Under current federal law, the Medicare payroll tax only applies to wages. Beginning in 2013, a Medicare tax will, for the first time, be applied to investment income.
The unearned income Medicare tax will be imposed on individuals, estates and trusts for their tax years beginning after Dec. 31, 2012.
For an individual, the tax is 3.8% of the lesser of either:
(1) Net investment income or
(2) The excess of modified adjusted gross income (MAGI) over the threshold amount.
The threshold amount is $250,000 for a joint return or surviving spouse, $125,000 for a married individual filing a separate return, and $200,000 for all others.
Example: For 2013, a single taxpayer has net investment income of $100,000 and MAGI of $220,000. The taxpayer would pay a Medicare contribution tax only on the $20,000 amount by which his MAGI exceeds his threshold amount of $200,000, because that is less than his net investment income of $100,000. The taxpayer's Medicare contribution tax would be $760 ($20,000 × 3.8%).
For an estate or trust, the Medicare contribution tax is 3.8% of the lesser of either:
(1) Undistributed net investment income or
(2) The excess of AGI over the dollar amount at which the highest income tax bracket applicable to an estate or trust begins.
Net investment income
Net investment income is includes:
• Interest, dividends, royalties, annuities and rents
• Income derived from passive activities
• Trading of financial instruments and commodities
• Net capital gains derived from the disposition of property (other than property held in an active trade or business)
Net investment income does not include:
• Active trade or business income
• Gain on the sale of an active interest in a partnership or S corporation
• Distributions from IRAs or qualified retirement plans
• Income from tax-exempt municipal bonds
• Tax-deferred nonqualified annuities
• Income taken into account for self-employment tax purposes
• Capital gain excluded under Internal Revenue Code
Thus, for a taxpayer who doesn't engage in a passive activity or a financial instrument or commodities trading business, “net investment income” will include non-business income from interest, dividends, annuities, royalties, rents, and capital gains, minus the allocable deductions. Business income won't be included.
For a taxpayer who does engage in a passive activity or a financial instrument or commodities trading business, “net investment income” will include the above items, plus the gross income (minus allocable deductions) from the passive activity or trading business
In the case of the disposition of a partnership interest or stock in an S corporation, gain or loss is taken into account only to the extent gain or loss would be taken into account by the partner or shareholder if the entity had sold all its properties for fair market value immediately before the disposition. Thus, only net gain or loss attributable to property held by the entity that is not property attributable to an active trade or business is taken into account. (Code Sec. 1411(c)(4))
Investment income does not include distributions from a qualified retirement plan (i.e., a plan or arrangement described in Code Sec. 401(a), Code Sec. 403(a), Code Sec. 403(b), Code Sec. 408, Code Sec. 408A, Code Sec. 457(b)) or amounts subject to SECA tax. (Code Sec. 1411(c)(5))
Planning for the Medicare surtax should be an important part of your 2012 tax planning process.
If you would like additional information about the new Medicare surtax, please feel free to contact Mark at email@example.com or give him a call at 412-697-5247.
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