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Additional Medicare Taxes
August 2, 2010
The health care reform acts have brought numerous changes to many avenues, including Medicare taxes. The Patient Protection & Affordable Care Act assesses an additional 0.9% Medicare tax on wages of certain taxpayers. The Health Care & Education Reconciliation Act of 2010 imposes an additional 3.8% Medicare tax on net investment income of specific taxpayers. Both additional taxes will become effective beginning January 1, 2013. Who will be subject to these taxes? What is net investment income? How is the net investment income tax calculated?
Who will be subject to this tax?
The Medicare tax on net investment income will be applicable to individuals, trusts, and estates. For individuals to be subject to the tax, their modified adjusted gross income must exceed $250,000 if married filing joint or surviving spouse, $125,000 if married filing separate or $200,000 for all other filers. Modified adjusted gross income means the adjusted gross income increased by the excluded foreign income less the deductions related to that foreign income.
The additional 0.9% Medicare tax will be collected on any taxpayer's wages above a certain threshold. This tax applies to wages received from employment and to self-employment income reduced by the wages that are subject to FICA. This tax is not applicable to corporations, trusts, or estates. If the taxpayers are married filing joint, then any wages exceeding $250,000 will be subject to the 0.9% tax. If filing married filing separate, then wages above $125,000 are taxable. For all other taxpayers, the threshold is $200,000. Furthermore, the additional tax is assessed on the combined wages of married taxpayers. The employer is required to withhold the additional 0.9% on wages of individuals that exceed $200,000. However, the employer is not mandated to consider the marital status of the employee and withhold for those individuals who individually are not subject to the tax but jointly are. The result of this additional tax on eligible taxpayers is that effectively 3.8% of their wages (or self-employment income) are subject to Medicare taxes. In addition, the employer is only responsible for 1.45%, which leaves the employee responsible for 2.35% on earnings exceeding the above thresholds. Lastly, the additional 0.9% tax is non deductible for self-employed taxpayers.
What is net investment income?
Net investment income is the excess of investment income over the deductions that are allocable to such income. This includes gross income from the following sources: interest, dividends, annuities, royalties, rents, income from a trade or business deemed a passive activity, income from a trade or business that trades financial instruments or commodities, and the net gain resulting from the disposition of property that is not held for a trade or business or is held by a business considered a passive activity.
There are several exceptions to what is included in net investment income. First, the income earned from the following types of qualified plans is excluded from the investment income calculation: qualified pension, profit sharing, and stock bonus plans; qualified annuity plans; annuities purchased by 501(c)(3) organizations or public schools; individual retirement accounts (IRAs); Roth IRAs; and deferred compensation plans. Second, any income that is used to calculate the self-employment tax is excluded. Third, rental income may be excluded if it is derived in the ordinary course of a trade or business and is not considered a passive activity. Fourth, charitable remainder and other tax-exempt trusts are excluded from this tax.
How is the net investment income tax calculated?
For individual filers, the tax will be calculated as 3.8% of the lesser of either (1) net investment income or (2) the excess, if any, of modified adjusted gross income over the appropriate threshold.
Individual Example:
| Facts: | Lesser of (1) or (2): | Tax Calculation: |
| Married filing joint | (1) $400,000 | = 3.8% * Lesser of (1) or (2) |
| (1) Net investment income = $400,000 | (2) $300,000 - 250,000 = $50,000 | = .038 * 50,000 |
| (2) Modified adjusted gross income = $300,000 | Lesser = (2) = $50,000 | Tax = $1,900 |
| Threshold = $250,000 |
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For trusts and estates, the tax is 3.8% of the lesser of either (1) undistributed net investment income or (2) the excess, if any, of adjusted gross income over the beginning dollar amount of the highest tax bracket for that taxable year.
This information represents a brief overview of the key elements of the additional Medicare taxes. There are other facts and circumstances that could dictate if the income is considered investment income for this tax calculation. In addition, there will still be information released in the future regarding the procedural collection of these taxes. Please do not hesitate to call your 415 Adviser, 330-492-0094, to help you determine if you will be subject to these additional taxes.
by: Maria K. Liossis, CPA
