Will You be Hit by the Medicare Surtax?

On January 1, a new 3.8 percent tax on certain kinds of investment income took effect. The Medicare surtax (officially termed the Unearned Income Medicare Contribution) is slated to affect single filers with adjusted gross incomes above $200,000 and most joint filers with adjusted gross incomes above $250,000, according to the Wall Street Journal online.

What is the most important thing to know about the new 3.8 percent tax? This has been characterized as a flat tax on investment income for the wealthiest Americans, but it is a little more complex than that.

The 3.8 percent surtax will actually be levied on the lesser of two amounts: either a) your net investment income or b) your modified adjusted gross income (MAGI) in excess of either the $200,000 or $250,000 threshold. Should either a) or b) be zero, the tax won’t apply to you in 2013, according to www.cliftonlarsonallen.com and Financial Advisor magazine online.

Adjusted gross income is easily defined: it includes wages, income from partnerships and small businesses, retirement income, and interest, dividends and capital gains. Defining net investment income under the new surtax is a bit hazier, because (as of November) the IRS has yet to issue formal guidance, according to Business Management Daily online.

What kinds of net investment income could be taxed? Many tax professionals believe the 3.8 percent surtax will apply to short- and long-term capital gains, dividends, interest (but not interest from muni bonds), royalties, returns realized from partnerships and activities not requiring material participation, and forms of income linked to real estate: passive income from rental property, income from the sale of a principal residence above the $250,000/$500,000 exclusion, and net gains from selling a second home, according to the Wall Street Journal online.

Would certain net investment income be exempt? Besides muni bond interest, the surtax is not supposed to apply to regular or Roth IRA distributions, distributions from qualified retirement plans like 401(k)s and 403(b)s, veterans’ benefits, life insurance payouts, Social Security income or annuitized income from a retirement plan. Gains from the sale of property owned in an active trade or business would also be exempt, along with Schedule C income and income from a business on which you pay self-employment tax, according to the Wall Street Journal online and Business Management Daily online.

With the surtax looming, there has been an upswing of interest in Roth IRA conversions and the acceleration of investment income into 2012. Installment sales have also become less attractive to business owners, and family businesses who are considering a sale may want to make sure sons and daughters with an ownership interest are also employees rather than sitting on the sidelines.

What about the 0.9 percent tax? This is actually a payroll tax, so it only applies to employment income (the self-employed are not exempt). Like the 3.8 percent tax, it will kick in above the $200,000/$250,000 levels. While employers aren’t required to withhold the tax until an employee amasses $200,000 in wages, this tax could prove nightmarish for high-earning married professionals who file jointly in 2013: the first $200,000 of their individual wages wouldn’t be subject to such withholding, but their combined earned incomes would be taxed once they exceed $250,000, according to the Wall Street Journal online and Business Management Daily online.

It isn’t too late to strategize. If your MAGI or your net investment income might put you at risk for the tax, talk to a qualified financial or tax professional about your options for 2012 and 2013.

This material was prepared by MarketingLibrary.Net Inc., and does not necessarily represent the views of the presenting party, nor their affiliates. All information is believed to be from reliable sources; however we make no representation as to its completeness or accuracy. Please note – investing involves risk, and past performance is no guarantee of future results. The publisher is not engaged in rendering legal, accounting or other professional services. If assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. This is neither a solicitation nor recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. All indices are unmanaged and are not illustrative of any particular investment.

Tom Small may be reached at tom@MichiganMoneyManagement.com or (517) 349-7111. Thomas W. Small, CFP®, AIF®, is a representative with Cambridge Investment Research, Inc. and is a CERTIFED FINANCIAL PLANNER™ practitioner and an Accredited Investment Fiduciary. He has 25+ years experience in the retirement and investment planning industry. Small provides retirement planning workshops to clients and the general public and welcomes all requests for speaking engagements. Find out more at www.MichiganMoneyManagement.com. Registered Representative: Securities offered through Cambridge Investment Research, Inc., a Broker/Dealer, Member FINRA/SIPC. Investment Advisor Representative: Cambridge Investment Research Advisors, Inc., a Registered Investment Advisor. Cambridge and Michigan Money Management, LLC are not affiliated.


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