductions forthose making more than $250,000
• A new 0.9 percent tax on Medicare wages for those making morethan $200,000

Taxpayers who have income outside of wages and salary– ScheduleC self-employment income, capital gains, interest anddividends–need to pay estimated taxes in quarterly installments.(You don’t have to make estimated payments if your tax due—aftersubtracting withholding and credits–is less than $1,000). Typicallytaxpayers who pay estimates use what’s known as the “prior yearsafe harbor.” That means they pay in 100% of the prior year’s taxas estimates (or 110% if their adjusted gross income was above$150,000).

There’s the new top income tax rate of 39.6% rate, up from 35%;there’s the new top rate on capital gains and dividends of 20%, upfrom 15%; there’s an additional 3.8% Obamacare tax on netinvestment income; there’s a 0.9% Medicare tax; and there’s thereturn of phase-outs of itemized deductions and personalexemptions.Use the “prior year safe harbor” rule that lets youpay in 110% of the prior year’s tax in estimated taxes. (If youradjusted gross income is $150,000 or less, the safe harbor is 100%of the prior year’s tax.) Keep in mind if you use the prior yearsafe harbor because you expect your 2013 tax bill will be muchhigher, you’ll need to be prepared to pay big bill next April.

.Using the 100%/110% prior year safe harbor is easy but in somecase it means you’re overpaying. The alternative rule–to avoidpenalties for underpaying estimated tax payments—is to pay in 90%of your current year estimated tax. Last year, many taxpayersaccelerated income and sold stock realizing capital gains to lockin lower tax rates in anticipation of all the tax hikes that hit inJanuary. For some of them, paying 90% of 2013 estimated taxes willbe less than 110% of 2012 taxes.

“You really have to do the calculation,” says Tom Butler, a CPAwith Berdon LLP in New York. “High income and high net worthindividuals really don’t want to give the government an interestfree loan. They take their estimated tax payments seriously.” Ifyou go the 90% of current year route, you’ll need to monitor yourincome throughout the year and alert your tax advisor if there’s asignificant change in what you’re forecasting for income for theyear.