Taming the New Medicare Surtax

The wealthy will likely see higher 2013 income taxes. One of the newest additions to the tax bill is the 3.8% Medicare surtax. By planning ahead, you may be able to reduce the tax bite—or possibly avoid being bitten altogether.

When Congress ironed out the new healthcare legislation in 2010, it added a new tax provision called the Unearned Income Medicare Contribution. Starting in 2013, this levy requires some high earners to pay a surtax on some or all income generated from investments, such as capital gains, dividends and taxable interest.

For higher-income taxpayers, the tax is essentially an add-on income tax. And it means some investors could owe close to 4% more on some or all of their net investment income.

Here's whom the new 3.8% Medicare surtax will affect:

  • Single taxpayers whose income exceeds $200,000
  • Married couples filing jointly who together earn more than $250,000
  • Married taxpayers filing separately who individually earn more than $125,000
The surtax will be applied to the lesser of the following: modified adjusted gross income (MAGI) above the threshold, or net investment income for the year.

But some items don’t count as investment income, including:

  • Distributions from IRAs or qualified retirement plans
  • Qualified college-savings-plan distributions
  • Income from tax-exempt municipal bonds
  • Active trade or investment income
  • Tax-deferred nonqualified annuities
If your MAGI is below the threshold, the surtax doesn’t apply to you. Therefore, if you think you might be close to the MAGI threshold this year, consider deferring some of your income. For example, pretax contributions to a 401(k) or 403(b) plan lower the wages counted toward MAGI.

And to lessen the tax in future years, taking advantage of qualified retirement plans or college-savings plans is smart—because investment gains from those plans are excluded from the 3.8% surtax.

If you think you’re in danger of triggering the 3.8% tax, there’s still time to reduce the consequences. The approach can be simple: limit the amount of money subject to the tax. It makes a lot of sense to speak to a financial advisor and/or tax advisor and find out other possible ways to reduce the tax bite.

The views expressed herein do not constitute, and should not be considered to be, legal or tax advice. The tax rules are complicated, and their impact on a particular individual may differ depending on the individual’s specific circumstances. Please consult with your legal or tax advisor regarding your specific situation.

Richard A. Davies

Senior Managing Director, Global Head—Defined Contribution and Multi-Asset Business Development
Richard A. Davies is Senior Managing Director and Global Head of Defined Contribution, responsible for the overall leadership and strategic direction of AB’s global defined contribution and multi-asset businesses. He previously served as co-head of Institutions for the firm’s North America Client Group, while leading its US defined contribution activities. Davies rejoined AB in 2013 after spending several years leading Russell Investments’ institutional defined contribution business. During his earlier, 16-year career with AB, he led the firm’s institutional defined contribution, sub-advisory, and retail retirement and college savings businesses. Davies also served as head of global marketing and product management and led several business lines and distribution channels for the mutual funds group. He joined the firm in 1995 from First Chicago Corporation, where he served as president of retail investment services and was a managing director of First Chicago Investment Management Company. Prior to joining First Chicago in 1989, Davies was a strategy consultant and manager with The Boston Consulting Group. He worked in brand management for Procter & Gamble before attending graduate school. Davies holds a BA in economics, with honors, from the University of Wisconsin, Madison, and an MBA from Harvard Business School. He chairs the Advisory Board of the University of Wisconsin’s economics department. Davies is a Trustee of the Employee Benefit Research Institute and was a founder of the Defined Contribution Institutional Investment Association. Location: New York

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