Plan now for the 3.8% medicare tax on Investment income

The recently enacted health care reform legislation includes a 3.8% Medicare contribution tax on net investment income of higher income taxpayers. Even though the tax does not kick in for a couple of years, start planning now on how to minimize the impact.

For tax years beginning after December 31, 2012 the tax will apply to higher income taxpayers. The tax is 3.8% on the lessor of (1) net investment income or (2) the excess of your modified adjusted gross income over the threshold amount ($250,000 for joint filers, $125,000 for married filing separate returns and $200,000 for singles and head of household filers).

What is included in investment income you ask? Investment income includes interest, dividends, annuities, royalties, and rents unless derived in the normal course of a trade or business. It also includes capital gains, possibly even from the sale of your principal residence or second/vacation home.

How does the tax work? Here is an example. If you file a joint return with your spouse and you have less than $250,000 in modified adjusted gross income (usually the last number on the first page of your Form 1040) you will not be subject to the tax, regardless of how much investment income you have. If you income exceeds the threshold you will pay 3.8% tax on the amount of your income that exceeds the threshold to the extent you have investment income. Let's say you have modified adjusted gross income(MAGI) of $300,000 of which $10.000 is in investment income. You then owe Medicare tax on the full $10,000. If your MAGI is $255,000 then you will only owe medicare tax on the first $5,000 of investment income.

To know more about how this could effect your individual situation I would be glad to discuss this with you.