Additional 0.9% Medicare tax imposed on wages over $200,000 / $250,000 starting in 2013

The employee portion of the Medicare hospital insurance payroll tax rate rises by 0.9% (from 1.45% to 2.35%) on wages over $200,000 (single or head-of-household filers), wages over $250,000 (joint filers), or wages over $125,000 (married-filing-separately filers). The employer portion of this tax remains 1.45% for all wages. Employers are required to withhold the additional 0.9% on all wages over $200,000, regardless of filing status or the employee's spouse's wage level. Therefore, the amounts withheld by employers may be inadequate to cover a couple's additional obligation, or it may be in excess of their obligation for this tax increase.

Self-employed individuals will also be subject to this 0.9% self-employment tax increase on earnings from self-employment that exceeds the threshold for their filing status.

3.8% Medicare tax imposed on net investment income if income exceeds $200,000 / $250,000 starting in 2013

Medicare tax of 3.8% is imposed on the net investment income of individuals if modified AGI exceeds $200,000 (single & head-of-household), $250,000 (joint) or $125,000 (married-filing-separately). The tax is imposed only to the extent that income exceeds these thresholds. An individual will therefore pay this tax on 100% of investment income only if modified AGI exceeds the threshold by the amount of unearned income. In other words, the tax is assessed on the lesser of net investment income, or the amount by which income exceeds the threshold for the individual's filing status.

Net investment income includes taxable (but not tax-exempt) interest, dividends, royalties, rents (with exceptions), trade or business income from a passive activity, and net gains from sale of property (with exceptions), reduced by expenses that are allocable to this income (e.g., investment interest expense such as margin interest, or the expenses of rental activity).

Happily for owners of closely-held businesses, the business income that flows-through to the owner of an S corporation, partnership or LLC would not be subject to this tax, provided the taxpayer materially participates in the flow-through entity’s business, as the tax is explicitly not imposed on business income, gains from the disposition of business property, or rents if they are earned by an activity with respect to which the taxpayer is non-passive. For rental activities, only the net rental income of rental real estate professionals is exempt from the tax – the net rental income of all others is considered passive regardless of their degree of participation in the activity.

There is also good news for retirees: the tax is not imposed on distributions from qualified retirement plans (401(k), 403(b), 457, IRA, Roth IRA, SEP-IRA, etc.)

This tax is imposed on estates and trusts on the lesser of undistributed net investment income or the excess of AGI over the dollar amount at which the highest estate and trust income tax bracket begins.

This bulletin is a summary and is not intended as tax or legal advice. You should consult with your tax advisor to obtain specific advice with respect to your fact pattern.

Based on the most recent "best practice" standards for tax advisors issued by the Treasury Department, commonly referred to as Circular 230, we wish to advise you that this bulletin has not been prepared to be used, and cannot be used, to provide assurance that penalties which may be assessed by the IRS or other taxing authority (including specifically section 6662 understatement penalties) will not be upheld.