1. INSIGHTS FROM OUR NATIONAL TAX OFFICE JULY 23, 2012
The 3.8% Medicare Surtax
The Patient Protection and Affordable Care Act has several revenue provisions. The most significant
provision was included in the Reconciliation Bill (H.R. 4872) as the Unearned Income Medicare
Contribution or the "Medicare Surtax." Beginning on Jan. 1, 2013, individuals will be subject to a 3.8%
Medicare contribution tax on the net investment income of single taxpayers with modified adjusted
gross income (MAGI) exceeding $200,000 ($250,000 for joint filers). Modified adjusted gross income
for most taxpayers will be adjusted gross income unless the taxpayer has foreign earned income. For
estates and trusts, beginning on Jan. 1, 2013, there will be a 3.8% tax on the undistributed net
investment income with adjusted gross income exceeding the beginning of the highest tax bracket for
estates and trusts ($11,650 in 2012).
Net investment income includes the gross income from any of the following, less any deductions
related to such income:
Interest, dividends, royalties, annuities, rents (unless an active interest)
Net capital gains derived from the disposition of property (other than property held in an active
trade or business and a primary personal residence)
Income from passive activities
Trading financial instruments and commodities.
Surtax Application Illustrations
General Net Investment Income
The following examples show the application of the Medicare surtax provision to varying scenarios
with general net investment income:
A single taxpayer with $100,000 of wages and $125,000 of net investment income will be
subject to the 3.8% surtax on $25,000 of net investment income that exceeds the single AGI
threshold of $200,000. If the single filer has $225,000 of wages only, the surtax would not
apply since there is no investment income.
Married taxpayers filing jointly with $300,000 of income from an active trade or business with
no investment income would not be subject to the 3.8% surtax. If the same taxpayers received
an additional $75,000 of net investment income, the $75,000 would be subject to the surtax.
Married taxpayers filing jointly with pension income of $125,000 and investment income of
$120,000 would not be subject to the surtax since MAGI is below the threshold. A Roth
distribution of $50,000 would not cause the taxpayers to be subject to the surtax because a
Roth distribution is not included in MAGI and is not considered net investment income. If the
IRA distribution was from a Traditional IRA, $45,000 of the net investment income (the amount
which exceeds the threshold) would be subject to the 3.8% surtax. While the Traditional IRA
distribution is not considered net investment income, it is included when calculating MAGI.
A trust with net investment income of $50,000 and no distributions would be subject to the
surtax on the amount that exceeds the threshold amount. If 100% of the income was
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2. distributed for the year, the trust would not incur the surtax but it may be a concern for the
beneficiary.
Sale of a Primary Residence
The application of the surtax to home sales has caused some confusion due to misinformation
prevalent on the Internet. Under existing tax law, the gain on the sale or exchange of a primary
residence is excluded from gross income up to $250,000 for a single filer and $500,000 for joint filers
if the taxpayer(s) meet residence and use tests. This exclusion applies for capital gains tax as well as
the Medicare surtax.
In this example, married taxpayers filing a joint return with wages totaling $120,000 sell their personal
residence for $900,000 which they purchased ten years ago for $300,000. The capital gain on the
sale of their home is $600,000 with $100,000 subject to tax after the application of the $500,000 joint
filing exclusion. Their MAGI is $220,000 for the taxable year, so the gain on the sale of the home is
not subject to the 3.8% surtax but other capital gain rates would still apply. However, if the wages
totaled $300,000 for the year, the surtax would apply to the $100,000 gain because the MAGI of
$400,000 would exceed the threshold. If the gain on the sale of the home was less than $500,000,
neither the capital gains tax nor the surtax would apply since the exclusion would eliminate the entire
amount from gross income.
Planning Opportunities:
There are several planning opportunities available to minimize either the net investment income or
adjusted gross income to decrease the amount that exceeds the threshold after 2013 or to accelerate
income to 2012 to take advantage of the lower rates.
Pre-Jan. 1, 2013, Opportunities
If you anticipate being subject to the Medicare surtax and you are considering selling your home in
the near future, attempt to sell your home before 2013 if your home has a potential gain above the
exclusion amount of $500,000 for joint filers or $250,000 for single filers.
Before the surtax takes effect, consider harvesting any capital gains to take advantage of the lower
rate in 2012. Investments can be repurchased in 2013 if you wish to maintain the investment.
If you can afford to pay the tax due upon conversion, convert traditional IRAs to Roth IRAs in order to
remove the distributions from MAGI in the future.
Post-Jan. 1, 2013, Opportunities
To minimize net investment income after Jan. 1, 2013, consider increasing the proportion of tax-
exempt municipal bond investments or tax-deferred annuities in your investment portfolio.
Investments such as life insurance proceeds are exempt from taxation, while investments such as oil
and gas or real estate have related non-cash expenses that will reduce the gross income from the
investment.
To minimize MAGI, maximize deductible contributions to retirement plans or Traditional IRAs.
Consider installment sales to minimize the annual capital gain realized on the sale or exchange of
property and to manage the MAGI to avoid exceeding the thresholds.
Gifting income-producing property to individuals in lower tax brackets or charitable organizations will
reduce the income to the donor from such asset and may result in a deduction.
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does not constitute legal, accounting or other professional advice. It is not intended to be responsive to any individual situation or
concerns as the contents of the publication are intended for general informational purposes only. Readers are urged not to act upon
the information contained in this publication without first consulting competent legal, accounting or other professional advice
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3. regarding implications of a particular factual situation. Questions and information for publication can be submitted to your Eide
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