Beginning on January 1, 2013, certain taxpayers will be subject to a new 3.8% surtax that will help support the expanding costs of Medicare under provisions of The Patient Protection and Affordable Care Act (Obamacare). The surtax will apply to certain passive investment income of individuals as well as estates and trusts.
For individual taxpayers, the income thresholds for application of the surtax are as follows:
- Married taxpayers, filing jointly $250,000
- Married taxpayers, filing separately $125,000
- All other individual taxpayers $200,000
For individual taxpayers, the 3.8% surtax will be based on the lesser of (1) net investment income, or (2) the amount by which modified adjusted gross income (MAGI) exceeds the threshold amount in that tax year.
For estates and trusts, the 3.8% surtax will be based on the lesser of (1) the undistributed net investment income of a trust or estate, or (2) the excess of adjusted gross income over the top bracket for estate and trust income (the brackets are adjusted for inflation and the top bracket is expected to be approximately $12,000 in 2013).
What types of income will be subject to the 3.8% surtax? Interest, dividends, royalties, annuities, certain rents, capital gains from the sale of property that is not used in an active trade or business, and trading of financial instruments and commodities.
What types income won't be subject to the 3.8% surtax? Active business income, ordinary and capital gain on the sale of an active interest in a partnership or S corporation, distributions from IRAs and qualified retirement plans, income from tax-exempt municipal bonds, tax-deferred nonqualified annuities, income subject to self-employment tax, and excludable gain from the sale of principal residence.
For individuals and estates and trusts that may be subject to the 3.8% surtax, the time to plan for reducing or eliminating the surtax is now. Strategies for reducing or eliminating the surtax may include:
- Investing in tax exempt bonds
- Converting from traditional to Roth IRAs
- Choosing a tax year beginning in 2012 instead of 2013 for estates and trusts
- Making estate or trust distributions to individual beneficiaries who will not be subject to the surtax
- Charitable planning
- Creating above-the-line deductions
If you are an individual, executor of an estate, or trustee of a trust who is concerned about being subject to the 3.8% surtax, consult with your tax advisor now in order to determine your potential surtax liability and strategies that can be implemented to reduce or even eliminate your surtax liability.