The recently enacted health reform legislation creates a new 3.8% tax on unearned income of individuals who exceed certain high income thresholds.  For a married couple, the gross income threshold is $250,000 ($200,000 for a single individual).

 

In a nutshell the 3.8% tax will be assessed on the lesser of net investment income or the excess of gross income over the threshold mentioned above.

 

Net investment income will include interest, dividends, annuities, rent & royalties and net capital gains.  This income will be reduced by deductions that are directly related to producing the income, such as depreciation and operating expenses.

 

With that as a background, strategies to minimize the tax might include:

 

Capital Gains - sales of highly appreciated assets like a business, vacation home or art should be timed in such a way as to occur in a low-income year, or before 2013, if prudent to do so.

 

Tax-Exempt Income - investment income for purposes of the new tax will not include interest from tax-exempt obligations.  As a result, the yield on these types of investments may become more attractive.  Tax-exempt income will also help keep your gross income at or below the gross income threshold. 

 

Retirement Savings - adding to a 401(k) or IRA may make much more sense.  Not only does the income earned inside the account escape the new tax, but future withdrawals will not be treated as investment income.  Of course, withdrawals will increase your gross income for the threshold, so the timing and amount of withdrawals will be important.  More than ever, a Roth IRA may be the best overall vehicle.  Income earned in the Roth account avoids the new tax when it is both earned and withdrawn.