Unless Congress changes the law, in 2013 an additional tax on investment income begins for individuals, estates and trusts with "high" incomes. This is really a "third" tax system after the regular income tax and the alternative minimum tax.
The 3.8 percent Medicare surtax applies to net investment income, defined as income from interest, dividends, annuities, royalties, rents and anything other than income from ordinary business operations. It does not include distributions from IRAs or qualified retirement plans, interest from tax-exempt bonds, gains on sale of an active interest in a partnership or S corporation, income from an active trade or business and a few other items.
The surtax only applies to amounts greater than the "threshold amount". For married taxpayers filing joint returns, the threshold amount is $250,000. For single taxpayers it is $200,000. For estates and trusts, it is about $13,000.
An example might be Joe, a single taxpayer, age 71, who has investment income of $200,000 and a Required Minimum Distribution from his IRA of $125,000. His Modified Adjusted Gross Income is then $325,000. After subtracting the threshold amount of $200,000, the amount subject to the Surtax is $125,000. His surtax is 3.8 percent of $125,000, or an additional tax of $4,750.
A different example could be made by Bill and Joan, a married couple that files a joint return. They have 2013 income of $140,000 from wages (or net business profits) and $100,000 of net investment income. That's a total of $240,000 MAGI. The threshold amount is $250,000 for them, so they have no surtax.
Another example is Peter and Penny, who are married and filing jointly, and who have $400,000 of salaries and $50,000 of net investment income. They will pay the 3.8 percent surtax on $50,000.
Another example is the Mary Jones Trust, which has investment income of $51,000 and makes no distributions. The amount that is greater than the threshold amount of $13,000 in 2013 is subject to the 3.8 percent surtax. The Trust will pay about $1,444 of surtax ($51,000 minus $13,000 equals $38,000, then multiplied by 3.8 percent).
Some planning could be in order to reduce the surtax in 2013 and future years. Maybe a partial conversion of a regular IRA to a ROTH IRA in 2012 could be considered. Maybe the trust or individuals could consider changing investments to stocks that do not pay much or any dividends (but are good stocks) and also look at tax exempt municipal bonds instead of taxable bond interest?
There is still time to plan and act so the 3.8 percent surtax will be reduced or avoided in 2013 and later years.
• John Bullis is a certified public accountant, personal financial specialist and certified senior adviser, serving Carson City for 45 years. He is founder emeritus of Bullis and Company CPAs, LLC.
