John R. Bullis: What is the 3.8 percent Medicare surtax?
June 19, 2017
IRS Code Section 1411 charges 3.8 percent additional Medicare tax on unearned income of high earning taxpayers. That surtax is called "unearned income Medicare contribution tax" or the "Net Investment Income Tax." It is in addition to the regular income tax.
The tax applies, in certain situations, on investment income such as interest, dividends, annuities, royalties and rents-unless it is from the ordinary course of a trade or business.
Investment income is not distributions from IRAs and other tax-favored retirement plans; tax exempt income and earnings from sole owner businesses and similar income that is subject to the self-employment tax and a few other items.
This surtax is on the lesser of the net investment income or the excess of modified adjusted gross income over $250,000 for joint returns and $200,000 for single folks.
For example, if Joe, a single taxpayer, has $180,000 of wages and $20,000 of interest and dividends there is no net investment income tax. His total modified adjusted gross income is not more than $200,000.
But if Joe had $200,000 of wages and $20,000 of unearned income from interest and dividends, the 3.8 percent surtax would apply on the $20,000. He would pay $760 surtax.
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The surtax applies on passive income. But in the case of rental income, if he shows he has "material participation" in the rental activity then the rental income is not subject to the surtax. Special rules apply to real estate professionals.
If Joe sold his home, his principal personal residence, that he owned and occupied for two of the five years before sale, he can exclude up to $250,000 of gain from the tax.
Gain greater than the home sale gain exclusion ($250,000) would be subject to the tax as would any gain from sale of a second home, a vacation home and most other capital gains.
The tax law on this has all kinds of other special definitions and rules. Congress really complicated this but with planning, the surtax can be reduced or avoided. Timing the receipt of certain types of income, using the installment sale provision on certain sales, etc., can be helpful.
Did you hear? Epitaph on a pessimist's headstone: "I expected this."
John Bullis is a certified public accountant, personal financial specialist and certified senior adviser who has served Carson City for 45 years. He is founder emeritus of Bullis and Company CPAs.