Spring 2013 issue of Horizons

FEATURE

Net Investment Income Explained Net investment income that is subject to the 3.8% tax includes: interest, dividends, annuities, royalties, rents, and net capital gains, other than such income which is derived in the ordinary course of a non-passive trade or business. However, passive activity business income is subject to the tax. Net capital gains include the gain on a sale of a residence only to the extent that it is not excluded by other provisions in the tax code. For example, while other factors can reduce the excluded amount, the normal gain exclusion on the sale of a principal residence is $500,000 for married filing joint taxpayers ($250,000 for other taxpayers). If the gain is excluded under those provisions, it is excluded for the 3.8% tax as well. Remember, however, that the exclusion provisions don’t apply to sales of vacation homes or other second residences. Rule of thumb here, if the housing gain is subject to regular capital gains taxation, it’s also subject to the 3.8% tax. Income that does not bear the 3.8% tax includes: tax-exempt bond interest, retirement plan distributions, IRA distributions, Social Security payments and, of course, any earned income such as wages or self- employment income (although earned income above certain thresholds may be subject to a separate 0.9% tax). It’s not only the investor that is targeted by increased Medicare tax. Also new for 2013, some high wage earners will pay an extra 0.9% Medicare tax on a portion of their wage income. This is on top of the 1.45% Medicare tax that they are already paying. The 0.9% tax applies to wages in excess of $250,000 for joint filers, $125,000 for married individuals filing separately, and $200,000 for all others. The 0.9% tax applies only to employees, not to employers. 0.9% Medicare Tax on Wage and Self-Employment Income

Oddly increasing the “marriage penalty” for joint filers, the additional tax applies to the spouses’ combined wages. For example, suppose that a married couple each earns $150,000 for a combined amount of $300,000 in 2013. If single, neither would pay the additional tax; however, because they are married they will pay 0.9% on $50,000 of their combined wages. In this instance, the tax will be paid by adding it to their tax return for the year. If an employee’s wages reach $200,000 for the year, the employer must begin withholding the additional 0.9% tax from the wages. This withholding could either end up in two situations. First, if the withholding is in excess of a married employee’s liability, the employee will claim a refund on the tax return for that year. For example, if the employee earned $240,000, 0.9% would be withheld on $40,000. But if the spouse did not work, no liability would result because the total wages would not be $250,000. Alternatively, the withholding may prove insufficient if the employee has additional wage income from another job or if the employee’s spouse also has wage income. In this case, the tax would have to be paid with the tax return. The extra 0.9% Medicare tax also applies to self-employment income for the tax year in excess of $250,000 for joint filers, $125,000 for married individuals filing separately, and $200,000 for all others. This 0.9% tax is in addition to the regular 2.9% Medicare tax on all self-employment income. The $250,000, $125,000, and $200,000 thresholds will be reduced by the taxpayer’s wage income. While self-employed individuals can claim half of their self-employment tax as an income tax deduction, the additional 0.9% tax won’t generate any income tax deduction.

page 8 | horizons Spring 2013