If October and Halloween have you seeing ghosts and goblins and hearing things that go bump in the night, here’s something else that could make you tremble.
Usually you know roughly how much you’ll owe in federal, state, and local taxes at the end of the year. But there are also several taxes, surtaxes, and surcharges you may know less about, or may never have heard of. While these assessments aren’t exactly hidden, they could give you a ghoulish surprise if you owe them.
Many of these charges may initially have been designed for higher earners, but may now affect people with more moderate income, as they are not adjusted for inflation. The net investment income tax (NIIT), for example, affects people with modified adjusted gross income between $200,000 and $250,000 depending on filing status. As such, they may require an extra dose of planning.
So if the thought of unexpectedly owing money makes your blood run cold, here’s how to help ward off 4 taxes that may be lurking in the shadows.
1. Alternative minimum tax, or AMT
As its name suggests, the AMT is an alternative tax primarily for higher earners that runs in tandem with the federal tax system. Under IRS rules, personal deductions and other tax benefits can significantly reduce a taxpayer's regular tax amount. For high earners, the alternative minimum tax (AMT) sets a limit on those benefits, helping to ensure that they pay at least a minimum amount of tax. The AMT has its own set of forms, rates, rules, and brackets, and requires taxpayers to calculate their federal income tax using this alternate system, which has a top tax rate of 28%.
A certain amount of income is generally exempt from the AMT. For 2023 that amount is $81,300 and phases out at $578,150 for single filers; the exemption for joint filers is $126,500 with a phase out at $1,156,300.
Things that can trigger the AMT are having a high household income along with numerous itemized deductions, a large amount of realized capital gains, and exercising incentive stock options, which are typically offered at a discounted price. While you may choose not to sell the shares once exercised, on paper there may be a profit on which you’ll have to pay federal, state, and local taxes.
Good to know: After the passage of the 2017 Tax Cuts and Jobs Act (TCJA), certain AMT brackets and thresholds were automatically indexed to inflation. These changes may phase out as the TCJA sunsets at the end of 2025.
Ways to address it
Consider either accelerating or delaying some transactions, such as selling an asset with a large gain, to plan for the AMT. For example, if you know you’ll be subject to the AMT next year, consider increasing your deductions this year when the deductions are still available to you. While capital gains generally qualify for the same lower rates under the AMT as under the regular tax rules, a capital gain may cause you to lose part or all your AMT exemption.
If you hold stock that you want to sell that is not publicly traded, you may be able to delay a sale into a future year when you know you will not be subject to the AMT, or use an installment sale to spread the gains and potential tax liability over a number of years.1
Also remember that should you have to pay the AMT, you can take a credit against what you’ve paid in subsequent years where the AMT isn’t owed.
2. Net investment income tax, or NIIT
The NIIT applies to people with modified adjusted gross income (MAGI) above $200,000 for single filers and $250,000 for couples filing jointly. The tax of 3.8% is on top of capital gains taxes. So for people paying long-term capital gain rates, they can be as high as 23.8%, not including state and local taxes, which can push your tax rate even higher.
The tax is levied on net capital gains, dividends, and interest income. In addition to sales of securities, it applies to interest on bank accounts and CDs, dividends, rental income, and house sales for those living in the house for at least 2 of the last 5 years, where the net gain exceeds the $250,000 exemption for single filers and $500,000 for couples filing jointly.
Social Security benefits, tax-exempt interest from municipal bonds, and retirement account withdrawals are exempt, but the income from all three can increase your modified adjusted gross income to a point where it enters the threshold and you may have to pay the NIIT.
Ways to address it
Contributions to qualified retirement accounts such as traditional IRAs, 401(k)s, and health savings accounts (HSAs) can all lower your gross income, so if you’re at the income threshold where sale of stock or interest income could push your MAGI to the NIIT threshold, consider maximizing your contributions to these accounts.
While required minimum distributions (RMDs) are not subject to the NIIT, they may push other investment income into the threshold where the NIIT may be owed. If you are taking withdrawals as opposed to saving, withdrawals from a Roth IRA don’t count toward your gross income for the NIIT. A Roth conversion, or series of them over time, could also reduce RMDs from traditional accounts when those begin at age 73.
Making use of tax-loss harvesting can also help. This tactic generally allows you to sell investments that are down, replace them with reasonably similar investments, and then use those losses to offset realized investment gains or up to $3,000 of regular income each year for single filers and married couples filing jointly. Losses that exceed $3,000 can be carried forward into subsequent years.
Finally, charitable donations for people who itemize can also reduce gross income. If you are of RMD age, but have no need of your RMD, you can consider making a qualified charitable distribution (QCD) from an IRA to a qualifying charity up to $100,000 per individual annually. A QCD won’t reduce gross income directly, but it can meet an RMD requirement and can help avoid withdrawals that would otherwise increase income. Important to know: Anyone age 70½ or older can make a QCD from an IRA, and that amount would not be subject to ordinary income tax.
3. The income-related monthly adjustment amount, or IRMAA
The income-related monthly adjustment amount, or IRMAA, is a Medicare-related premium surcharge on Medicare Parts B and D, the medical services and drug components of the federal health care plan. IRMAA is assessed on higher-earning retirees, based on modified adjusted gross income (MAGI) on IRS tax returns from the prior 2 years.
For those who retire and are not covered by a working spouse or domestic partner's employer health plan, Medicare coverage can become effective as early as the first day of the month of your 65th birthday (or the month before if you were born on the first). So the look-back period, to age 63, might reflect higher income from years when you were still working, assuming you enroll in Medicare as soon as you are eligible.2
Generally speaking, the IRMAA is added to your monthly base premium if your modified adjusted gross income is above $97,000 for single filers and $194,000 for married couples filing jointly, as of the 2021 tax year. (It’s added incrementally as income thresholds increase.) In 2024, the thresholds are $103,000 for single filers and $206,000 for married couples filing jointly, based on 2022 income.
Additionally, IRMAA is a “tax cliff,” meaning you could owe it even if you earn just one extra dollar that bounces you into a higher marginal income bracket. Here’s something else to keep in mind: Premiums for Medicare Part B, including any applicable IRMAA, would also be deducted automatically from your monthly benefit. (Read more about provisional income below.)
Good to know: If you have a Medicare Part D plan, you would pay the IRMAA directly to the plan. However, you can also choose to pay Part D premiums and any applicable IRMAA from your Social Security.
Ways to address it
If you can, try to avoid large, income-generating financial transactions as you approach Medicare eligibility. Such transactions include real estate sales, distributions from retirement accounts, transactions with large capital gains, such as stock or mutual fund sales, and Roth IRA conversions. Interest from federally tax-exempt municipal bonds, while not considered for taxable income purposes, contributes to your overall income when determining IRMAA.
How and when you choose to withdraw from various accounts in retirement also can have an impact on your income and the taxes you pay in different ways. A traditional approach is to withdraw money first from taxable accounts, then tax-deferred accounts such as traditional IRAs and 401(k)s, and then tax-free accounts such as a Roth. You can also consider taking proportional withdrawals from your taxable and non-taxable accounts, based on that account’s percentage of total savings, which could result in a more stable or lower tax bill over time.
You can find out more about tax-savvy withdrawals in Viewpoints.
As with the NIIT, a QCD from a qualified retirement account to make a charitable donation does not count as income when it comes to IRMAA. (See above.)
Finally, you can ask to reduce or eliminate the IRMAA if you’ve had a life-changing event that may have reduced your household income such as marriage, divorce, the death of a spouse, loss of work, or an employer settlement payment. For example, if an individual or couple is now retired, and their IRMAA is based on income from when they were still working, they can opt to utilize a more recent tax year's MAGI that reflects the change in their income brought about by a life-changing event.
Read more about the IRMAA in Viewpoints: Will your retirement income impact Medicare surcharges?
4. Social Security tax torpedo
Social Security benefits are taxed according to your provisional income, which is essentially your modified adjusted gross income, plus nontaxable interest income, and half of your Social Security benefits for the year.
Provisional income in excess of $34,000 for a single filer and $44,000 for married couple filing jointly can result in up to 85% of your Social Security benefit being taxed. (Below these thresholds, a smaller percentage of your benefit is taxed.) The phenomenon called the “tax torpedo” occurs when your provisional income bumps you into a higher Social Security tax bracket.
This means that every additional dollar of income can have a double impact—taxation of the additional dollar and taxation of another portion of your Social Security benefit. However, once you surpass the threshold, this double impact stops.
Find out more about taxes on Social Security in Viewpoints.
Ways to address it
Delay taking Social Security until age 70, if you can, and begin drawing down from retirement accounts, which can reduce your adjusted gross income and your tax burden later. As with the IRMAA above, when and how you choose to withdraw from various accounts in retirement also can have an impact on your income (and taxes), and it can help you manage your income below higher Social Security provisional income thresholds that might result in paying more taxes.
Waiting to claim your Social Security benefit will result in a higher monthly benefit. For every year you delay past your full retirement age (FRA), you get an 8% increase in your monthly benefit. That could be up to a 24% higher monthly benefit if you delay claiming until the maximum age, which is 70.
If you’re retiring prior to receiving maximum benefits at age of 70, you can also consider a Roth conversion strategy that would reduce the amount of your future required minimum distributions. Assets in Roth accounts can then grow tax-free, and withdrawals from them are not counted toward your provisional income. Also, Roth accounts have no RMD requirements, assuming the 5-year aging rule has been met.
Remember, everyone’s financial situation is different, so consider speaking with a financial consultant and consult your tax advisor to get a complete understanding of your circumstances. And while Halloween is a time to revel in everything that’s scary, don’t add ghost taxes to the list of things that can give you a fright.