January 1, 2013. Many of us will be waking up from a night of celebrating the dawning of a new year and new beginnings. Many of us will be also be waking up to the beginning of two new individual taxes that will take effect as of that date as part of provisions of President Obama’s Affordable Care Act passed by Congress in March of 2010. These new taxes are intended to generate government revenue to help finance reforms under the health care legislation. And, while we can all agree to disagree on whether universal healthcare is a positive or negative for the future of our economy, the focus of this article will be to not only make you aware of the new taxes but also to help you determine whether you and your family will be subject to either or both of the new taxes so that you can prepare in advance for the impact to your household budget.
3.8% Unearned Income Medicare Contributions Tax
This is a Medicare contribution tax levied on unearned income. The tax will be imposed on certain individuals, estates, and trusts. For individuals, the tax is 3.8% of the lesser of (1) net investment income or (2) the excess of Modified Adjusted Gross Income (“MAGI”) over $250,000 (for Married Filing Joint taxpayers)/$125,000 (for a Married Filing Separate taxpayers)/$200,000 (for all other filers).
For purposes of the tax, net investment income is generally defined as income from interest, dividends, annuities, royalties, rents and other passive activity income, and net capital gains derived from the disposition of property. Investment income does not include the following:
- Income derived from an active trade or business
- Distributions from IRAs or other qualified retirement plans
- Any income taken into account for self-employment tax purposes
- Gain on the sale of an active interest in a partnership or S-corporation
- Items which are otherwise excluded or exempt from income under income tax law, such as interest from tax-exempt bonds.
This tax is not imposed on persons who are nonresidents for U.S. tax purposes.
For U.S. citizens and green card holders living abroad, Modified Adjusted Gross Income is calculated by adding back to federal Adjusted Gross Income, the foreign earned income exclusions.
Sample calculation: Matt and Susan are married and file a joint tax return. They have $275,000 of salary income combined and $50,000 of investment income from dividends and capital gains. Their adjusted gross income is $325,000. They don’t have any foreign income exclusions.
- Step 1: Calculate their net investment income, or $50,000.
- Step 2: Calculate their modified adjusted gross income in excess of the threshold amount, or $325,000 minus $250,000 for joint filers = $75,000.
- Step 3: Take the lower of net investment income or modified adjusted gross income over the threshold, which is $50,000 in this case.
- Step 4: Multiply $50,000 by 3.8% = $1,900.
0.9% Additional Medicare Tax
In addition, also beginning January 1, 2013, there is scheduled to be an additional Medicare tax of 0.9% (an addition to the Hospital Insurance portion of Medicare) on employee’s wages and on self-employment income in excess of certain threshold amounts. Employers are responsible for withholding the tax on their employee’s wages. For self-employed individuals, the additional tax would need to be included in their quarterly estimated federal income tax payments.
The income thresholds are the same as for the 3.8% Unearned Income Medicare Contributions tax (see above) but only the wages/net self-employment income that is in excess of the threshold for the individual’s filing status would be subject to the additional 0.9% Medicare tax.
There are no special exemptions or rules for nonresidents working in the United States. Taxable wages earned by such individuals that are subject to Medicare tax will be subject to the additional Medicare tax withholding if the individual’s total wages exceed the threshold for his/her filing status.
It is possible to be subject to both the 3.8% Unearned Income Medicare Contributions tax and the 0.9% Additional Medicare tax on wages/self-employment income.
Sample calculation: Grant is single and filing as a Single taxpayer. He has $290,000 of salary income combined and $35,000 of investment income from rental income and capital gains. His adjusted gross income is $325,000. He doesn’t have any foreign income exclusions.
- Step 1: Calculate his net investment income, or $35,000.
- Step 2: Calculate his modified adjusted gross income in excess of the threshold amount, or $325,000 minus $200,000 for single filers = $125,000.
- Step 3: Take the lower of net investment income or modified adjusted gross income over the threshold, which is $35,000 in this case.
- Step 4: Multiply $35,000 by 3.8% = $1,330
- Step 5: Calculate his wages in excess of the threshold amount, or $290,000 minus $200,000 for single filers = $90,000.
- Step 6: Multiply $90,000 by 0.9% = $810
Stay tuned to Tax Alerts from The Wolf Group as we will keep you informed of any important changes in individual income taxation.
ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY THE WOLF GROUP TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN.