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.

Daniel A. Notto

Senior Retirement Plan Counsel—AllianceBernstein Investments
Daniel A. Notto provides legal support for AllianceBernstein’s retirement plan and Section 529 college savings plan businesses. He has focused on the legal matters relating to tax-favored savings plans such as 401(k)s, IRAs and Section 529 plans for over 25 years. Before joining AllianceBernstein, Notto held several positions, including vice president and general counsel and consulting practice director, with Universal Pensions (now Ascensus), a national retirement plans consulting firm. There, he helped some of the country’s largest financial-services organizations build or refine their retirement plan services, and authored retirement plan documents used by thousands of employers throughout the nation. Prior to that, Notto worked in the legal department of Investors Diversified Services (now Ameriprise Financial). He has been a frequent speaker and author on retirement plan and Section 529 plan topics. Notto holds a BS in pharmacy from the University of Minnesota and received his JD (cum laude) from William Mitchell College of Law. He has received the Certified Pension Consultant (CPC) designation from the American Society of Pension Professionals & Actuaries (ASPPA). Notto is a member of the bar of New York. Location: New York

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