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Reader Question: How Does the 3.8% Medicare Tax on Home Sales Work?

By JLP | September 17, 2010

I received the following email this morning:

Hi JLP,

I am a long time reader of your blog and enjoy it very much. Thanks for all the hard work you put into it.

I have a question that I can’t seem to find a straight answer to, and am wondering if you may consider a future post on this subject.

My question is regarding the Obamacare tax that is to be imposed on 1/1/2013 and involves the 3.8% tax on all home sales. I’m trying to determine if that is a tax on the entire sale price of the home or a tax on the capital gains above the $250,000 threshold for individuals/$500,000 threshold for couples.

Thanks and have a great weekend.

S.

From what I found by doing a Google search, is that this new tax will affect couples who make $250,000 or more (or $125,000 for singles) and is based on the gain minus the capital gains threshold. Snopes looked into the matter and offered up this example:

As a simple example, if a couple with a combined income of over $250,000 per year decided to scale back by selling their large $2 million residence in favor of a smaller home, and they made a $750,000 profit on the sale, they would have to pay an additional 3.8% tax on $250,000 (i.e., the $750,000 profit minus the $500,000 capital gains threshold), for a total of $9,500.

Personally, I hate this idea. I mean, those who make more than $250,000 per year are already paying medicare tax on all their income as there is no cap like there is on the social security tax. I also do not like the fact that the tax system is becoming more and more complicated. With all the different taxes on all the different items, it’s very difficult to make informed decisions with regard to taxes.

I would rather the government create a tax code that says, “You make this much, this is how much you pay.”

Topics: Taxes | 24 Comments »


24 Responses to “Reader Question: How Does the 3.8% Medicare Tax on Home Sales Work?”

  1. The Biz of Life Says:
    September 17th, 2010 at 11:12 am

    I’d rather the government get out of this class warfare mentality, and do away with any income tax whatsoever (but there must be a constitutional amendment to codify it into law) and move to a consumption based tax. There is so much corruption and special interest favors in the current laws that could be eliminated by this type of tax simplification.

  2. Mark Says:
    September 17th, 2010 at 12:44 pm

    I have to agree that these linkages are ridiculous. Healthcare and a tax on house price increases (which are mostly governed by inflation anyway).

    But it is good to know that we seem to have settled on $250K per year as “rich” (not good that they did it, just good to know the thresholds to avoid.)

    I hope that number is indexed for inflation, otherwise it will be like the AMT, and by 2030 or so we will all be rich.

  3. Stacey Says:
    September 17th, 2010 at 1:13 pm

    This is from a CPE class I took:

    New IRC §1411 imposes 3.8-percent
    tax on lesser of individual’s:
    – Net investment income for year, or
    – Amount by which modified AGI
    exceeds—
    • $250,000 (MFJ)
    • $125,000 (MFS)
    • $200,000 (all other)

    I’m unsure that Snopes got it right (I’m not sure that I’m right, either!) Given the example of the $250K home gain, one would presumably subtract the $250K threshold from the above and have zero taxable gain.

    • Net investment income includes:
    – Interest, dividends, annuities,
    royalties, rents, and net gain from
    sale of nonbusiness property, AND
    – Passive income and income from
    trading financial instruments and
    commodities

  4. Nazim Says:
    September 17th, 2010 at 1:18 pm

    JLP said: “I would rather the government create a tax code that says, “You make this much, this is how much you pay.””

    This. This is the real issue. More than than any other detail. The tax code is beyond ridiculous. Not only is there no need for it to be so complicated, it’s also unfair.

  5. J Says:
    September 17th, 2010 at 1:38 pm

    Long time reader, first time commenter :)

    I, too, am for a much simpler tax code. I also know that because the federal income tax takes such a huge chunk out of our pocketbooks, it’s the one people most focus on.

    However, I worry that if we replace our convoluted tax code with a simple progressive income tax as you mentioned, we may end up paying more out of pocket. I’m talking about things like exemptions and deductions that cause most of us to have an AGI that is lower than our actual salaries. If we get rid of capital gains taxes, the gov’t will have to make up for that from somewhere else. Even little things like the taxes we pay on our cell phone bills add up. Even if we (pure fantasy here, now) dramatically downsize the government, there will be a few things we will never be able to get rid of, things like defense, infrastructure, SS, judicial salaries, etc.

    Any readers’ thoughts on this?

    Also, I think consumption tax is great. I live in a jurisdiction that imposes vehicle property tax. I’m considering getting a new, relatively expensive car (~$40,000), but the thought of having to pay an extra ~$1,500 a year (!!!) on my car for taxes is seriously making me reconsider. I think it can work to force people to save, i.e., actually be fiscally responsible.

  6. BG Says:
    September 17th, 2010 at 2:39 pm

    Obviously there are people here who think they should be able to earn $500,000 (in profit!) on the sale of their house and not pay a single penny in taxes on it: this is the tax code we have today.

    I’m all for Obama/Congress/whomever is behind partially closing this tax loophole enjoyed by uber-richies. I don’t think they are going far enough.

    I kinda agree that the tax-code should be simpler: all capital gains should be taxed at income tax rates, and also subject to medicare and social security taxation.

    Why should the vehicle that produced your wealth (salary or home sale) determine how that wealth is taxed?

  7. JLP Says:
    September 17th, 2010 at 2:45 pm

    BG,

    This is nothing more than class warfare. Why not tax ALL capital gains from home sales rather than just taxing those deemed “rich” by our politicians?

    And you go WAY TOO FAR when you say that capital gains should face social security and medicare taxes.

  8. BG Says:
    September 17th, 2010 at 3:29 pm

    JLP: I agree that ALL capital gains from homes sales should have been included is this tax-law change. That is what I meant by “they didn’t go far enough”. I agree that it is unfair to have this new tax only for earners over $250k.

    As I said in other posts, I will listen to a discussion on a flat-income tax, but only if:

    a.) you start with social security to show me you are serious and

    b.) ALL forms of income are taxed equally: salaries, dividend-income, capital-gains (house/stocks whatever), and any other currently known or unknown forms of ‘income’ are ALL subject to the exact same flat-tax rate.

    I have a feeling that we will _never_ agree on this, and it just boggles my mind. I have tried to see this from your view-point and I just can’t see how you can claim (with a straight face) that your ideas on taxation would be ‘fair’ under any definition.

    You want a flat-income tax, but social security taxes should not be flat — you love the idea that only the poor/middle class pays a 12.4% SS tax, and the rich have percentages MUCH lower.

    You want a flat-income tax, but not on capital-gains / home sales or whatnot. The poor/middle class have practically NO capital-gains, the uber-rich’s income is PRIMARILY made up of capital gains.

    It seems to me you want taxes on 97% of the working American population, and NO taxes on the top 3% of the population.

    Try to convince me otherwise.

  9. Stacey Says:
    September 17th, 2010 at 5:24 pm

    BG #6. The code is the code. Is it fair to continually be taxed on the same dollar…when I make it, when I earn interest on it, when I parlay it into a stock purchase to build up a kitty to buy a house (divs and cap gains), when I sell said house for a large gain, and then finally when I expire and the death tax grabs the last dollar from my cold fist?

    It’s the hand we’re dealt and no one will have the cahones to change it to be more “fair”…they will tweak it to suit the political whims of Washington to conjure up more votes and fund their wasteful spending.

  10. BG Says:
    September 17th, 2010 at 5:57 pm

    Stacey: I agree, we are taxed on every conceivable thing. But, to be “fair”: everyone should be taxed _equally_ on every conceivable thing.

    Is it fair that I pay a 12.4% SS tax, while uber-rich CEO pays 0.000002% SS tax? Is it fair that I pay a higher percentage for title insurance (in Texas) just because my house is cheaper? Is it fair that my income is subject to income tax (my last dollar rate is 25%), yet uber-rich CEO gets all of his coin in dividends which are taxed at 15%?

    Perhaps Obama/Congress/whomever is behind this new tax on homesales (for profits over $500k, and only for earners who make more than $250k) is trying to make things just a little more ‘fair’ — without having to throw out the entire tax code and starting over.

    AS for the ‘spending’: I just want PAY-GO back — and will put my vote behind whatever candidate is going to stand on those principles.

  11. JLP Says:
    September 17th, 2010 at 5:59 pm

    BG wrote:

    “Is it fair that I pay a 12.4% SS tax, while uber-rich CEO pays 0.000002% SS tax?”

    HELL YES, IT’S FAIR because the benefits are capped and highly in your favor. WHY can’t you understand this?

  12. BG Says:
    September 17th, 2010 at 6:58 pm

    JLP) I guess I’ll have to get back to you in 30-40 years and let you know if this entire SS-tax thing works out in my favor or not.

    But I can tell you: I’m already losing the race by paying a 12.4% tax verses the uber-rich CEO that is only paying a 0.000002% tax — I’ll have to do quite a bit of catch-up if/when I get a single penny out of social security.

  13. JLP Says:
    September 17th, 2010 at 7:10 pm

    BG,

    He is paying 12.4% on the first $106,000 (or so) income just like you are.

    Instead of worrying about what the uber-rich pays, why don’t you try to increase your income? If you don’t want to become uber-rich, then why are you griping about the CEO that has? Clearly, the uber-rich has made choices and sacrifices to get where he is. Why should he be penalized for that?

  14. BG Says:
    September 17th, 2010 at 7:38 pm

    Let’s set a tax-rate of 90% on all income of $50 million or more. It’ll be “fair” because if/when I make $50 mill a year, I’ll be paying it too — just like they are.

    Instead of uber-rich CEO’s worrying about my tax rate, they should look closer at their own incomes and justify why they should be paid 1000 times more than their employees. If the uber-rich don’t want to become poor, then why are they griping about what I (don’t) have. Clearly, the poor are sacrificing on their measly salaries. Why should the poor be penalized for that?

    See how I turned that around?

  15. JLP Says:
    September 17th, 2010 at 7:45 pm

    BG,

    I’m pretty sure you make more money than other people in this country. Is it fair for you to make more than someone who carries out groceries or works at McDonalds?

    It’s supply and demand that creates those wages. I’m with you in that I think they are crazy. But, I don’t want the government interfering in the private sector.

  16. John Says:
    September 17th, 2010 at 8:06 pm

    The flat tax is just another way for the upper income people to lower their taxes. A cosumption, like a sales tax, is regressive and would tax lower income people at a higher percentage. The tax code is so complex because special interest groups can dictate to congress what to do because of the money they give them. When Reagan took office, the top income tax rate was 70% on income over $3 million. He lowered that rate to 28%. This started the biggest shift in income and wealth since the 1920′s. In 1974, the average CEO made 40 times the salary of the average worker. Today that figure is 300 times.

  17. BG Says:
    September 18th, 2010 at 11:55 am

    JLP) Nothing wrong with having people earn more than others — I don’t want government dictating income caps either. The problem I have is taxes like this new law is addressing: half a million in profit from a home-sale is TAX FREE today! Now, who do you think lobbied for that loop hole?

    I’m all for Congress closing up these types of loop-holes that are CLEARLY only for the benefit a a single ‘class’ of citizen. You like to talk about how this new law (to partially close a tiny part of the loop-hole) is ‘class-warfare’.

    The ‘class-warfare’ started when the loop-hole was originally created — the uber-rich are the ones that fired the first shot.

    Now, if we talk about social security — and it were taxed ‘fairly’ as in a flat-income tax, then for someone with a $50k income should only be paying $13.19 (instead of the current $6,200) for social security tax — which would represent the exact same tax rate that someone earning $50 million pays toward the same tax today. If we all could enjoy the tiny tax rates of the uber-rich, then we’d all _be_ rich.

    Think how much more the guy with the $50k income could save, invest, grow his business, if he had that extra $6,189/year in his pocket — we wouldn’t even _need_ a social security program.

    Social security should be ‘means-tested’, and taxed on all income — with the tax rate down around 2% or so. I don’t want to buy your ‘insurance’ policy — I don’t need it or want it. But I will pay 2% to support those that do desperately need it: just like we do for food-stamps, prisons, wars, education and all the other ‘wasteful’ spending you can think of.

  18. Jack Says:
    September 20th, 2010 at 11:44 am

    Look, BG, Social Security is already means-tested to some extent. First, in the benefits. For the computed average income over the 35 years used, the payout is 90 cents on the first dollar, but only 15 cents on the last. So, as one reaches the maximum contribution level, he is essentially taxed SIX TIMES more than someone at the lower levels, relative to the benefit he will receive. Then, in the benefits themselves. At higher income levels, Social Security benefits are taxed. Not so at lower income levels — AND one’s tax rate is higher, too.

  19. Jack Says:
    September 20th, 2010 at 12:32 pm

    “If we all could enjoy the tiny tax rates of the uber-rich, then we’d all _be_ rich.”

    Most of the rich did not start out rich. But they started companies, created jobs, and made wise choices. But they did not get rich because the federal taxes on the “uber-rich” are lower than they are for the rest of us.

    Do you really believe that those in the middle quintile, who pay a total of about 14.3% of their income to federal taxes (2007), or the bottom quintile, which pays 4.0%, would benefit by paying 25.1%, as the top quintile does?

    Oh, the “uber-rich”? Yes, increasing everyone’s total tax rate to 29.5%, which the top 1% pay, would sure make everyone richer.

    http://www.cbo.gov/publications/collections/tax/2010/average_rates.xls

  20. BG Says:
    September 21st, 2010 at 8:22 pm

    Jack, I’m talking about the _uber_ rich — something like the top 0.01% of the population. Is is not fair to even lump them in with the top 1% because their incomes are ballistic. These are the Warren Buffets / Hedge Fund Manager / CEOs. Their effective tax rate is around 17%-18%.

    Basically these are the guys that have the majority of their income in the form of dividend-income, which is taxed at the flat rate of 15%. Dividend-income is not even subject to SS-tax or Medicare taxes thanks to the law change in 2004 (guess who was president).

    Under Reagan, the dividend-income tax rate was never less than 28% (and it was subject to social security and medicare taxation too).

  21. Jack Says:
    September 21st, 2010 at 10:14 pm

    Show me the numbers. Be sure to include, as the numbers I gave do, what they pay in corporate income taxes, dividend taxes, excise taxes, etc.

    Don’t forget to provide a citation for your numbers.

  22. Jeff Says:
    September 23rd, 2010 at 9:09 am

    If the home is a personal residence the gain will not be taxed the additional 3.8% (unless it is over the $250,000 and $500,000 personal residence exemptions). The law exempts the gain on the sale of a personal residence from the new medicare tax. The only way there would be medicare tax is if it is over the exemption amounts.

  23. BG Says:
    October 5th, 2010 at 10:12 am

    #21 Jack) Google search for “Buffett tax rate washington post” — click the first link.

    It’s one thing to listen to me complain about uber-rich tax rates, it’s completely different when it is one of the uber-rich themselves that are agreeing that is is unfair.

    From the Washington Post article:

    “NEW YORK, June 26 — Warren E. Buffett was his usual folksy self Tuesday night at a fundraiser for Sen. Hillary Rodham Clinton (D-N.Y.) as he slammed a system that allows the very rich to pay taxes at a lower rate than the middle class.

    Buffett cited himself, the third-richest person in the world, as an example. Last year, Buffett said, he was taxed at 17.7 percent on his taxable income of more than $46 million. His receptionist was taxed at about 30 percent.

    Buffett said that was despite the fact that he was not trying to avoid paying higher taxes. “I don’t have a tax shelter,” he said. And he challenged Congress and his audience to see what the people who “clean our offices” are taxed, to loud applause.”

  24. Jack Says:
    October 12th, 2010 at 10:37 am

    You give one example, and a bad one at that. Is Buffett including the taxes he pays in corporate income taxes? Does he explain how he gets that a large portion of his secretary’s tax is Social Security, and that she will get that back in retirement or disability? Does he explain that her 30% includes Medicare tax, which she will also recoup if she should live so long?

    Even if all he says is true, he is only one data point. If he is so concerned, he has every right to contribute to the federal government:
    https://www.pay.gov/paygov/forms/formInstance.html?agencyFormId=23779454

    If he does not do that, then there is nothing to his words but noise. Last year, contributions were only $3.063M. If Buffett put his money where his mouth is, and put in the 12.3% he thinks he is undertaxed, that would be at least $5.658M — all from Buffet.

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