Tax changes keep my job interesting! In that sense, I think they’re great. If you aren’t the heir to a wealth of tax expertise, however, they can be a little confusing. As taxpayers begin preparing their tax returns for April 15, they must take into consideration several new tax rates that have come into being recently. One new piece of tax legislation of particular interest that will be the focus of this blog is the 3.8% net investment income tax.

In 2010, as part of the health care legislation often referred to as ‘Obamacare’, Congress passed a new tax provision, the “Unearned Income Medicare Contribution.” this levy, which places a 3.8% tax on various forms of investment income for individuals, trusts, and estates, has been referred to by a number of names.  Some of these include the 3.8% Medicare Contribution tax, the 3.8% investment tax and the 3.8% Medicare tax. I prefer to call it the Medicare Surtax. Simple and to the point.

Before focusing on the specific application of the 3.8% Medicare Surtax to an individual investment situation, it is important to establish a general understanding of the tax. The 3.8% Medicare Surtax is outlined in IRC Section 1411 which I have read over thoroughly so you don’t have to. It came along with a hundred-plus page regulations guide which includes a preamble and 11 sections remained open to revisions and comments throughout last year.

Currently, there are four parts to Code Sec. 1411 by itself:
Calculation of 3.8% Medicare Surtax for individuals
Calculation of 3.8% Medicare Surtax for trusts and estates
General definition of terms
Special exceptions and situations

For individuals, the calculation of the 3.8% Medicare Surtax is dependent on two components: a taxpayer’s net investment income (NII) and his or her modified adjusted gross income (MAGI).  For each taxable year, the MAGI, after being reduced by a fixed threshold, is compared to NII.  The 3.8% Medicare Surtax is applied on the lesser of the two. This means that for individuals who have little or no net investment income, their 3.8% Medicare Surtax will be minimal if not zero. The three thresholds mentioned above are:

$250,000 for married couples filing jointly
$125,000 for married couples filing separately
$200,000 for everyone else

To illustrate the effects of this tax on an individual, take the following example.  Let’s say that Barbie made $150,000 in salary for 2013. She and Ken have both moved on from one another and she is currently single. In addition to her salary, she collected $75,000 of net investment income as she is very stock market savvy.  Her modified adjusted gross income would be the sum of his salary and net investment income this year, or $225,000. Since she is not married, her threshold is $200,000, which means her MAGI after being reduced by a fixed threshold of $200,000 is $25,000. Since this is less than the $75,000 NII, this $25,000 figure is where the 3.8% Medicare Surtax is applied.  After all that, Barbie’s taxes will increase by $25,000 x 0.038 or $950.

Exactly how this new tax will affect you and your checkbook can be hard to calculate with no help. That’s what I’m here for! If you’d like to know more about your own surtax situation, just call my office.

Buffie the Tax Heiress