Planning for the 3.8% Investment Tax

Higher income investors need to plan for the 3.8% “unearned income Medicare contribution” tax. This 3.8% tax was enacted as part of the 2010 health care overhaul.

Some Details

The tax applies only to taxpayers with modified adjusted gross income (AGI) above these levels: $200,000 (single/head of household), $250,000 (married filing jointly/surviving spouses), or $125,000 (married filing separately). The tax is calculated on the lesser of net investment income or the amount of modified AGI in excess of the threshold.

Example. Bill’s modified AGI is $250,000, $50,000 more than the $200,000 threshold for his single filing status. His net investment income is $60,000. Bill will owe the 3.8% tax on $50,000 since that amount is less than his $60,000 net investment income.

Net investment income generally includes interest, dividends, capital gains, annuities, royalties, and rents. It also includes income from “passive” trade or business activities, such as pass-through income from limited partnerships, S corporations, and limited liability companies in which a taxpayer does not materially participate.

Strategies

Taxpayers will have to plan carefully to minimize their exposure to the tax. Various timing strategies may be effective, especially if modified AGI is close to the threshold. Other strategies that may be helpful include:

  • Increasing involvement in profitable trade or business activities so that material participation can be shown
  • To the extent possible, offsetting capital gains with losses
  • Investing in municipal bonds, since tax-exempt interest is not included in net investment income or modified AGI for purposes of this tax
  • Maximizing pretax contributions to retirement plans

Of course, taxes are only one factor to consider when weighing investment decisions.

If you need some assistance, we would be happy to help. Contact me, Crystal Wampler, or Amit Chandel here or by phone at 562-281-1040. We are always available to answer any questions you may have.