High Income Medicare Surtax Planning in 2013

Deborah Helton

Deborah Helton


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Michael McDevitt

Michael McDevitt


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The health care legislation, commonly known as “Obamacare,” creates additional Medicare taxes for high-income taxpayers. There are two new Medicare tax increases: (1) a 3.8% tax on “net investment income,” and (2) a 0.9% Medicare tax on earned income. Generally, if your income exceeds $200,000 (single filing), or $250,000 (joint filing), you are at risk for these new taxes.

Net Investment Tax of 3.8 percent

Beginning in 2013, higher income individuals with “net investment income” will be subject to an additional 3.8% tax of the lesser of two amounts:

  • Your “net investment income,” or
  • the excess of the taxpayer’s modified adjusted gross income over a $200,000 (single) or $250,000 (joint filers) threshold amount.

If the taxpayer’s adjusted gross income is greater than the $200,000/$250,000 threshold, the excess becomes a limitation on the amount of net investment income exposed to the surtax. For example, if a joint return has a modified adjusted gross income of $260,000, the $10,000 excess becomes the limitation.

Net investment income includes three broad categories:

  • Interest, dividends, annuities, royalties, and rents
  • Income from a business in which the taxpayer does not personally, materially participate, and business income from trading and financial instruments or commodities
  • Capital gains and other net gains from the sale of property


Most investment income categories are exempt from the tax if they are derived from a business activity in which the taxpayer materially participates (other than trading in financial instruments and commodities).

Any income subject to the self-employed Social Security tax is excluded, as is tax-exempt interest income, retirement plan distributions, and tax-free gains from a principal residence.

Medicare surcharge tax on earned income

Presently, the Medicare tax applies to all wages and self-employment income. For wage earners, both the employer and the employee pay 1.45%, whereas a self-employed taxpayer pays the entire 2.9%.

Beginning in 2013, the health care legislation imposes an additional 0.9% surtax — but only on higher income households. The tax applies to income in excess of:

  • A single person’s wage and self-employment income over $200,000, or
  • the combined wage and self-employment income of a married couple exceeding $250,000.

While both taxes only impact high income earners, the threshold for the 3.8% tax focuses on total income in the tax return (technically “modified adjusted gross income,” which is generally the total income on page 1 of Form 1040). On the other hand, the 0.9% Medicare surcharge focuses only on the wage and self-employment earned income of the taxpayer. In both cases, the new taxes only apply to the investment income or earned income that is in excess of the thresholds.

Net investment income tax of 3.8% Planning

The more complex planning challenges come into play with the net investment income portion of the new tax. But with careful execution of a well-designed plan, there may be ways you can potentially reduce net investment income and, thus, the potential impact of this new tax.

If your income is at or near these thresholds, the focus will be on maintaining a consistency in reportable income from year to year so as to stay beneath the thresholds. Spikes in income from large IRA withdrawals, bonuses, and substantial capital gain recognition, can trigger these taxes.

Using an installment sale to shift a large capital gain from an investment into multiple tax years could help you stay beneath the threshold of the 3.8% tax.  Similarly, a lump sum distribution from a retirement account could trigger the 3.8% tax, so consider taking payments out over a number of years.

An owner occupied commercial building could utilize a strategy to manage the income in the LLC entity by modifying rents.  This strategy should take into consideration practical cashflow concerns of covering building expenses as well as ensuring the rent still represents a fair market value.  Consult with your tax advisor to implement a strategy that benefits you while ensuring you are within the regulatory boundaries.

One possible strategy would be to shift some of your investments with taxable earnings into municipal bonds and municipal bond funds, whose earnings are excluded from the MAGI and the net investment income calculation. They also provide a double potential benefit of not triggering the surtax on other investment income and are also excluded from the Medicare surtax. Additionally, investments that produce taxable interest or that pay dividends could be held in a tax-deferred account like an IRA or possibly a tax-deferred annuity.

You may also consider owning a form of permanent life insurance, as the cash value of these polices when withdrawn is not considered net investment income.

Medicare Surtax of 0.9% Planning

Be prepared. If you’re married, filing jointly, and your combined wages will exceed the $250,000 income threshold for couples, you’ll want to make sure that your joint Medicare surtax for the year isn’t significantly higher than you anticipated.

Your employer won’t take your spouse’s income into consideration when figuring your Medicare tax withholding, but you can use IRS Form W-4 to have an additional amount deducted from your pay to cover the extra 0.9% tax on the amount by which you and your spouse exceed the combined income threshold.

Reducing MAGI is difficult for those who are still working. One strategy would be to maximize your contributions to pretax retirement plans like traditional 401(k)s or 403(b)s.

If you have control over the level of wages paid to you (i.e., you are the owner of your company), consider whether the wages you pay yourself are too high for the services rendered to the company.  If so, you may want to consider reducing your wages and paying the difference in distributions.  Be careful though – if you need to maintain a high wage to justify large pretax retirement contributions, this strategy make backfire.  Careful consultation with your tax expert is required.

All in all, a tax-smart investment plan is more important than ever. Talk to your tax adviser to help ensure your tax planning matches your investment and income needs.

For questions, contact Deborah Helton, CPA, at dhelton@biggskofford.com.

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