A few moments ago, health care reform passed the House of Representatives and is now on its way to the President's desk to be signed into law. The bill includes a provision that will affect a tiny percentage of you statistically (as you learned in an earlier article, Average Household Income in the United States, only a tiny fraction of Americans, perhaps 1/100th of households, would be hit by the this tax).
Starting in 2012, unearned income (such as rents on real estate, dividends on shares of stock, etc.) will be charged a new 3.8 percent tax for families making more than $250,000 per year or individuals making more than $200,000 per year.
In addition, your Medicare Part A (hospital insurance) will increase by 0.9 percent to 2.35% (currently, the Medicare payroll tax is 2.9% on all wages with the employee paying 1.45% and the business paying 1.45%). That means for someone who is self-employed and makes above the threshold, you are going to be paying an effective Medicare rate of 4.7% instead of the old 2.9% on your earned income.
The bottom line: If you are in the top 1/100th of household income in the United States, you will now be paying a 3.8% tax on your dividend and interest income and your Medicare tax rate will have increased from 2.9% to 4.7% if you are self-employed.
Social security taxes remain unchanged at 12.4% on the first $106,800 in earned income, of which half (6.2%) is paid by the employer and half (6.2%) by the employee.
One thing is certain ... this is going to fuel the dividend tax debate.
Nice point, Joshua…it’s amazing that nobody seems to realize that this is only affecting the top 1% of earners out there. The only thing we hear are the talking heads on the radio screaming “run for the hills!” I even heard one guy (Ray Lucia, I am looking at you…) say that $250,000 is not a lot of money. I would gladly change where I am today to make $250K+ a year and pay slightly higher taxes, but that’s just me.
Its’ me again…
In light of recent events, can you explain this dividend tax issue? Normally, dividends are taxed at 15%…but now there is this fear and worry that dividends are going to be taxed as ordinary income. That means in states that have a state income tax such as CA or NJ, once everyone gets their cut, dividends, interest, royalties, etc. may be taxed at more than 50%. How does this play out for us “beginning investors”? Anything we should do to prepare for this?
Thanks, as always…
Response from Joshua Kennon:
Michael,
Dividends will NOT be taxed at personal income tax rates. For those who have an individual income of $200,000 or more or a household income of $250,000 (think a married couple), they will have to pay a special 3.8% tax on their dividends, interest, and rental income. That will be on top of the regular dividend tax.
The health care bill alone should not influence state tax rates on dividends or anything else. Anyone who tells you otherwise is either lying, stupid, or misinformed. (There is no other polite way to say that and I want to be clear.)
That said, there is nothing stopping Congress from changing the way dividends of taxed, which has always been their right. It just has nothing to do with this bill.
States are free to tax dividends however they wish, which has always been the case. That is why a lot of people prefer to live in places like Texas or Florida because those states have NO income tax (meaning you only pay Federal taxes and, on the local level, property tax and sales tax).
Personally, this tax doesn’t bother me near as much as the 15.3% paid by small business owners who start a company and have to pay double what an employee does for Social Security and Medicare. When I started my first company, that was a much bigger hurdle to getting off the ground than the dividend tax will be. In fact, if Congress would pass a law that CUT the payroll tax by 50% so small business owners and workers ended up with more money in their paychecks but my dividend taxes went up 10%, I’d GLADLY support it. We have to make upward mobility our priority. That has been destroyed over the past 20 years. We need a strong middle class, which means continuing to lower the middle class tax burden. That means that I and people like me, who are a tiny fraction of households, will have to pay a bigger portion of the tab.
Is anyone aware of the taxes that will be added to all medical items such as cough medicine bandages tampons etc. If you think only the rich will pay you haven’t been paying attention. Everyone will pay.
Response from Joshua Kennon:
I mean this to be polite, but you’re mistaken. The “Q-Tip” tax was an idiotic proposal by one Democratic Chairwoman that was killed in committee and never made it into the final bill. That was way back in September of 2009 and anyone that is still talking about that is either purposely misleading you or is misinformed.
There is a special four-year medical device tax that will be applied on products with a value of more than $100, such as heart valves that will help pay for the legislation. That specific tax is estimated to raise $4 billion a year. Given that there are 308 million Americans, this works out to about 3.56 cents per day per American.
If you think that tiny, insignificant amount is comparable to me having to pay an extra 4% on dividends, interest, and rental income, you’re delusional. The top 1% is paying for almost all of this bill. That’s the economic reality of it.
There is a wide body of evidence that shows that 95 out of 100 households are paying the lowest tax rates they have under Obama as they have since Ronald Reagan slashed tax rates his second term. People like me are going to get slammed with the tax increases. We have a right to be upset. I don’t think the 95 other people do. They are going to benefit from this. Visit great resources such as the Tax Foundation. It will show you the actual bill you might have to pay based upon where you fall in the income spectrum.
Why am I okay with this? Take Johnson & Johnson, of which I am a proud stockholder. They just got another 30 million customers. That means that my dividend income should go up, even adjusted for the small tax, over the next ten years. If anything, it will be an economic wash. I’ll be paying higher tax with the left hand and getting higher dividend income from the pharmaceuticals on the right.
This bill isn’t nearly as catastrophic as people say it is. And, frankly, unless you are affected and fall into the same $21,000+ in monthly income category, I’m not certain you have a right to complain about it. After all, it’s our money. That’s like me (a protestant) complaining about the rules and beliefs of the Catholic church. They just don’t influence me or my family.
I would call this an Asset Tax rather than an “investment tax”. A fixed return like a dividend is more like a rent payment to the owner of property. The bill, for example, does not have a capital gains tax. So, it’s more taxing those who have cash hoarded and expect a guaranteed return rather than an “investor”who is seeking gains through growth and business opportunity.
As somebody who is not in the 1% .. I can say that it makes me disgusted that society is ok with robbing one group of people to pay for another. I have never heard on argument that makes any sense against a flat tax. Why should one person work 2.5 days a week to support the government when your neighbor only works 1 day a week or none. If everyone was taxed equally it would be harder to get these entitlements passed.
your blog is very interesting.
Cynthia
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