December 20, 2012
MEDICARE TAX ON NEW INVESTMENT INCOME (NII)
By: Joseph L. Striegel, EA – Director
The New Year is upon us, and I hope everyone had a safe and wonderful holiday. With the New Year brings a new tax on net investment income. The creation of the 2010 Health Care Bill brought upon a new surtax of 3.8%. This tax will be imposed on all investment income, including interest, dividends, annuities, royalties, rents, gross income from passive activities and capital gains on high income tax earners. This tax will be assessed to all single individuals who have modified adjusted gross incomes of $200,000 or more, and for married couples filing jointly with modified adjusted gross incomes of $250,000 or more. The tax is applied to the lesser of (i) the individual’s net investment income or (ii) the excess of the individuals modified adjusted gross income over $200,000.00 ($250,000.00 for married filing joint). If you are under those thresholds, no surtax will apply to your NII.
Mr. and Mrs. Smith have income of $260,000.00. In addition, they have interest of $15,000.00, dividends of $25,000.00, and rental Income of $13,000. Their modified adjusted gross income would be $313,000.00. The surtax of 3.8% would apply since the MAGI is over the threshold. The amount subject to tax would be the lesser of (i)the net investment income of $53,000.00 (15,000.00 +25,000.00 +13,000.00) or (ii)the excess of MAGI $63,000.00 ($313,000.00 - $250,000.00). The Smith’s will have a surtax of $2,014.00 ($53,000.00 X 3.8%).
With this new surtax, planning needs to be done to minimize the surtax impact. If you currently have rental property, maximizing your expenses and minimizing your net income will reduce the amount of surtax.
If you are planning on selling your home this year - and it was your primary residence for the last two out of five years - then you are still entitled to the exclusion of $250,000.00 for a single taxpayer and ($500,000.00 for MFJ). If the gain from the sale exceeds the exclusion amount, the portion that exceeds this amount could be subject to the additional surtax if your MAGI is above the threshold.
Selling your second home or rental property for a gain will result in the surtax applying if you exceed the MAGI threshold as well. If you are planning on selling one of your rental properties at a gain, you may want to consider a 1031 exchange instead. By doing a 1031 exchange the gain on the sale is deferred, therefore the gain would not be subject to the Medicare surtax.
Planning will be a critical part in helping you to reduce the surtax. Some of the ways in which you can reduce the amount of surtax you pay will be to reduce your net investment income. You can do this by putting more of your savings into Municipal bonds, tax deferred annuities, and life insurance. Some additional ways to reduce your MAGI is to do a Roth conversion, installment sale, or a charitable remainder trust.
Start tax planning now with your tax advisor and your broker to make sure that you are minimizing the surtax at the end of the year.