The Patient Protection and Affordable Care Act (sometimes called
"Obamacare") comes with two new taxes for higher income
taxpayers beginning on January 1, 2013: (i) a 3.8 percent Medicare
contribution tax on net investment income ("Net Investment
Income Tax"), and (ii) a 0.9 percent additional Medicare tax
on wages and self-employment income. This Alert provides a
general overview of these taxes and some of their potential
Net Investment Income Tax
This new 3.8 percent tax will only affect taxpayers whose
adjusted gross income ("AGI") exceeds $250,000 for joint
filers, $200,000 for single taxpayers and heads of household, and
$125,000 for a married individuals filing separately. AGI consists
of your gross income minus your adjustments to income.
If your AGI is above the threshold that applies to you, the 3.8
percent tax will apply to the lesser of (1) your net investment
income for the tax year or (2) the excess of your AGI for the tax
year over your threshold amount. This tax will be in addition to
the income tax that applies to that same income.
The "net investment income" that is subject to the 3.8
percent tax consists of interest, dividends, annuities, royalties,
rents, and net gains from property sales. Income from an active
trade or business is not included in net investment income, nor is
wage income. However, passive business income is subject to the Net
Investment Income Tax. Thus, while rents from an active trade or
business are not subject to the tax, rents from a passive activity
are subject to it. Income from a business of trading financial
instruments or commodities is also included in net investment
Income that is exempt from income tax, such as tax-exempt bond
interest, is likewise exempt from the Net Investment Income Tax.
Thus, switching some of your taxable investments into tax-exempt
bonds may reduce your exposure to the 3.8 percent tax.
If you sell your main home, you may be able to exclude up to
$250,000 of gain, or up to $500,000 for joint filers, when figuring
your income tax. This excluded gain will not be subject to the Net
Investment Income Tax. However, gain that exceeds the limit on the
exclusion will be subject to the tax. Gain from the sale of a
vacation home or other second residence, which does not qualify for
the income tax exclusion, will also be subject to the Net
Investment Income Tax.
Distributions from qualified retirement plans, such as pension
plans and IRAs, are not subject to the Net Investment Income Tax.
However, those distributions may push your AGI over the threshold
that would cause other types of investment income to be subject to
the tax. This makes Roth IRAs more attractive for higher-income
individuals, because qualified Roth IRA distributions are neither
subject to the Net Investment Income Tax nor included in AGI.
The Net Investment Income Tax must be included in the
calculation of estimated tax that you owe. As a result, if you will
be subject to the tax, you may have to make or increase your
estimated tax payments to avoid a penalty.
Additional 0.9 Percent Medicare Tax on Wage and Self-Employment
Also beginning in 2013, some high wage earners will pay an extra
0.9 percent Medicare tax on a portion of their wage income, in
addition to the 1.45 percent Medicare tax that all wage earners
pay. The 0.9 percent tax applies to wages in excess of $250,000 for
joint filers, $125,000 for a married individuals filing separately,
and $200,000 for all others. The 0.9 percent tax applies only to
employees, not to employers.
Once an employee's wages reach $200,000 for the year, the
employer must begin withholding the additional 0.9 percent tax from
the wages. However, this withholding may prove insufficient if the
employee has additional wage income from another job or if the
employee's spouse also has wage income. To avoid that result,
an employee may request extra income tax withholding by filing a
new Form W-4 with the employer.
An extra 0.9 percent Medicare tax also applies to
self-employment income for the tax year in excess of $250,000 for
joint filers, $125,000 for married individuals filing separately,
and $200,000 for all others. This 0.9 percent tax is in addition to
the regular 2.9 percent Medicare tax on all self-employment income.
While self-employed individuals can claim half of their
self-employment tax as an income tax deduction, the additional 0.9
percent tax won't generate any income tax deduction.
Employers with medical reimbursement plans such as health reimbursement arrangements need to review them as soon as possible, to make sure they don’t accumulate heavy tax penalties from noncompliance with Affordable Care Act rules.
In 2014, the U.S. Tax Court issued two opinions with significant implications in the captive insurance world. On January 14, 2014, the court issued a reviewed decision in Rent-A-Center, Inc. v. Commissioner.