The Medicare surtax on investment income
Points to know
- The Medicare surtax applies to taxpayers above certain income thresholds.
- If the surtax applies to you, you'll owe an additional 3.8% tax rate on your investment income.
What's the Medicare surtax?
The Affordable Care Act of 2010 included a provision for a 3.8% "net investment income tax," also known as the Medicare surtax, to fund Medicare expansion.
It applies to taxpayers above a certain modified adjusted gross income (MAGI) threshold who have unearned income including investment income, such as:
Realized capital gains.
Modified adjusted gross income (MAGI)
An amount used to determine a taxpayer's IRA eligibility. Generally, it's the taxpayer's adjusted gross income calculated without certain deductions and exclusions.
Income you can receive by investing in bonds or cash investments. The investment's interest rate is specified when it's issued.
The distribution of the interest or income produced by a fund's holdings to its shareholders, or a payment of cash or stock from a company's earnings to each stockholder.
An increase in the value of an investment over the initial purchase price. A capital gain is "unrealized" until the investment is sold, when it becomes a "realized" gain. Realized gains are taxable, but the tax burden is deferred if you hold the investment in an IRA or a 401(k).
Other types of income subject to the Medicare surtax
Nonqualified annuities, rents, royalties, passive income from business activities, and undistributed net investment income from a trust or estate could also be subject to the Medicare surtax.
How is the tax calculated?
If the tax applies to you, you'll need to calculate the following 2 amounts using IRS Form 8960. You'll owe the 3.8% tax on the lesser amount.
- Your net investment income, which is your investment income minus expenses. (For estates and trusts, use undistributed net investment income.)
- The amount by which your MAGI exceeds the relevant amount listed above.
How to calculate your net investment income
To calculate your net investment income, you subtract—or "net out"—from your investment income certain expenses you incurred while investing to generate the income.
These expenses include investment interest expense (not interest from your mortgage), investment advisory and brokerage fees, expenses related to rental and royalty income, tax-preparation fees, state and local income taxes, and fiduciary fees (for an estate or trust).
You can get more information at irs.gov
How is the Medicare surtax reported?
If you owe the tax, you'll report it on your Form 1040 (and also include Form 8960, as stated above). If you believe you'll be subject to the tax, you may want to make quarterly estimated tax payments to avoid potential penalties. Talk to a tax advisor about your specific situation.
Is there any way to reduce the tax?
You can sell some securities at a loss to offset investment gains if you think you might be subject to the surtax this tax year. And when planning for the future, you can also choose investments that are naturally more tax-efficient.
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