The 3.8% Medicare Surtax — Will It Affect You?
Apr 07, 2015
When filing 2015 tax returns, higher income taxpayers might have to pay the 3.8% Medicare surtax on net investment income.
How Does the Tax Apply?
This tax is imposed on the lesser of (1) net investment income or (2) the amount by which modified adjusted gross income (MAGI) exceeds a threshold amount: $200,000 (unmarried), $250,000 (married filing jointly), or $125,000 (married filing separately). Because the tax applies to “the lesser of” net investment income or the amount by which the applicable threshold is exceeded, taxpayers want to take steps to minimize either MAGI or net investment income, or both.
Generally, net investment income includes all taxable income from the following sources: interest, dividends, capital gains, nonqualified annuities, royalties, rents, and passive trade or business activities. Note that net investment income includes gain from the sale of a personal residence but only to the extent the gain exceedsthe amount excluded from income for regular tax purposes. The gain exclusion can be as much as $250,000 — or $500,000 for a married couple filing jointly or a qualifying surviving spouse.
Net investment income does not include wages, income subject to self-employment tax, or active trade or business income. It also does not include distributions from qualified retirement plans or traditional or Roth individual retirement accounts (IRAs).
How Do You Plan?
- Going forward, possible planning steps for reducing exposure to the new tax include the following:
- Increasing contributions to qualified retirement plans
- Rebalancing portfolios to increase the percentage of tax-exempt bonds and non-dividend-paying growth stocks
- Transforming passive business activities into active business activities
- Deferring capital gains through the use of installment sales
- Giving income-producing properties to children in lower tax brackets (“kiddie tax” rules may apply)
- Contributing to Roth IRAs and Roth retirement plans (sole proprietors may want to consider a solo Roth 401(k))
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