The New Medicare Surtax: What Will You Pay?

 It is hard to believe it’s been almost two years since The Patient Protection and Affordable Care Act was passed!   At the time, some of the new provisions seemed to be a very distant burden.  Now they are fast approaching.  The new Medicare surtax was put in place to help raise money to assist in funding health care reform and will take effect January 1, 2013.   Here’s how it could affect you:

What income sources does this new tax affect?

• Wages:  Wage surtax 0.9%:  This tax is new and will apply to wages and self-employment income in excess of $250,000 (married filing jointly) and $200,000 (single tax payers).
• Net investment income for some tax payers includes the following:
  • 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% 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.

• For Estates and Trusts
  • 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:  $11,650

Here are few scenarios:

• A married couple filing jointly with combined income of $280,000 and no net investment income 
  • WOULD NOT BE SUBJECT TO THE TAX. 
• A married couple filing jointly with combined salaries of $300,000 and net investment income of $40,000
  • The 3.8% Medicare surtax would apply to the $40,000 of net investment income.
• A married couple filing jointly has combined salaries of $200,000 and $150,000 of net investment income.
  • The 3.8% surtax would apply to $100,000 of income (the lesser of rule excess of $350,000 MAGI over the $250,000 threshold amount).

Potential Ways to help plan for the tax:

• Consider converting traditional IRA’s to Roth IRA’s, assuming you can afford to pay any tax liability due.  Converting a traditional IRA into a ROTH IRA has various tax implications.  Investors should consult a tax advisor before deciding to do a conversion.

• Contribute to tax exempt or tax deferred investments such as:
  • Maximization of contributions to retirement plans and IRA’s.
  • Increase exposure to municipal income bonds.  Income from muni bonds is not subject to federal taxation; however, they may be subject to state and local taxes and, for certain investors, may be subject to the federal alternative minimum tax.
  • Tax-deferred non-qualified annuities (during the deferral period)
  • Establishment and contribution to non-qualified deferred compensation plans (NQDC)
  • Life insurance

• If you are considering sale of your primary residence that would result in a capital gain greater than the IRS exclusion of $250,000 for singles and $500,000 for married couples (with depreciated home values this may be hard to achieve) then you may want to sell your home prior to January 1, 2013.
• All gain from the sale of an investment real estate property, or business with passive ownership could trigger the surtax.  Again selling an investment or business prior to January 1, 2013 could help avoid the trigger of the surtax.   Assuming the sale can only be made after 2013, structuring the sale via an installment sale where payments are made over time (smoothing the payments out over multiple tax years) might help to reduce the trigger of the surtax.
• Establishment of charitable trusts.

As always work with your financial and tax professionals regarding the particulars of your situation.  If you have additional questions feel free to email me at Julie.hall@centerfinplan.com.

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The information contained in this report does not purport to be a complete description of the developments referred to in this material.  The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete.  Any opinions are those of Center for Financial Planning, Inc., and not necessarily those of RJFS or Raymond James.  Investments mentioned may not be suitable for all investors.  Please note, changes in tax laws may occur at any time and could have a substantial impact upon each person’s situation.  While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors or RJFS, we are not qualified to render advice on tax or legal matters.