Spring 2013 issue of Horizons

While many taxpayers were anxiously keeping an eye on Congress toward the end of 2012 to see if any last minute action would raise their taxes in 2013, the Patient Protection and Affordable Care Act (“ACA”) enacted in 2010 was already poised to do just that. The ACA calls for a 3.8% surtax on the lesser of net investment income or the amount by which modified adjusted gross income exceeds certain levels. Separately, taxpayers with wages or self employment income above certain levels will also see a rise of 0.9% on the excess.

To those taxpayers that breathed a sigh of relief when they saw that the provisions of the newest law were aimed at taxpayers in the $400,000 plus range, you’re not out of the woods yet.

3.8% Medicare Tax on Investment Income This new tax will only affect taxpayers who have investment income and whose adjusted gross income (AGI) exceeds:

∙ $250,000 for joint filers and surviving spouses

∙ $200,000 for single taxpayers and heads of household

∙ $125,000 for married individuals filing separately

Rather than measuring your income by using a taxable income standard (income after deductions), this rule essentially looks at your total income. While you may see the term “Modified Adjusted Gross Income” used, the only modification is the foreign income exclusion. For the vast majority of taxpayers then, the measurement will be the bottom line on Page 1 of their Form 1040.

If your AGI is above the applicable threshold, the 3.8% tax will apply to the lesser of either:

∙ Your net investment income for the tax year

∙ The excess of your AGI for the tax year over your threshold amount

This tax is on top of any income tax you are already paying on that income.

Let’s look at three examples to illustrate how this works. We’ll use taxpayers with a married filing joint status so their thresholds would each be $250,000.

$250,000

Although Taxpayer C has far more investment income than the other two taxpayers, he is not subject to the tax because the total income does not exceed the threshold. Only $10,000 of the investment income is subject to the tax because the total income exceeds the threshold. Additional tax = $380 ($10,000 x 3.8%). All of the investment income is subject to the tax because the regular income exceeds the threshold. Additional tax = $1,520 ($40,000 x 3.8%).

Taxpayer A

$260K

$40K

Taxpayer B

$220K

$40K

Taxpayer C

$250K

regular (non-investment) income

investment income

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