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The 2010 health care act includes some significant tax provisions, the most notable of which impose expanded Medicare taxes on higher-income taxpayers. Could these taxes take a bite out of your 2013 income?
Additional 0.9% Tax on Earned Income
The health care act levies an additional 0.9% Medicare tax on FICA wages and self-employment income in excess of $200,000 ($250,000 for married couples filing jointly and $125,000 for married couples filing separately). Employers are required to withhold the additional tax beginning in the pay period when wages exceed $200,000 — regardless of the employee’s filing status.
As a result, your employer might have to withhold the tax even though you don’t owe it — for example, if your wages exceed $200,000 but you and your spouse’s combined wages don’t exceed $250,000. In this case, you can claim a refund when you file your 2013 tax return.
Or, your employer might not withhold the tax even though you owe it — for instance, if your wages alone don’t exceed $200,000, but you and your spouse’s wages together exceed $250,000. In this situation, consider submitting a W-4 to your employer requesting additional income tax withholding, which can be used to make up the difference and avoid interest and penalties.
New 3.8% Tax on Investment Income
Traditionally, unearned income hasn’t been subject to Medicare tax. The health care act changes this, imposing a 3.8% Medicare contribution tax on some or all net investment income if a taxpayer’s modified adjusted gross income (MAGI) exceeds the same dollar thresholds that trigger the 0.9% tax.
Net investment income generally includes interest, dividends, capital gains, and rental and royalty income, reduced by certain expenses that can be allocated to that income, such as interest expense, advisory and brokerage fees, and state and local income taxes. The 3.8% tax applies to the lesser of net investment income or the amount by which your MAGI exceeds the applicable threshold.
Distributions from qualified retirement plans and IRAs aren’t subject to the 3.8% tax. However, they are included in MAGI, so they may trigger the tax on your net investment income. Other income that’s excluded from income tax is also generally excluded from the 3.8% tax, such as gain on the sale of a principal residence that qualifies for the $250,000 ($500,000 for joint filers) gain exclusion.
What Can You Do?
Timing strategies that can save income and capital gains tax may also help you reduce or avoid the expanded Medicare taxes. But the rules are complex. For additional information on our estate & trust services, please contact Jordon Rosen, CPA, AEP, at 302.225.0600 or click here to email Jordon. In a brief consultation he can assess your situation and determine the best way to proceed.