As you may recall, the 2010 Health Care Bill included an additional 3.8% “Medicare Tax” tax on net investment income, commencing on January 1, 2013. This new “Medicare Tax” will be imposed on taxpayers with adjusted gross income in excess of $250,000 for married taxpayers and $200,000 for non-married taxpayers. Once taxpayers reach the income thresholds, the 3.8% Medicare Tax will generally apply to all non-business related income, including the following:

  1. interest, dividends, annuities, royalties, and rental income;
  2. other income generated from a passive activity business;
  3. gains on the disposition of non-business property, such as a home, or the sale of stock or securities; and
  4. any capital gain income.

The tax does not apply to earned wages, income derived from a trade, or business that is not a passive activity. Some exceptions to the Medicare Tax include distributions from qualified plans, i.e., 401(k) plans, individual retirement accounts and tax-sheltered annuities. A planning tool may be to shift wages to these investment plans such that future appreciation is not subject to the Medicare Tax.

In addition to the Medicare Tax beginning January 1, 2013, the reduction in income tax rates from the Bush tax cuts are scheduled to expire and the top marginal income tax rates are set to increase from 33% to 35% and 36% to 39.6% respectively. In addition, dividends currently taxed at capital gains rates, will be subject to ordinary income tax, and therefore the cumulative rate on dividends could increase to 43.4%, including the Medicare Tax. The capital gains rate will increase to 20% and therefore the cumulative tax on capital gains, beginning in 2013 with the new Medicare Tax, will be 23.8%. If you are interested in learning more or how to plan for this upcoming new tax, please feel free to contact our Tax Department.

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