Even those who closely followed the numbing, eye-glazing and, at times, frustrating so-called fiscal cliff drama of late December — and people could be forgiven for tuning it out because it coincided with New Year's Eve — find themselves trying to figure out the best angles through the tax increases wrought by the deal. And if they are not scratching their heads now, wait until April 2014, when they could see a drastic increase in their tax bill.
Consider these two situations.
First, a person has income of $350,000, which is under the $400,000 threshold that sets off the highest marginal income tax rate and an increase in the capital gains tax to 20 percent, from 15 percent. That income is, however, sufficiently high that the Medicare surcharge of 0.9 percent on wage income and 3.8 percent on investment income has been applied. If that person sold a large amount of Apple stock, with over $1 million in capital gains, would those gains be taxed at the lower or higher capital gains rate?
In the second case, a person has an annual salary of $100,000 and sells a home that she has rented out for years. Having owned it for several decades, she has capital gains of $400,000. Would the person pay 15 percent because her wage income is under $200,000? Or would she pay various and higher rates because her total income would be $500,000, pushing it through the thresholds for the Medicare surcharge and higher capital gains rate?
Both situations came from a real estate developer in Baltimore, who asked not to be named because he "did not want to come across as gaming the U.S. Treasury." Far from gaming the system, he was asking questions many Americans should be asking now to prevent a surprise come 2014.
In the first situation, the person would qualify as rich under the new tax structure and end up paying more, as President Obama intended. But the less-well-off person in the second situation is the one who really loses, because her tax bill would have been much lower had she sold the rental property last year.
To an accountant, the questions about tax liability are straightforward, but the answers may surprise people not used to such calculations. Both cases deal with how taxes are stacked on top of one another. That hasn't changed: taxes on wage, or ordinary, income come first, with capital gains taxed on top of that. Then come the details of the new rates and the variables of individual cases.
Robert Keebler, a certified public accountant with his own firm in Green Bay, Wis., said that in the first example, the large capital gain in a stock sets off the higher tax rates. The first $50,000 in capital gains would be taxed at 18.8 percent, while all the capital gains above the $400,000 threshold for the highest capital gains rate would be taxed at 23.8 percent (both rates include the Medicare surcharge).
The second example is more complicated, he said, because the owner of the rental house would have been able to deduct improvements made to the house over the years, although the same stacking of taxes would apply. But even this hypothetical $100,000 wage earner would have to pay the Medicare surcharge over $200,000 in income — even though it was both earned income and capital gains. And everything over $400,000 is subject to the higher capital gains tax as well. She would also lose some percentage of her deductions.
Mr. Keebler cautioned people against rash reactions to such new tax realities. "You have to let common sense prevail," he said. Even with capital gains taxed at 20 percent, he said, "you still get to keep 80 percent of the value. You may want to hedge things, but you don't want to put off selling things because of taxes."
But answers like this, while logical to an accountant, might not dissuade worried investors from choices that could sidetrack their long-term investment goals. Some investments driven by tax avoidance that have drawn attention since the year-end fiscal deal could cost people taxes in other ways, while some work for people at certain ages but not at others. Some that promise tax savings could deliver them at the cost of a total loss of that investment.