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What you need to know about the 3.8 percent Medicare tax

This tax season, you may have to pay an additional tax when you file your 2013 federal tax return.


Depending on your net investment income, your tax services professional may tell you that you have to pay a 3.8 percent “Medicare tax.” As part of the Health Care and Education Reconciliation Act of 2010, the new tax was created to generate funds for the Medicare Trust Fund under President Barack Obama’s health care bill, and it applies to estate, individual and trust tax returns.


The stated purpose of the Medicare tax is to ensure that the fund will have an adequate supply for many years ahead. Previously, the Medicare tax was 2.9 percent and split evenly between employers and employees.


How does this factor into your income?
Your net investment income is composed of a few things:

  • Interest;
  • Dividends;
  • Capital gains;
  • Rental and royalty income;
  • Nonqualified annuities;
  • Income from businesses involved in trading of financial instruments or commodities; and
  • Income from businesses that are passive activities for the taxpayer.


Net investment income is calculated by reducing investment income by certain expenses properly allocable to the income.


The NIIT (Net Investment Income Tax) does not apply to wages, unemployment compensation, operating income from a nonpassive business, social security benefits, tax exempt interest, self-employment income, and distributions from qualified retirement plans, 401(k) plans and IRAs. There is also an exemption for real estate professionals who participate in rental real estate activities more than 500 hours per year.


Gains included in net investment income include gain from the sale of stocks, bonds and mutual funds; capital gain distributions from mutual funds; gains from investment real estate – including gain from the sale of a second home; and gains from the sales of certain partnership and S corporation interests. The tax also applies to the gain on the sale of a personal residence, but only after the $250,000 exemption – $500,000 for married couples – from such gain.


If your adjusted gross income meets certain thresholds – $125,000 for married couples filing separately, more than $200,000 for single filers and $250,000 for married couples filing jointly – you will be required to pay the new tax. Based on the income requirements for paying the tax, the additional tax is clearly aimed at Americans in higher tax brackets. The Medicare tax applies to the lesser of:

  • The amount of your AGI that exceeds the thresholds; or
  • Your net investment income.


If you have questions about this new tax or any other tax issues, please contact LaPorte Tax Director Jeanne Driscoll at [email protected].