Medicare Tax On High Earners’ Investments

Posted on: October 27th, 2011 by Lawrence A. Friedman

Beginning in 2013, people with higher incomes will pay a 3.8 percent Medicare surtax on net investment income such as interest, dividends, rents, net capital gains on investments, and certain other income. However, net investment income doesn’t include tax exempt municipal bond interest, annuity distributions, distributions from IRAs and qualified plans, and various other kinds of income. The surtax only applies to the lower of net investment income or the excess of modified adjusted gross income over thresholds that vary by filing status (e.g. $200,000 single persons, $250,000 married persons filing jointly). The tax also can apply to trusts and estates with undistributed net investment income.

Since the surtax isn’t effective until 2013, accelerating income (especially investment income) into 2012 can generate significant savings. For instance, if you are considering converting a regular IRA to a Roth IRA, it may be beneficial to convert in 2012 rather than 2013 to avoid the surtax. By the same token, it may be beneficial to sell in 2012 assets with substantial built-in capital gain that otherwise would be liquidated in the next few years. Similarly, exposure to the surtax can be lessened through strategies that reduce modified adjusted gross income generally. For instance, investments that generate income subject to the surtax can be sold and proceeds invested in municipal bonds. Maximizing contributions to 401(k) plans, IRAs, other tax favored savings, and cafeteria plans all serve to reduce income.

In short, higher income taxpayers will face a significant Medicare surtax beginning in 2013, but advance planning can limit the exposure. FriedmanLaw can guide you to develop effective plans to limit the impact of the Medicare surtax and realize your overall tax and estate planning goals.

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