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?
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 $12,750 in 2019. 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? Investment Income includes interest, dividends, capital gains (long and short), annuities (not those in IRAs or company plans), royalty income, passive rental income, 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, gains on the sale of an active interest in a partnership or S corporation.
Here are five things that can help you understand the impact of health care taxes on your investment income:
- Identify the surtax income thresholds. The first step is to know 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 ($12,750 for 2019). Trusts and estates are hit particularly hard with the surtax kicking in at a much lower income level.
- 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.
- 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. Taxpayers with income below those MAGI levels will NOT be subject to this tax.
- 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 10% of AGI to be deductible. That 10% also applies to the medical expense exception to the 10% penalty on early IRA or plan withdrawals.
- 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. Fill out the form below to set up an appointment with one of our advisors. Our appointments can be done in person, on the phone, or through a virtual meeting online.
Investment advisory services offered through Barber Financial Group, Inc., an SEC Registered Investment Adviser.
The views expressed represent the opinion of Barber Financial Group an SEC Registered Investment Advisor. Information provided is for illustrative purposes only and does not constitute investment, tax, or legal advice. Barber Financial Group 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.