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New tax for high-income taxpayers.

Starting in 2013, certain taxpayers will owe an additional 3.8% "Medicare" tax. (The money raised will be allocated to the Medicare program.) To be affected, you must have both an ample gross income and income from investments.

* Gross income. This 3.8% surtax applies to taxpayers filing joint returns or surviving spouses with modified adjusted gross income (MAGI) over $250,000, married individuals filing separate returns with MAGI over $125,000, and all other individuals with MAGI over $200,000. MAGI, for this purpose, is your regular AGI plus any foreign earned income you've excluded. "MAGI and AGI will almost always be the same," says Bob Keebler of Keebler & Associates, a tax advisory and CPA firm in Green Bay, Wisconsin. "MAGI does not include tax-exempt income, excluded gain on the sale of a principal residence, or veteran's benefits."

* Investment income. This includes taxable interest, dividends, capital gains, annuities, royalties, and real estate rentals. The tax is on net investment income, so you'll subtract expenses such as investment interest you've paid.

Crunching the numbers

The tax will be owed on the lesser of two numbers. One is your net investment income; the other is the amount by which your MAGI exceeds the relevant $125,000, $200,000, or $250,000 threshold.

Example 1: Phil Roberts, a single taxpayer, has MAGI of $300,000 in 2013 but no countable investment income because he invests solely in tax-exempt bonds. With net investment income of zero, Phil will not owe the 3.8% surtax, no matter how high his AGI or MAGI might be.


Example 2:

Suppose that Phil has the same $300,000 of MAGI in 2013, but it includes $75,000 of net investment income. Now, Phil's net investment income ($75,000) is less than the $100,000 excess over his $200,000 MAGI threshold. The 3.8% is imposed on the smaller amount, so Phil will owe 3.8% of $75,000 in surtax: $2,850.

Example 3: Now suppose Phil Roberts' $300,000 of MAGI in 2013 includes $125,000 of net investment income. Phil is still $100,000 over the MAGI threshold, but that overage is less than his $125,000 of net investment income, so he will owe a $3,800 surtax: 3.8% of $100,000.

First call

You cannot reduce the 3.8% surtax by taking large itemized deductions, such as charitable contributions and mortgage interest. This surtax is based on your AGI, which you report on the bottom of page 1 of your income tax return. Anything that swells your AGI--including capital gains and retirement plan distributions--increases the likelihood that you'll be over the MAGI threshold for your tax filing status and, thus, owe the surtax.

The November 2012 CPA Client Bulletin will be devoted to year-end tax tips, including ways to minimize the 3.8% surtax in the future.

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Publication:CPA Client Bulletin
Date:Oct 1, 2012
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