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Starting in 2013 high income taxpayers [whose income is at or above $200,000] may be subject to two new Medicare taxes which consist of a 0.9% tax on earned income and self-employment income, and a 3.8% tax on net investment income.
The additional .9% tax applies to wage and self-employment income when income from these sources exceeds the threshold amount in table 1.
The additional 3.8% tax applies to the lesser of net investment income or the Modified Adjusted Gross income over the threshold amount in Table 1, below:
|Table 1 – High Income Thresholds|
|Single||$ 200,000||Not adjusted for inflation|
|Married Filing Joint||$ 250,000||Not adjusted for inflation|
|Married Filing Separate||$ 125,000||Not adjusted for inflation|
|Estates and Trust||$ 11,950||Adjusted for inflation|
Modified adjusted gross income is defined as adjusted gross income as shown on IRS Form 1040 line 37 plus net foreign earned income excluded plus or minus certain foreign income from Controlled Foreign Corporation’s and Qualified Electing Funds.
Investment income must be broken out into one of three categories listed below. Losses in one category do not offset gains in another category.
|3.8% Net Investment Income tax|
|IRS Category||Type of Income||Subject to NOL carryover/carryback|
|1||Interest, dividends, annuity distributions (income portion), rents, royalties (unless trade or business)||NO, could be negative as NII is reduced by expenses|
|2||Passive Activity Income from a trade or business (generally a limited partner cannot be a material participant unless meeting the 500 hour material participation test, then income will avoid NII tax)||NO, could be negative if disposing of activity with suspended loss|
|3||Net Capital Gain from Disposition of Property not used in trade or business (not material participant)||Yes|
|Not subject to 3.8% Net Investment Income tax|
|Salary, wages, bonuses, Self-employment income, Distributions from IRA’s or qualified plans, Gains on the sale of an active interest in Partnerships or S Corps, Tax exempt income (i.e. muni bond interest, capital gains under 121), social security benefits, personal services on a non-recurring basis (i.e. executor of family estate)|
Income from a trade or business that is from passive activities under IRC § 469 will be subject to net investment tax as category 2 income. In general, IRC § 469 defines passive activity as an activity in which the taxpayer does not materially participate. Material participation means the taxpayer is regularly, continuously, and substantially involved in the business operations. Once passive activities have been grouped together they cannot be regrouped in later years. A special one-time “fresh start” rule applies after 12/31/12 to regroup passive activities for the purpose of net investment tax.
Disposing of Partnership or S Corp Interest may not be taxable for net investment tax if you meet certain exceptions:
Trust and Estates may also be subject to the net investment tax, if income is accumulated in the trust or estate then it is taxed to the trust or estate. If the income is distributed to the beneficiaries then trust or estate gets an income distribution deduction and the beneficiaries have taxable income.
CIRCULAR 230 DISCLOSURE: To ensure compliance with requirements imposed by the United States Treasury Department, you are hereby informed that any tax advice contained in this written or electronic communication (including attachments) is not intended or written to be used, and cannot be used, for the purpose of avoiding penalties under the Internal Revenue Code or any governmental taxing authority or agency. This advice may not be forwarded without our express written consent. Securities and Advisory Services offered through Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Adviser. Fixed insurance products and services, as well as tax services, offered by Summit Financial Strategies, Inc. are separate and unrelated to Commonwealth.