There are two components of the 2010 health care reform law that add additional Medicare taxes for high income taxpayers; a .9% increase in the Medicare tax on wages and self-employment income, and a 3.8% Medicare tax on investment income. Both of these changes took effect on January 1, 2013 and taxpayers may be subject to both taxes. In this newsletter we will explain the impact of these changes.
Additional .9% Medicare Tax on Wages & Self Employment Compensation
The new regulations define the threshold of high compensation based on a taxpayer’s filing status as follows:
- • $250,000 – Married Filing Jointly
- • $125,000 – Married Filing Separately
- • $200,000 – Single, Head of Household, and Qualifying Widow(er) with a dependent child
The additional .9% Medicare tax affects wages, self-employment compensation, tips, non-cash fringe benefits, such as the personal use of a company automobile, and Railroad Retirement Act Compensation in excess of the threshold amount.
Employers are required to withhold the additional .9% of tax on all wages in excess of $200,000, without regard to the employee’s filing status. Withholding of the additional .9% Medicare tax begins with the first paycheck once the taxpayer’s wages exceed the $200,000 base. Employers that do not withhold the tax are subject to failure to withhold and failure to deposit penalties.
Therein is the first of many under withholding problems. A taxpayer that files, Married Filing Separately, and earns $180,000 in wages will not have any withholding for the new tax, however he will be liable for $495 of additional tax ($180,000 – $125,000 = $55,000 x .009 = $495).
If a taxpayer has both wage income and self employment income the amounts are added together to determine the amount in excess of the threshold. For example, a single taxpayer has wages of $150,000 and self-employment income of $100,000, $50,000 would be subject to the additional .9% Medicare tax or $450 in additional tax, with nothing being withheld by his employer, as the wages did not exceed $200,000.
The under withheld situation can be more complicated for a married couple, neither of whom makes more than the $200,000 employer withholding threshold. For example, taxpayer has wages of $180,000 and self employment income of $90,000 and the spouse has wages of $200,000 and self-employment income of $50,000 for a total income of $520,000 less the $250,000 threshold, resulting in $270,000 in income subject to the .9% additional Medicare tax or $2,430 in additional tax, with nothing being withheld by their employers.
Over withholding is also possible. A married taxpayer that earns $240,000 in wages and has a non-working spouse will have additional withholding of $360 ($240,000 less the withholding threshold of $200,000 = $40,000 x .9% = $360), which would be treated as an additional payment toward the current year income tax liability, similar to excess Social Security withholding when a person works for more than one employer and exceeds the Social Security wage limit of $113,700.
While the under withholding for the additional Medicare tax on wages and self-employment compensation may not be excessive, coupled with the Medicare tax on investment income and the new rate increase for high income taxpayers many taxpayers maybe under withheld for 2013.
3.8% Medicare tax on investment income
Individuals will owe the 3.8% Medicare tax on investment income if they have Net Investment Income and also have modified adjusted gross income (MAGI) in excess of the following thresholds.
- • $250,000 – Married Filing Jointly and Qualifying Widow(er) with a dependent child
- • $125,000 – Married Filing Separately
- • $200,000 – Single and Head of Household
- • $ 11,950 – Estates and Trusts
Before explaining all of the terms an example will provide an understanding of how the tax is determined. A married taxpayer filing jointly has $30,000 in net investment income and $240,000 in wages and other income for a total of $270,000 of modified adjusted gross income, less the threshold amount of $250,000 results in $20,000 subject to the 3.8% Medicare tax on investment income or $760 in additional tax. If the taxpayer had $260,000 in wages and $10,000 in net investment income, only the $10,000 would be subject to the 3.8% Medicare tax on investment income.
Investment income in general includes interest, dividends, capital gains, rental & royalty income, non-qualified annuities, income from passive activities, and investment income of your children if the income is reported on your tax return. Investment income is reduced by investment expenses to calculate Net Investment Income.
Investment expenses in general includes investment interest expense, investment advisory and brokerage fees, expenses related to rental and royalty income, and state and local income taxes allocable to items included in Net Investment Income. Investment expenses are included in calculating modified adjusted gross income (MAGI).
Non Investment Income in general includes wages, unemployment compensation, alimony, Social Security Benefits, taxable pension and IRA distributions, income from non-passive businesses, and tax-exempt interest. Your non investment income is included in calculating modified adjusted gross income (MAGI).
There is significant complexity in determining MAGI and Net Investment Income and we have not seen all of the new forms or worksheets that will be used, however, taxpayers that have not itemized their deductions may now need to provide their tax preparers with additional information.
Unlike the additional .9% Medicare tax there is no withholding taxes associated with the 3.8% Medicare tax on investment income, therefore, taxpayers will need to be careful when determining their estimated tax payments for 2013. If you are subject to these taxes, it may be best to use the safe-harbor estimated tax payments for 2013, or have your tax preparer prepare a detailed tax projection for 2013 to determine the appropriate estimated tax.
If you have any questions please contact us and setup a meeting to review the particulars of your tax situation.
About Blackman & Sloop CPAs, P.A.:
Blackman & Sloop is a full-service CPA firm headquartered in Chapel Hill, North Carolina and is actively involved in auditing, taxation, management consulting, financial planning, and related services. The firm directs a large part of its services toward providing management with advice on budgeting, forecasts, projections, financing decisions, financial analysis, and tax developments. The firm also performs review and compilation services and prepares not-for-profit, corporate, individual, estate, retirement plan, and trust tax returns as well as technology consulting services regarding installation and training on QuickBooks. Blackman & Sloop provides services in Raleigh, Durham, Chapel Hill, RTP, Hillsborough, Pittsboro, Charlotte, and the rest of North Carolina. To find out more please visit http://www.blackmansloop.com
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