Be prepared to pay an extra tax starting in 2013 on your net investment income if you are in the higher income tax brackets. You should be working with your tax and investment advisers over the next few months if this tax applies to you. Many taxpayers are waiting until closer to the end of the year to begin tax planning. With the Affordable Care Act already in place, the likelihood of this legislation being overturned by year end is small. So, you should start planning now.
The Medicare contribution tax is equal to 3.8 percent of the lesser of net investment income or the amount by which modified adjusted gross income exceeds the tax threshold. These thresholds are set at $200,000 for individual filers and $250,000 for joint filers.
Trusts and estates are also subject to the tax. The tax does not apply to nonresident aliens or certain charitable and tax exempt trusts.
Net investment income includes such items as interest, dividends, annuities, royalties and rents less allocable deductions. Passive activities are included. Income derived in the ordinary course of a trade or business is not included. It also includes net gains from the disposition of property (other than property used in any trade or business that is not considered passive).
It does not include distributions from most qualified plans or tax-exempt interest.
One item that has been speculated about in the media is the sale of a primary residence. The gain realized from the sale of a primary residence would only be included in the net investment income calculation if the gain is included in federal taxable income.
Following are some strategies to consider if this tax could apply to you as you get closer to year end:
1. Analyze investment portfolios to possibly take advantage of capital gains before year end.
2. Consider investing in tax-exempt bonds.
3. Look into investing in stocks not for the dividend payout, but for the long-term gain potential. This defers income into future years when you may be under the income threshold.
4. Move more of your investable dollars into qualified retirement plans.
5. Take a hard look at your trade or business portfolio classifications. Passive investments are subject to this tax. Active trade or business investments are not. You will need to consider possible self-employment tax on income if you switch to being an active investor.
6. Consider the type of entity that is holding your investments. If you are an active investor in an S corporation, you are not subject to self-employment tax and can avoid the Medicare Contribution Tax.
7. This tax should be considered as real estate deals are put together.
There are advantages and disadvantages to each of these planning options and there are other options to consider. A careful analysis of your investment activities before year end would be wise and could save you tax dollars.
Sandy Marshall is a Senior Tax Director with Cannon Wright Blount LLC and a board member of Memphis Commercial Real Estate Women.