Having a high income may mean you owe two extra taxes: the 3.8% net investment income tax (NIIT) and a 0.9% additional Medicare tax on wage and self-employment income. Let’s take a look at these additional taxes and what they could mean for you.

1. The NIIT

In addition to income tax, this tax applies on your net investment income. The NIIT only affects taxpayers with adjusted gross incomes (AGIs) exceeding $250,000 for joint filers, $200,000 for single taxpayers and heads of household, and $125,000 for married individuals filing separately.

If your AGI is above the threshold that applies ($250,000, $200,000, or $125,000), the NIIT applies to the lesser of 1) your net investment income for the tax year or 2) the excess of your AGI for the tax year over your threshold amount.

The “net investment income” that’s subject to the NIIT consists of interest, dividends, annuities, royalties, rents, and net gains from property sales. Wage income and income from an active trade or business aren’t included. However, passive business income is subject to the NIIT.

Income that’s exempt from income tax, such as tax-exempt bond interest, is likewise exempt from the NIIT. Thus, switching some taxable investments to tax-exempt bonds can reduce your exposure. Of course, this should be done after taking your income needs and investment considerations into account.

Does the NIIT apply to home sales? Yes, if the gain is high enough. Here’s how the rules work: If you sell your principal residence, you may be able to exclude up to $250,000 of gain ($500,000 for joint filers) when figuring your income tax. This excluded gain isn’t subject to the NIIT.

However, gain that exceeds the exclusion limit is subject to the tax. Gain from the sale of a vacation home or other second residence, which doesn’t qualify for the exclusion, is also subject to the NIIT.

Distributions from qualified retirement plans, such as pension plans and IRAs, aren’t subject to the NIIT. However, those distributions may push your AGI over the threshold, which would cause other types of income to be subject to the tax.

2. The additional Medicare tax

In addition to the 1.45% Medicare tax that all wage earners pay, some high-wage earners pay an extra 0.9% Medicare tax on part of their wage income. The 0.9% tax applies to wages in excess of $250,000 for joint filers, $125,000 for married individuals filing separately, and $200,000 for all others. It applies only to employees, not to employers.

Once an employee’s wages reach $200,000 for the year, the employer must begin withholding the additional 0.9% tax. However, this withholding may prove insufficient if the employee has additional wage income from another job or if the employee’s spouse also has wage income. To avoid that result, an employee may request extra income tax withholding by filing a new Form W-4 with the employer.

An extra 0.9% Medicare tax also applies to self-employment income for the tax year in excess of the same amounts for high-wage earners. This is in addition to the regular 2.9% Medicare tax on all self-employment income. The $250,000, $125,000, and $200,000 thresholds are reduced by the taxpayer’s wage income.

Mitigate the effect

As you can see, these two additional taxes may have a substantial effect on your tax bill. Contact us to discuss how the impact could be reduced.

Federal estimated tax payments are designed to ensure that certain individuals pay their fair share of taxes throughout the year. If you don’t have enough federal tax withheld from your paychecks and other payments, you may have to make estimated tax payments. This is the case if you receive interest, dividends, self-employment income, capital gains, a pension, or other income that’s not covered by withholding.

Individuals must pay 25% of a “required annual payment” by April 15, June 15, September 15, and January 15 of the following year, to avoid an underpayment penalty. If one of those dates falls on a weekend or holiday, the payment is due on the next business day.

So the third installment for 2024 is due on Monday, September 16 because the 15th falls on a Sunday. Payments are made using Form 1040-ES.

The amount due

The required annual payment for most individuals is the lower of 90% of the tax shown on the current year’s return or 100% of the tax shown on the return for the previous year. However, if the adjusted gross income on your previous year’s return was more than $150,000 ($75,000 if you’re married filing separately), you must pay the lower of 90% of the tax shown on the current year’s return or 110% of the tax shown on the return for the previous year.

Most people who receive the bulk of their income in the form of wages satisfy these payment requirements through the tax withheld by their employers from their paychecks. Those who make estimated tax payments generally do so in four installments. After determining the required annual payment, divide that number by four and make four equal payments by the due dates.

However, you may be able to use the annualized income method to make smaller payments. This method is useful to people whose income flow isn’t uniform over the year, perhaps because of a seasonal business. For example, if your income comes exclusively from a business operated in a resort area during June, July, and August, no estimated payment is required before September 15.

The underpayment penalty

If you don’t make the required payments, you may be subject to an underpayment penalty. The penalty equals the product of the interest rate charged by the IRS on deficiencies, times the amount of the underpayment for the period of the underpayment.

However, the underpayment penalty doesn’t apply to you if:

• The total tax shown on your return is less than $1,000 after subtracting withholding tax paid;
• You had no tax liability for the preceding year, you were a U.S. citizen or resident for that entire year, and that year was 12 months;
• For the fourth (January 15) installment, you file your return by that January 31 and pay your tax in full; or
• You’re a farmer or fisherman and pay your entire estimated tax by January 15, or pay your entire estimated tax and file your tax return by March 1.

In addition, the IRS may waive the penalty if the failure was due to casualty, disaster or other unusual circumstances and it would be inequitable to impose the penalty.

The penalty can also be waived for reasonable cause during the first two years after you retire (and reach age 62) or become disabled.

We can help

Contact us if you need help figuring out your federal estimated tax payments or you have other questions about how the rules apply to you.

The current estate tax exemption amount ($13.61 million in 2024) has led many people to feel they no longer need to be concerned about federal estate tax. Before 2011, a much smaller exemption resulted in many people with more modest estates attempting to avoid it. But since many estates won’t currently be subject to estate tax, it’s a good time to devote more planning to income tax saving for your heirs.

Important: Keep in mind that the federal estate tax exclusion amount is scheduled to sunset at the end of 2025. Beginning on January 1, 2026, the amount is due to be reduced to $5 million, adjusted for inflation. Of course, Congress could act to extend the higher amount or institute a new amount.

Here are some strategies to consider in light of the current large exemption amount.

Using the annual exclusion

One of the benefits of using the gift tax annual exclusion to make transfers during your lifetime is to save estate tax. This is because both the transferred assets and any post-transfer appreciation generated by those assets are removed from your (the donor’s) estate.

As mentioned, estate tax savings may not be an issue because of the large exemption amount. Further, making an annual exclusion transfer of appreciated property carries a potential income tax cost because the recipient receives your basis upon transfer. Thus, the recipient could face income tax, in the form of capital gains tax, on the sale of the gifted property in the future. If there’s no concern that an estate will be subject to estate tax, even if the gifted property grows in value, then you might want to base the decision to make a gift on other factors.

For example, gifts may be made to help a relative buy a home or start a business. But a donor shouldn’t gift appreciated property because of the capital gains that could be realized on a future sale by the recipient. If the appreciated property is held until the donor’s death, under current law, the heir will get a step-up in basis that will wipe out the capital gains tax on any pre-death appreciation in the property’s value.

Spouses now have more flexibility

Years ago, spouses often undertook complicated strategies to equalize their estates so that each could take advantage of the estate tax exemption amount. In many cases, a two-trust plan was established to minimize estate tax. “Portability,” or the ability to apply the decedent’s unused exclusion amount to the surviving spouse’s transfers during life and at death, became effective for estates of decedents dying after 2010. As long as the election is made, portability allows the surviving spouse to apply the unused portion of a decedent’s applicable exclusion amount (the deceased spousal unused exclusion amount) as calculated in the year of the decedent’s death. The portability election gives married couples more flexibility in deciding how to use their exclusion amounts.

Valuation discounts

Be aware that it may no longer be worth pursuing some estate exclusion or valuation discount strategies to avoid inclusion of property in an estate. It may be better to have the property included in the estate or not qualify for valuation discounts so that the property receives a step-up in basis. For example, the special use valuation — the valuation of qualified real property used for farming or in a business, based on the property’s actual use rather than on its highest and best use — may not save enough, or any, estate tax to justify giving up the step-up in basis that would otherwise occur for the property.

If you want to discuss estate planning or income tax saving strategies, contact us.

Buckle up, America: Major tax changes are on the horizon. The reason has to do with tax law and the upcoming elections.

Our current situation

The Tax Cuts and Jobs Act (TCJA), which generally took effect in 2018, made sweeping changes. Many of its provisions are set to expire on December 31, 2025.

With this date getting closer each day, you may wonder how your federal tax bill will be affected in 2026. The answer isn’t clear because the outcome of this November’s presidential and congressional elections is expected to affect the fate of many expiring provisions. A new political landscape in Washington could also mean other tax law changes.

Corporate vs. individual taxes

The TCJA cut the maximum corporate tax rate from 35% to 21%. It also lowered rates for individual taxpayers, with the highest tax rate reduced from 39.6% to 37%. But while the individual rate cuts expire in 2025, the law made the corporate tax cut “permanent.” (In other words, there’s no scheduled expiration date. Tax legislation could still change the corporate tax rate.)

In addition to lowering rates, the TCJA revised tax law in many other ways. On the individual side, standard deductions were increased, significantly reducing the number of taxpayers who benefit from itemizing deductions for certain expenses, such as charitable donations and medical costs. (You benefit from itemizing on your federal income tax return only if your total allowable itemized write-offs for the year exceed your standard deduction.)

In addition, through 2025, certain itemized deductions are eliminated. Others are more limited, including those for home mortgage interest and state and local tax (SALT).

For small business owners, one of the most significant changes is the potential expiration of the Section 199A qualified business income (QBI) deduction. This is the write-off for up to 20% of QBI from noncorporate pass-through entities, including S corporations and partnerships, as well as from sole proprietorships.

The expiring provisions will affect many taxpayers’ tax bills in 2026, unless legislation extending them is signed into law.

Possible scenarios

The outcome of the presidential election in less than five months, as well as the balance of power in Congress, will determine the TCJA’s future. Here are four possible scenarios:

1. All of the TCJA provisions scheduled to expire will actually expire at the end of 2025.
2. All of the TCJA provisions scheduled to expire will be extended past 2025 (or made permanent).
3. Some TCJA provisions will be allowed to expire, while others will be extended (or made permanent).
4. Some or all of the temporary TCJA provisions will expire — and new laws will be enacted that provide different tax breaks and/or different tax rates.

How your tax bill will be affected in 2026 will partially depend on which one of these scenarios becomes reality and whether your tax bill went down or up when the TCJA became effective back in 2018. That was based on a number of factors including your income, your filing status, where you live (the SALT limitation negatively affects more taxpayers in certain states), and whether you have children or other dependents.

Your tax situation will also be affected by who wins the presidential election and who controls Congress. Democrats and Republicans have competing visions about how to proceed when it comes to taxes. Proposals can become law only if tax legislation passes both houses of Congress and is signed by the President (or there are enough votes in Congress to override a presidential veto).

The tax horizon

As the TCJA provisions get closer to expiring, it’s important to know what might change and what tax-wise moves you can make if the law does change. We’ll keep you informed about what’s ahead. We’re here to answer any questions you may have.

Employees, self-employed individuals and employers all pay Social Security tax, and the amounts can get bigger every year. And yet, many people don’t fully understand the Social Security tax they pay.

If you’re an employee

If you’re an employee, your wages are hit with the 12.4% Social Security tax up to the annual wage ceiling. Half of the Social Security tax bill (6.2%) is withheld from your paychecks. The other half (also 6.2%) is paid by your employer, so you never actually see it. Unless you understand how the Social Security tax works and closely examine your pay statements, you may be blissfully unaware of the size of the tax. It’s potentially a lot!

The Social Security tax wage ceiling for 2024 is $168,600 (up from $160,200 for 2023). If your wages meet or exceed that ceiling, the Social Security tax for 2024 will be $20,906 (12.4% x $168,600). Half of that comes out of your paychecks, and your employer pays the other half.

If you’re self-employed

Self-employed individuals (sole proprietors, partners, and LLC members) know all too well how hard the Social Security tax can hit. That’s because they must pay the entire Social Security tax bill out of their own pockets, based on their net self-employment income. For 2024, the Social Security tax ceiling for net self-employment income is $168,600 (same as the wage ceiling for employees). So, if your net self-employment income for 2024 is $168,600 or more, you’ll pay the maximum $20,906 Social Security tax.

Projected future ceilings

The Social Security tax on your 2024 income is expensive enough, but it could get worse in future years — much worse, according to Social Security Administration (SSA) projections. That’s because the Social Security tax ceiling will continue to go up based on the inflation factor that’s used to determine the increases. In turn, maximum Social Security tax bills for higher earners will go up. The latest SSA projections for Social Security tax ceilings for the next nine years are:

• $174,900 for 2025,
• $181,800 for 2026,
• $188,100 for 2027,
• $195,900 for 2028,
• $204,000 for 2029,
• $213,600 for 2030,
• $222,900 for 2031,
• $232,500 for 2032 and
• $242,700 for 2033.

These projected ceilings are not always accurate (they could be higher or lower). If the projected numbers pan out, the maximum Social Security tax on wages and net self-employment income in 2033 will be $30,095 (12.4% x $242,700).

Your future benefits

Despite what you pay in, you might receive more in Social Security benefits than you pay into the system. An Urban Institute report looked at some average situations. For example, a single man who earned average wages every year of his adult life and retired at age 65 in 2020 would have paid about $466,000 in Social Security and Medicare taxes. But he can expect to receive about $640,000 in benefits during retirement. Of course, there are many factors involved, and each situation is unique. Plus, these calculations don’t account for the interest the Social Security tax dollars would have earned over the years.

Some people think the government has set up an account with their name on it to hold money to pay their future Social Security benefits. After all, that must be where those Social Security taxes on wages and self-employment income go. Sorry, but this is incorrect. There are no individual accounts — just a promise from the government.

Is the Social Security system financially solid? It’s on shaky ground. Congress has known that for years and has done nothing about it (although there have been many proposals on how to fix things). A Social Security Administration report states that “benefits are now expected to be payable in full on a timely basis until 2037, when the trust fund reserves are projected to become exhausted. At the point where the reserves are used up, continuing taxes are expected to be enough to pay 76% of scheduled benefits.”

The agency adds that “Congress will need to make changes to the scheduled benefits and revenue sources for the program in the future.” These changes could include a higher age to receive full benefits, additional Social Security tax hikes in the form of higher rates, some tax-law revision that effectively implements higher ceilings, or a combination of these.

Stay tuned

The Social Security tax paid by many individuals will continue to go up. If you operate a small business, there may be some strategies than can potentially cut your Social Security tax bill. If you’re an employee, you need to take Social Security into account in your financial planning. Contact us for details.