The New Federal Medicare Surtaxes - Do They Apply to You?

The New Federal Medicare Surtaxes - Do They Apply to You?

New Medicare surtaxes were signed into law effective January 1, 2013 - 3.8% surtax on Net Investment Income for individuals with Adjusted Gross Income over $200,000 and couples over $250,000, and a .9% surtax on Earned Income for those same taxpayers.  How to implement these new taxes has been a topic of discussion as we wait for the Internal Revenue Service to publish regulations, including the definitions of Net Investment Income.  The IRS has recently issued extensive proposed regulations addressing many of the uncertainties surrounding the new Medicare surtaxes.  While the regulations are not expected to be finalized well into 2013, the IRS has stated that they can be relied upon for purposes of planning and compliance for 2013.

It is clear that interest, dividends, and capital gains have always been, and are still, considered Net Investment Income, and will be subject to the 3.8% Medicare surtax if the income thresholds are met.  However, questions have arisen as to whether other common types of income will be subject to the 3.8% tax, namely pass through income from profits of a trade or business.  Under other sections of the tax code, trade or business income from an S Corporation has always been considered "investment" income with regard to social security self-employment tax, and therefore excluded from self-employment taxes.  So it is subject to the 3.8% surtax on Net Investment Income?

Other discussion points have been regarding distributions from qualified plans (IRA's, 401K's, etc.), and gains from the sale of certain assets, namely sales of homes and other real estate.  Are these items subject to the 3.8% surtax on Net Investment Income?      

The proposed Regs have identified that the major issue for small business owners in a trade or business is whether the owner materially participates in the business or not.  If so, the profits are not considered Net Investment Income and not subject to the 3.8% surtax.  In that situation, the broader question then becomes whether the owner is subject to the .9% surtax on Earned Income.  Many interpret the new Regs to say S Corporations are not.  However, it is clear that if an owner of a trade or business is "passive" by nature (not materially participating); they are subject to the 3.8% surtax. 

And how do we apply the rules to the sale of real estate, specifically principle residences?  Clearly, the sale of real estate would generally cause the income thresholds to be met, and trigger the surtaxes.  The proposed Regs say gains that are not recognized for income tax purposes will not be recognized for Net Investment Income purposes either.  That's good news for those who are selling their homes!  However, sales of investment property, second homes, or rental activities may be subject to the 3.8% surtax.

Also, the proposed Regs have indicated that distributions from qualified plans, although perhaps putting taxpayers over the income thresholds, would not be subject to the 3.8% surtax on Net Investment Income.   

Bottom line is that this is a complex area.  If you are approaching the income thresholds as discussed, we strongly recommend getting with your tax advisor to discuss how these new laws will affect you, and what you can do to minimize your tax liability.  Please feel free to call our office for help.

This post is contributed by a community member. The views expressed in this blog are those of the author and do not necessarily reflect those of Patch Media Corporation. Everyone is welcome to submit a post to Patch. If you'd like to post a blog, go here to get started.


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