Planning for the 3.8% Medicare Surtax

It’s been more than a year since the Patient Protection and Affordable Care Act was passed. What seemed at the time (March 2010) to be very distant concerns are becoming more important every day. One such concern is the 3.8 percent Medicare surtax that will take effect Jan. 1, 2013.

Intended to raise revenue to pay for health care reform, the surtax will apply to certain types of unearned income of individuals, trusts and estates. Specific income thresholds will apply.

A Tax on Net Investment Income
The new Medicare surtax will not apply to everyone. It will only be levied on net investment income, which includes:

Interest, dividends, royalties, annuities and rents
Income derived from passive activities
Trading of financial instruments and commodities
Net capital gains derived from the disposition of property (other than property held in an active trade or business)

Net investment income does not include:

Active trade or business income
Gain on the sale of an active interest in a partnership or S corporation
Distributions from IRAs or qualified retirement plans
Income from tax exempt municipal bonds
Tax deferred nonqualified annuities
Income taken into account for self-employment tax purposes
Capital gain excluded under Internal Revenue Code

Who is Affected?
For individuals, the 3.8 percent surtax would be imposed on the lesser of:

Net investment income for the tax year, or
The amount by which the modified adjusted gross income (MAGI) exceeds a threshold amount in that year: $200,000 for singles, $250,000 for married filing jointly, $125,000 for married filing separately

Here are Some Examples

A single taxpayer has $215,000 of net investment income. The 3.8 percent tax would apply to $15,000 of income since it is the lesser of net investment income ($215,000) and the excess over the MAGI threshold of $200,000.
A married couple with combined income of $275,000 and no net investment income would not be subject to the surtax.
A married couple with combined salaries of $200,000 and net investment income of $150,000 would pay the surtax on $100,000 of income since it is the lesser of $150,000 of net investment income or the excess over the MAGI threshold of $250,000.

Trusts and Estates
The new tax would also be imposed on trusts and estates on the lesser of:

The undistributed net investment income for the tax year, or
The excess (if any) of the taxpayer’s adjusted gross income over the dollar amount at which the highest tax bracket begins.

Strategies to Reduce the Tax
Even though some are challenging the constitutionality of the Patient Protection and Affordable Care Act, it is best to think of the Medicare surtax as if it will take effect in 2013 and be around for awhile. Your goal should be to manage income thresholds and the level of net investment income earned in a year. Some thoughts:

Income from municipal bonds is not considered net investment income. Consider rebalancing your investment portfolio to increase exposure to municipal bonds.
If you are contemplating the sale of your home, consider doing so before Jan. 1, 2013. Sale of a residence could trigger the surtax if the taxpayer’s MAGI exceeds the prescribed thresholds and the sale of the home results in a capital gain greater than the IRS exclusion of $250,000 for singles and $500,000 for married couples.
If you are contemplating the sale or transfer of your interest in a business in which you have passive ownership, or the sale or transfer of your ownership interest in a C corporation, consider doing so before Jan. 1, 2013.
Maximize contributions to retirement plans and IRAs.
Convert traditional IRAs to Roth IRAs (if you can afford to pay the taxes that will be due).

Remember that planning for the Medicare surtax or any tax is just one part of a complete wealth management plan. Consider your overall goals and objectives and chose those actions that are best at helping you reach them.

Start planning now for this and other health care reforms. Contact Clifton Gunderson Wealth Advisors

FinancialInsight is brought to you by Clifton Gunderson. In an effort to provide more value to our clients and friends, we've designed this e-publication to share information about the latest personal and business financial strategies to help you evaluate your investments and financial planning. We'll strive to improve with every issue, and you can help by giving us suggestions about what you'd like to see. Just drop us a note at FinancialInsight@cliftoncpa.com with your thoughts. As always, thanks for giving us the opportunity to be your most trusted advisor.

Advisory services offered through Clifton Gunderson Wealth Advisors LLC, a Registered Investment Advisor. Securities offered through CG Brokerage L.L.C., member FINRA/SIPC or securities offered through ValMark Securities, Inc., member FINRA/SIPC – 130 Springside Drive, Suite 300, Akron, OH 44333-2431 (1-800-765-5201). ValMark Securities, Inc. is a separate entity from all Clifton Gunderson companies. CG Brokerage L.L.C., Office of Supervisory Jurisdiction, 8215 Greenway Boulevard, Suite 610, Middleton, WI 53562 (608) 662-8600. The information contained herein is general in nature and is not intended, and should not be construed, as legal, investment accounting, or tax advice or opinion provided by Clifton Gunderson LLP to the reader. The reader also is cautioned that this material may not be applicable to, or suitable for, the reader’s specific circumstances or needs, and may require consideration of non-tax and other tax factors if any action is to be contemplated. The reader should contact his or her Clifton Gunderson LLP or other tax professional prior to taking any action based upon this information. Clifton Gunderson LLP assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect the information contained herein.