[author: Beth S. Cohn, Esq.]
Health care reform creates new taxes, which you may be unaware of and yet still liable for. In 2012, there is a new tax imposed under the 2010 Health Care Act, as amended by the 2010 Health Care Reconciliation Act. This new tax is called the Medicare Contribution Tax ("MCT"). The MCT tax is levied on unearned income of individuals, estates and trusts. For MCT, unearned income includes interest, dividends, rents, and capital gains that include capital gains on the sale of a personal residence if the gain exceeds the defined threshold.
Summary of MCT
MCT is calculated by multiplying 3.8% times the lesser of the following:
(i) net investment income, less than the applicable threshold (investment income less properly allocated expenses); or
(ii) modified adjusted gross income ("MAGI") less the defined threshold.
Retirement distributions are excluded from investment income.
MAGI is adjusted gross income increased by the amount of excluded foreign income (net of allowed deductions and exclusions against foreign income).
The threshold for individuals is:
Married Filing Jointly (or surviving spouses): $250,000
Married filing Separate Returns: $125,000
Other Cases: $200,000
Even though the gain from the sale of a home may be subject to MCT, is not applicable to the extent that the gain is excluded from taxation. These rules are very complicated. Generally, if a married couple has lived in their primary residence for two of the last five years, and is filing a join return, the exclusion on the sale of the home is $500,000. For single taxpayers and married taxpayers not filing jointly, the exclusion is $250,000.
2013 Examples of MCT:
Single Taxpayer has MAGI of $300,000 and Investment income of $150,000
MAGI is $100,000 more than the threshold of $200,000. This is less than the net investment income.
The MCT is $3800 ($100,000 times 3.8%)
Single Taxpayer has MAGI in $400,000 which is Excess of
Net Investment Income of $150,000
The difference between MAGI and the threshold is $200,000 which is greater than the net investment income of $150,000.
The MCT is $5700 ($150,000 times 3.8%)
Sale of a Home a married couple has AGI of $400,000.
They sell their principal residence and have a capital gain of $600,000
Their MAGI is $400,000 plus $100,000 (the amount the gain on the sale of their home exceeds the $500,000 exclusion), for an amount equal to $500,000.
MCT is calculated on the lesser of $100,000 (reportable gain from the sale of the house) and MAGI of $500,000 minus the threshold amount of $250,000.
Their MCT is $3,800 ($100,000 times 3.8%). No liability from MAGI.
Under the Patient Protection and Affordable Care Act, there is a new 0.9% surtax on self- employment income of certain high earners ("Surtax"). Taxpayers with high income and investment income may be subject to both the MCT and the Surtax.
The Surtax is imposed on self-employment income in excess of the threshold amounts listed above for the MCT. The employer's portion of the Medicare Tax does not increase. This means that the employee's share of the Medicare Tax in 2013 will increase to 2.35% (instead of 1.45%) of the employee's self employment income over the applicable threshold amounts.
Planning Techniques for MCT and Surtax
Reduce 2013 taxable income and MAGI by accelerating income and bonuses in 2012. However, if 2013 MAGI is less than the applicable threshold, there will be MCT liability.
If a taxpayer is anticipating large capital gains from the sale of a business, investments or a house, the transaction should be completed before 2013 when the MCT becomes effective.
Taxpayers will need to implement techniques and strategies to reduce self-employment income.
Careful planning may help to eliminate, lessen or defer MCT and the self-employment Surtax. These are complex, complicated and new rules. We recommend that you contact your tax advisor to determine how these changes impact you and your individual planning situation.
About the author: Beth S. Cohn is a shareholder at the Phoenix law firm of Jaburg Wilk where she assists clients with business, tax, gifting programs, succession planning, asset protection and estate planning. She chairs the business law department and is a State Bar of Arizona certified tax specialist and a CPA. Beth can be reached at 602.248.1030 or firstname.lastname@example.org.
IRS CIRCULAR 230 DISCLOSURE: To ensure compliance with requirements imposed by the IRS, we inform you that, to the extent this communication addresses any tax matter, it was not written to be and may not be relied upon to (i) avoid tax-related penalties under the Internal Revenue Code, or (ii) promote, market or recommend to another party any transaction or matter addressed herein