Brian L Bentley
As of Jan. 1, 2013, some taxpayers are subject to a new 3.8 percent Medicare tax on their net investment income, but even though this tax has a wide reach, certain steps may be taken to lessen its impact.
Net investment income, for purposes of the new 3.8 percent Medicare tax, includes interest, dividends, annuities, royalties and rents, as well as other gross income attributable to a passive activity. Gains from the sale of property not used in an active business, and income from the investment of working capital, are treated as investment income, as well. However, the tax does not apply to nontaxable income, such as tax-exempt interest or veterans’ benefits.
Further, an individual’s capital gains income—both long-term and short-term—will be subject to the tax. This includes gain from the sale of a principal residence, unless the gain is excluded from income under Code Sec. 121, and gains from the sale of a vacation home. Planning the sale of big ticket items, therefore, often requires attention to the new 3.8 percent surtax.
Net investment income is reduced by deductions properly allocable to the qualifying income or gain. Therefore, it is critical to keep track of amounts, which increase your property’s basis or other investment expenses, which may reduce net gains. These include, interest on loans to purchase investments, investment counsel and advice, as well as fees to collect income. Other costs, such as brokers’ fees, may increase basis or reduce the amount realized from an investment.
The tax applies to the lesser of net investment income or modified AGI above $200,000 for individuals and heads of household, $250,000 for joint filers and surviving spouses, and $125,000 for married filing separately. The tax can have a substantial impact if you have income above the specified thresholds. Also, remember, in addition to the tax on investment income, you also may face other tax increases having taken effect in 2013.
The top marginal income tax rate is now 39.6 percent, and the top tax rate on long-term capital gains has increased from 15 percent to 20 percent. Thus, the cumulative rate on capital gains for someone in the highest rate bracket has increased to 23.8 percent in 2013. Moreover, the 3.8 percent surtax’s thresholds are not indexed for inflation, so a greater number of taxpayers may be affected as time elapses.
Please contact our office if you would like to discuss the tax consequences to your investments of the new 3.8 percent Medicare tax on investment income. Pearce, Gray and Co., PLC is located at 3514 N. Power Road, Suite 135. Call (480) 835-1124.
Brian L. Bentley is a partner at Pearce, Gray and Co., PLC, and has been with the firm for almost 10 years. He focuses on small businesses and multi-state taxation.