START PLANNING NOW FOR THE NEW MEDICARE SURTAX

I have been getting queries on the Medicare surtax, which is the the key revenue raiser in the new health reform law. First, the new tax does not take effect until 2013 but now is the time to start planning. Here is how the surtax works and how it will affect your tax planning strategies.

There are actually two surtaxes in the law:

• The first is a 0.9% levy on earned income, covering wages and income from self-employment. Singles owe the 0.9% surtax once total earnings are more than $200,000 - couples…over $250,000. That makes the effective Medicare tax on earnings over the thresholds 3.8%...the usual 2.9% rate plus the 0.9% surtax. In addition, self-employed taxpayers will not be able to deduct the surtax as part of their deduction for half their SECA tax.

• The second surtax is a special 3.8% Medicare surtax on unearned income of single filers with modified adjusted gross income (AGI) over $200,000 and joint filers above $250,000. Modified AGI is AGI less any excluded foreign earned income. The surtax is levied on the smaller of the filer’s net investment income or the excess of modified AGI over the thresholds. Investment income includes interest, dividends, capital gains, annuities, royalties and passive rental income, but not tax free interest or payouts from retirement plans such as regular IRAs, Roths, profit sharing plans and defined benefit plans.

For example: A couple with $50,000 of investment income and AGI of $270,000 will pay $760 (3.8% on the $20,000 excess over $250,000.) A single taxpayer with AGI of $300,000 and $50,000 of investment income will pay an additional $1,900 (3.8% of $50,000.)

Note the effect on capital gains and dividends. The maximum rate on both is currently 15%. If Congress adopts Obama’s budget plan to let the top rate rise to 20% for taxpayers, the surtax would effectively bump it to 23.8%. However, if Congress lets dividends be taxed as ordinary income again and sets the top rate at 39.6%, the surtax makes the maximum rate 43.4%, nearly triple the current levy. Add to that state taxes and you are well over a 50% tax rate.

Larry Kopsa CPA