« Back | September 2011
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
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