There’s a relatively new tax that started January 1, 2013 – the Health Care Surtax which is 3.8%.
This relatively new tax hits people with higher incomes over $200,000 and it affects income from your investments. This tax started back in 2013 and helps fund the Affordable Health Care Act or Obamacare. How it works is taxpayers may have to pay this 3.8% tax on the lesser of: net investment income, or the amount that your modified adjusted gross income (MAGI) goes over a certain threshold.
The main threshold amounts are:
- $250,000 – for Married filing jointly
- $200,000 – for Single or head of household
If you exceed these thresholds, you may have to pay the tax. Unfortunately, these thresholds are NOT adjusted for inflation.
Basically, net investment income items come from unearned income such as interest, dividends, capital gains, rental and royalty income, and non-qualified annuities.
It generally does NOT include items such as wages, unemployment compensation, Social Security, alimony, and most self-employment income.
The Health Care Surtax is different from the new additional Medicare Tax of 0.9%, which went into effect at the same time. You could be subject to both taxes, but it’s not on the same type of income. While the Healthcare Surtax applies to unearned income, the 0.9% Medicare Tax generally applies to earned income such as wages, compensation, and self-employment income over certain thresholds - not to items included for Net Investment Income.
This HealthCare Surtax is subject to the estimated tax provisions. So you should adjust your income tax withholding or estimated payments to avoid penalties if you think you might fall under this tax.
Let’s look at a couple basic examples:
- Bob is a single taxpayer, $100,000 of salary, and $50,000 of net investment income. Bob’s modified adjusted gross income is $150,000 which is below the threshold for single filers of $200,000. So there is NO 3.8% tax for Bob.
- Now let’s say Bob is single and has no employment income, but has $225,000 of net investment income. So Bob’s MAGI is $225,000 and the threshold is $200,000, so Bob is $25,000 over the threshold and will owe 3.8% on that $25,000.
Ways to lower Net Investment Income and MAGI
There are ways to try and lower this, for example, tax exempt income can help lower net investment income. When it comes to reducing MAGI, if you are close to the thresholds, if you can increase contributions to your 401k or employer sponsored retirement plan - this can reduce MAGI for the 3.8% healthcare surtax. Also above the line deductions can help.
The thing about the Health Care Surtax as you can sense, is it is frustratingly complex. Chances are you don’t know about these things. Your advisor should be talking with you about this and how it may affect you and ways to address it. If not, consider contacting us for more information.
The content is developed from sources believed to be providing accurate information. The information in this material is not intended as tax or legal advice. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security.