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Retirement

The Medicare surtax on investment income

If you're a high earner, an additional tax could apply to your investment income.
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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:

Taxable interest.

Dividends.

Realized capital gains.

See other types of income subject to the Medicare surtax

Modified adjusted gross income

An amount that is used for determining a taxpayer's IRA eligibility; it is generally the taxpayer's adjusted gross income (shown on IRS Form 1040 or 1040A) calculated without any IRA deduction, foreign earned income exclusion, foreign housing exclusion, student loan interest deduction, exclusion of qualified savings bond interest from Form 8815, exclusion of employer-paid adoption expenses from Form 8839, or deduction for qualified tuition and related expenses. Please note that MAGI for IRA conversion purposes will also exclude any current year conversion amounts to determine eligibility. IRS Publication 590 should be used to assist with IRA calculations pertaining to various definitions of MAGI.

Interest

The amount or rate charged when money is borrowed. For example, when you invest in bonds, you receive interest payments from the bond's issuer.

Dividend

The distribution of the interest or income produced by a mutual fund's holdings to the fund's shareholders, or a payment of cash or stock from a company's earnings to each stockholder. Dividends can be distributed monthly, quarterly, semiannually, or annually.

Capital gain

The difference between the sale price of an asset — such as a mutual fund, stock, or bond — and the original cost of the asset.

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.

See more about calculating your net investment income

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.

Offset gains through tax-loss harvesting

Choose tax-saving investments

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