A number of tax code changes took effect at the start of this year. There were changes made to the 2013 tax brackets thanks to the Taxpayer Relief Act. The Affordable Care Act added a 3.8% Medicare Surtax too. With half the year behind us, now is a good time to start planning for these changes, if you haven’t already.
Now, 3.8% seems like a drop in the bucket. But if you qualify (not everyone does), remember its a surtax. It’s a tax on top of what you’re already paying.
3.8% Medicare Surtax
Whether you qualify for the new 3.8% Medicare Surtax will depend on your net investment income or your Modified Adjusted Gross Income (MAGI). It will be the lessor of:
- Your net investment income, or
- the amount by which your MAGI exceeds the threshold amount of $200,000 for single filers, $250,000 for married filing jointly, and $125,000 for married filing separately
Remember, it’s the lessor of the two. This means two things. First, if your MAGI is at or below the threshold amount, then your Medicare Surtax will be zero. Second, if you don’t have any net investment income for the year, than your Medicare Surtax will be zero.
However, if you qualify, then the combination of your net investment income and MAGI exceeds the threshold and you’ll pay the 3.8% tax liability. Once you qualify, your investing success becomes more important, since any increase in your net investment income, means a higher tax bill too. It’s just one more reason to have a tax efficient investment strategy.
For example, say a single filer has a MAGI of $230,000 and $40,000 of that is net investment income. His MAGI is $30,000 over the threshold ($230,000 – $200,000 single filer threshold). Even though his net investment income is $40,000, he’ll owe the 3.8% tax on the $30,000 since it is lower. In the end, he’ll owe $1,140 ($30,000 x 0.038).
Now, what if the same filer only has $20,000 in net investment income? In this case, if the MAGI is the same $230,000 and $30,000 over the threshold, he’ll owe taxes on the $20,000 in net investment income since it’s lower. That means he’ll owe $760 ($20,000 x 0.038).
Finally, say a married couple filing jointly has a MAGI of $360,000 of which only $40,000 is net investment income. Their MAGI is $110,000 over the threshold ($360,000 – $250,000 married filing jointly threshold). Since their net investment income is lower, they’ll be taxed on that amount. That leaves them with a $1,520 surtax ($40,000 x 0.038).
Net Investment Income
So what qualifies as net investment income? In this case it includes:
- Interest
- Dividends
- Capital Gains – includes from stocks, bonds, mutual funds, mutual fund distributions, investment real estate sales, and sale of interest in a partnership and S Corp
- Rental and royalty income
- Non-qualified annuities
- Trading financial instruments and commodities
- passive income – income from a non active interest/ownership in a business
To find your net investment income you’d take your gross investment income (that’s the total of the items above) and subtract your capital losses and investment expenses. Our cost basis guide covers how capital losses work.
Based on all that, most people won’t have to worry about the surtax. In case you do qualify, I’d suggest sitting down with a good CPA and/or qualified financial advisor and put a solid tax plan in place. You can find out more about the Medicare Surtax at the IRS website.
