Two New Medicare Taxes Added in 2013

This is one in a regular series of notices regarding Health Care Issues and Health Care Reform written in understandable language.  Unless specified differently, opinions in this article are my own.  This article is a bit longer than usual, but I hope it is of interest to you. - Jim Chesterfield

Two Medicare Taxes Added in 2013

Effective January 1, 2013 we saw two new income taxes that were called “Medicare” taxes because the proceeds are expected to be allocated to help pay for Health Care Reform.


The first tax is called the MEDICARE SURTAX and is straightforward.  Anyone with gross wages greater than $200,000 filing as a single or $250,000 filing jointly will pay an additional Medicare tax of 0.9% on all amounts above that threshold.   The current individual Medicare tax at all income levels is 1.45%.


The second tax, called the MEDICARE INVESTMENT INCOME TAX is a bit more complicated.  It is a 3.8% tax on the lesser of (a) the amount of your adjusted gross income over $200,000 as an individual ($250,000 married filing jointly) or (b) your unearned income (i.e. interest, dividends, rents, etc).  Note that this is “adjusted gross income” and not “gross income” as in the first tax.


In other words, calculate the amount of your adjusted gross income above that $200,000 or $250,000 threshold (AGI is the amount at the bottom of the first page of your 1040 tax return), compare it to the amount of total unearned income you have (i.e. net investment income) and apply the 3.8% tax to the lower amount.


[Net investment income includes interest, dividends, annuities, royalties, rents and capital gains.  This includes the sale of your primary residence and potentially a second home.  There appears to be no difference between qualified or ordinary dividends or between short term and long term gains.  NOT INCLUDED are distributions from tax deferred retirement accounts such as IRAs and interest from municipal bonds.]


Example 1:  Total adjusted gross income for you and your spouse is $260,000 and your total net investment income (i.e. unearned income) is $18,000.  Thus, the AGI amount over $250,000 is $10,000.  You would pay 3.8% of $10,000, which is the lesser of the two, equal to $380 of additional tax.


Sale of your home(s) - I mentioned above that the sale of your home could be included in the tax calculation.  That may not be as onerous as it seems at first since you are allowed an exclusion (i.e. deduction) of $250,000 filing singly or $500,000 filing jointly from the sale price of the home before you compare it to the home's cost (typically purchase price plus improvements) to calculate the taxable gain.  To look at it another way, if the profit on your home is more than $250,000 (or $500,000 filing jointly) then the amount over that threshold is what you would compare to your income level to determine how much tax you owe or whether you owe a tax.  Ranches, farms and business properties are exempt from the tax.


Example 2:  A married couple has adjusted gross income of $290,000.  The purchase price of their home plus improvements is $300,000 and they sell it for $900,000.  After subtracting the $500,000 exclusion from the $900,000 sale price there is a profit of $100,000 (the amount over the $300,000 basis).  This is compared to the $40,000 that they are above the married couple income threshold of $250.,000.  In this case, the $40,000 is less than the $100,000 so the 3.8% tax is calculated on the $40,000 for an additional tax of $1,520.


Example 3:  Same as above except the couple makes $240,000 per year.  Since they are below the $250,000 threshold there is no additional tax due at all.


As you can see from the calculations, if your adjusted gross income does not exceed the thresholds, this second tax will never apply to you.


One of the interesting changes this brings to the tax system is that payroll taxes have always been flat taxes.  No matter what income level you have, you will get the same Original Medicare benefits as someone making much less money.  In 2013 the Medicare tax became a progressive income tax.


Credits:  Bloomberg Business Week, The Finance Buff, thestreet.com, realtor.org, aarp.org, CNNMoney.com, The Washington DC office of Senator Richard Lugar.


If you have any questions about how Health Care Reform might affect you or your group, please call Jim Chesterfield at 317-353-3700.