Who Has to Worry About the 3.8% Surtax

Who Has to Worry About the 3.8% Surtax

Individual taxpayers face the prospect of a darker tax climate in 2013 for investment income and gains. Under current law, higher-income taxpayers will face 3.8% surtax on their investment income and gains under changes made by the Affordable Care Act.

For tax years beginning after Dec. 31, 2012, a 3.8% surtax applies to the lesser of (1) net investment income or (2) the excess of modified adjusted gross income (MAGI) over the threshold amount ($250,000 for joint filers or surviving spouses, $125,000 for a married individual filing a separate return, and $200,000 in any other case).  MAGI is adjusted gross income (AGI) increased by the amount excluded from income as foreign earned income (net of the deductions and exclusions disallowed with respect to the foreign earned income).

observation: Thus, for those who must pay it, the surtax equals 3.8% multiplied by the lesser of: (1) net investment income; or (2) the amount by which MAGI exceeds the threshold amount.

observation: Only individuals with MAGI above the applicable threshold amount will be subject to the tax.

illustration 1: For 2013, a single taxpayer has net investment income of $50,000 and MAGI of $180,000. He won’t be liable for the tax, because his MAGI ($180,000) doesn’t exceed his threshold amount ($200,000).

illustration 2: For 2013, a single taxpayer has net investment income of $100,000 and MAGI of $220,000. He would pay the tax only on the $20,000 amount by which his MAGI exceeds his threshold amount of $200,000, because that is less than his net investment income of $100,000. Thus, the surtax would be $760 ($20,000 × 3.8%).

observation: An individual will pay the 3.8% tax on the full amount of his net investment income only if his MAGI exceeds his threshold amount by at least the amount of the net investment income.

illustration 3: For 2013, a single taxpayer has net investment income of $100,000 and MAGI of $300,000. Because his MAGI exceeds his threshold amount by $100,000, he would pay the tax on his full $100,000 of net investment income. Thus, the tax would be $3,800 ($100,000 × .038).

The tax is taken into account in determining the amount of estimated tax that an individual must pay, and is not deductible in computing an individual’s income tax.

 What is net investment income? For purposes of the Medicare contribution tax, “net investment income” means the excess, if any, of:

(1) the sum of:

… gross income from interest, dividends, annuities, royalties, and rents, unless those items are derived in the ordinary course of a trade or business to which the Medicare contribution tax doesn’t apply (see below),

… other gross income derived from a trade or business to which the Medicare contribution tax does apply (below),

… net gain (to the extent taken into account in computing taxable income) attributable to the disposition of property other than property held in a trade or business to which the Medicare contribution tax doesn’t apply, over

(2) the allowable deductions that are properly allocable to that gross income or net gain.

Beals, Caruana & Company, P.C.