Clients are unfamiliar with “Obamacare,” otherwise known as the “Affordable Care Act.” They may know about the impact on health insurance, but they probably do not know about the impact on their taxes. In prior tax years, there was no Medicare surtax on capital, dividend, or taxable interest. However, beginning January 1, 2013, under the Affordable Care Act, a new 3.8% Medicare surtax on net investment income earnings went into effect for taxpayers who earn over the following thresholds:

• $200,000 single

• $200,000 head of household

• $250,000 married filing joint

• $125,000 married filing separate

• $11,950 trusts and estates

The new investment earnings surtax applies to the lesser of the investment income or the amount by which the modified adjusted gross income (MAGI) exceeds the above thresholds. Net investment income includes interest, dividends, annuity distributions, and royalties. It also includes rents, passive activity income, and net capital gain income on dispositions.

The new tax does not apply to the following types of income:

• W-2 income including salary, wages and bonuses

• Social Security income

• Self-employment income

• Distributions from IRA’s and qualified retirement plans such as a 401(k)

• Tax exempt bonds

• Gain on active interest in a S corp or partnership

As an example:

Jane is single

Earns $100,000 W-2 salary income

$50,000 in rental income

$20,000 in dividend income

Threshold is $200,000.

Adjusted gross income is $200,000.

No surtax is due.

There are some tax strategies that can be used to reduce investment income and minimize MAGI such as converting a traditional IRA into a Roth IRA so that future distributions would be tax-free, shifting investment taxable earnings into tax-exempt bonds, capital loss harvesting to offset capital gains thereby reducing net investment income, managing retirement plan distributions to maintain MAGI so that income does not exceed the threshold amounts, installment sales, converting passive income from a trade or business into salary and making contributions to Charitable Remainder Trusts.

By having a thorough understanding of the Affordable Care Act’s tax provisions and advising clients how to carefully manage their income and earnings, estate planning attorneys may be able to help clients reduce or minimize their MAGI and avoid the new surtax.

Stephen C. Hartnett, J.D., LL.M.
Associate Director of Education
American Academy of Estate Planning Attorneys, Inc.
9444 Balboa Avenue, Suite 300
San Diego, California 92123
Phone: (800) 846-1555
www.aaepa.com