As part of the Affordable Care Act (the new health care legislation), a new tax kicks in this year. The official name of this tax is the Unearned Income Medicare Contribution Tax. Although the name implies it is a contribution, don’t get the idea that it is voluntary, or that you can deduct it, as a charitable contribution. Actually, it is a surtax levied on the net investment income of taxpayers in the higher income brackets. While it is perceived as an additional tax on higher-income taxpayers, it can affect those who normally don’t have higher income, e.g., if they have a large income from the sale of real estate, stocks, or other investments.
The surtax is 3.8% on whichever is less: your net investment income, or the excess of your modified adjusted gross income (MAGI) over a threshold based on your filing status. Net investment income is your investment income reduced by investment expenses; MAGI is your regular AGI increased by income excluded for working out of the country.
The filing status threshold amounts are:
- $250,000 for married taxpayers filing jointly and surviving spouses;
- $125,000 for married taxpayers filing separately, and/or
- $200,000 for single and head-of-household filers.
Example: A single taxpayer has net investment income of $100,000 and MAGI of $220,000. The taxpayer should pay a Medicare contribution tax only on the $20,000 amount by which his MAGI exceeds his threshold amount of $200,000, because that is less than his net investment income of $100,000. Thus, the taxpayer’s Medicare contribution tax should be $760 ($20,000 × 3.8%).
Investment Income Includes:
- Interest, dividends, annuities (but not distributions from IRAs or qualified retirement plans), and royalties;
- Rents (other than derived from a trade or business);
- Capital gains (other than derived from a trade or business);
- Home-sale gain in excess of the allowable home-gain exclusion;
- A child’s investment income in excess of the excludable threshold, if (when eligible) the parent elects to include the child’s investment income on the parent’s return;
- Trade or business income that is a passive activity, with respect to the taxpayer, and
- Trade or business income, with respect to trading financial instruments or commodities.
Planning Note: For surtax purposes, gross income doesn’t include interest on tax-exempt bonds. Thus, one can avoid or reduce the net investment income surtax by investing in tax-exempt bonds.
Investment Expenses Include:
- Investment interest expense;
- Investment advisory and brokerage fees;
- Expenses related to rental and royalty income, and
- State and local income taxes properly allocable to items included in Net Investment Income.
Do you think you will never get hit with this tax because your income is way under the threshold amounts? Don’t be so sure. When you sell your home, the gain is a capital gain, and to the extent that the gain is not excludable, using the home-gain exclusion, it will add to your income and possibly push you above the taxation thresholds. Since capital gains are investment income, you might be surprised. The same holds true for gains from selling stock, a second home, or a rental. So when planning to sell a capital asset, be sure to consider the impact of this new surtax.
Example: A taxpayer has owned a residential rental property for a number of years, and is planning to use the rental’s increased value to help fund his retirement. The taxpayer normally has income well below the threshold for this new tax. The taxpayer sells the rental and has a substantial gain. The gain from the rental sale gives the taxpayer a one-time windfall that pushes his income above the threshold for the new tax. Therefore, he must pay the regular capital gains tax, plus an additional 3.8% tax on the appreciation that is attributable to the increase in value that occurred over several years.
The surtax also applies to the undistributed net investment income of trusts and estates. There are also special rules that apply to the sale of partnerships and Sub-S Corporation interests.
If this surtax applies to you in 2013, you should increase your income tax withholding, or estimated tax payments. This should cover the additional tax so that you avoid, or minimize, an underpayment of estimated tax penalty, when you file your 2013 return.
If your income normally exceeds the threshold for this new tax, or you have (or are contemplating) a large capital gain and need to explore options to mitigate the tax impact, please contact your Tax Consultant.
If you have questions or need assistance, contact the Experts at Henssler Financial: experts@henssler.com or 770-429-9166.
Disclosures
This article is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
