The Impact of Health Care Taxes in 5 Easy Steps

By Modern Wealth Management

January 18, 2019

Understanding The Impact of Health Care Taxes

Chances are you have heard about the 3.8% surtax that went into effect in 2013 under the Affordable Care Act – but do you know if and when you might need to pay it and do you understand the impact of the health care taxes?

While there have been significant changes to the tax code over the past year, the Medicare tax and net investment income tax remain in effect. This surtax requires that an additional tax be paid by those with investment income, whether from interest, dividends, capital gains or rental properties when they are above the annual income threshold. Trusts and estates are hit especially hard; they reach the income threshold at only $12,950 in 2020. For those still earning wages or self-employment income, there might be an additional 0.9% Medicare tax to consider as well.

So what is considered investment income? In short, investment income includes interest, dividends, capital gains (long and short), annuities (not those in IRAs or company plans), royalty income, passive rental income, and other passive activity income. What is NOT Investment Income? Wages and self-employment income, active trade/ business income, distributions from IRAs, Roth IRAs and employer plans, excluded gain from the sale of a principal residence, municipal bond interest, proceeds of life insurance policies, veterans’ benefits, Social Security benefits, and gains on the sale of an active interest in a partnership or S corporation.

The Impact of Health Care Taxes in 5 Easy Steps

Here are five things that can help you understand the impact of health care taxes on your investment income:

1. Identify the surtax income thresholds.

Firstly, understand the MAGI (modified adjusted gross income) thresholds to avoid the 3.8% surtax on net investment income. They are as follows: Married Filing Jointly ($250,000); Individuals ($200,000); Married Filing Separately ($125,000); Trusts and Estates ($12,950 for 2020). Trusts and estates are hit particularly hard with the surtax kicking in at a much lower income level.

2. Look at TAXABLE income.

Taxable income from all sources can push taxpayers over the MAGI threshold and cause their investment income to be subject to the 3.8% surtax. Income tax-free Roth distributions will NOT affect MAGI.

3. Understand how much will be taxed?

The 3.8% surtax is imposed on the lesser of (1) net investment income or (2) the amount of MAGI over the certain income threshold. So, taxpayers with income below those MAGI levels will NOT be subject to this tax.

4. Know other health care tax provisions.

The 3.8% surtax gets the attention, but there is also an additional 0.9% Medicare tax on wages and self-employment income over the MAGI thresholds. Also, medical expenses must exceed 7.5% of AGI to be deductible. That 7.5% also applies to the medical expense exception to the 10% penalty on early IRA or plan withdrawals.

5. Discuss these tax planning points.

You need to know that while IRA and plan distributions are exempt from the surtax, taxable distributions from these accounts can push income over MAGI thresholds. Roth conversions can be a valuable tool to eliminate future taxable income, especially for taxpayers with significant investment income or a discretionary trust as their IRA beneficiary. However, conversions could push you above your threshold in the short-term. Salary deferrals (401(k)s for example) can reduce MAGI for the 3.8% surtax but NOT for the 0.9% additional Medicare tax.

If you’re interested in learning strategies to help reduce these health care taxes, we are happy to help. So, schedule a complimentary consultation below with one of our advisors. Our appointments can be done in person, on the phone, or through a virtual meeting online.

Schedule a Complimentary Consultation

Select the office you would like to meet with. We can meet in-person, by virtual meeting, or by phone. Then it’s just two simple steps to schedule a time for your Complimentary Consultation.

Lenexa Office Lee’s Summit Office North Kansas City Office

Investment advisory services offered through Modern Wealth Management, Inc., an SEC Registered Investment Adviser.

The views expressed represent the opinion of Modern Wealth Management an SEC Registered Investment Advisor. Information provided is for illustrative purposes only and does not constitute investment, tax, or legal advice. Modern Wealth Management does not accept any liability for the use of the information discussed. Consult with a qualified financial, legal, or tax professional prior to taking any action.