The 3.8% Medicare tax is in effect as of January 1, 2013. Do you understand how it will affect you? A taxpayer could pay a 3.8% surtax on the lesser of “net investment income (NII)” or modified adjusted gross income less the “applicable threshold.” NII includes but is not limited to interest income, dividends, capital gains, rent, royalty income, income and gains from passive activities. The applicable thresholds are for taxpayers: married filing jointly with modified adjusted gross income of $250,000; married filing separately with MAGI of $125,000; and for all others with MAGI of $200,000. I am not sure if the list of NII and thresholds provided you a sigh of relief or a gasp of concern.
A dealer’s income needs to be segregated to determine the NII. Regardless of the type of entity, an owner should evaluate the income to determine:
- Whether the activity involves in an active trade or business, and
- Whether the income is derived from the ordinary course of that trade or business, and
- Whether the activity is not a passive activity to the taxpayer, and
- Whether the activity does not involve the trading of financial instruments.
Owners who materially participate daily in the dealership should not have to worry regarding their interest in the operating partnership or S corporation being subject to the 3.8%. The income is more likely derived from an active trade or business. Keep in mind that this surtax is not applicable to an entity taxed as a C corporation.
Owners should be concerned when they limit their material participation or are retired. Dealers materially participate if they meet one of the following, but are not limited to the following:
- Work 500 hours or more during the year in activity
- Work on a regular, continuous and substantial basis in the operation of the dealership
- Materially participated in the activity for any 5 taxable years during the 10 taxable years that immediately precede the current year.
If owners do not meet any of these tests, they are considered to be passive, and the 3.8% surtax will apply.
More likely than not the owners of the real estate to which the dealership pays rents will be subject to the 3.8% Medicare tax. Rental activities are treated as passive by default unless the taxpayer is a real estate professional.
Dealers should ultimately consult their tax advisor to determine if their participation is active trade or business or passive.
Please contact me if you have further questions on how the 3.8% Medicare tax could affect you.
Steven A. Barber, firstname.lastname@example.org
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