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Planning for the New Medicare Surtaxes

These moves may save your clients some money next year.

Sandra L. Atkins and Helen Modly, 09/13/2012

At this point, it looks like the 0.9% Medicare surtax on earned income and the 3.8% Medicare tax on unearned income will both go into effect on Jan. 1, 2013. Use last year's tax return to determine if your clients are likely to pay these new taxes. If they are, you still have time to recommend some moves this year that will save them money next year.

The Patient Protection Affordable Care Act--commonly known as the health-care bill--was passed in March 2010. It included the imposition of Medicare taxes targeted at high net worth individuals to begin in 2013.

Not Everyone Will Pay
Most Americans will escape paying the new Medicare taxes on both earned and unearned income. In order for the tax to apply, there is a threshold amount, and those who fall under the threshold will escape these taxes completely.

The 0.9% tax is based on earned income in excess of $200,000 for singles and $250,000 for married couples. The employer will collect the tax on all salaries and bonuses paid in excess of $200,000, so married filers may either get a credit on their tax return or owe additional tax, depending on the earnings of the other spouse.

The 3.8% tax is based on unearned income for taxpayers who have modified adjusted gross income (MAGI) in excess of $200,000 for single filers and $250,000 for married filers. Net investment income basically includes interest income (except for municipal bond interest), dividends, capital gains, the taxable portion of annuity distributions, net rents and royalties, and passive income.

Taxable trusts have the worst deal with respect to the 3.8% tax. The threshold for trusts is only $11,650 for 2012. All investment income in a taxable trust should be passed through to the beneficiaries whenever possible so that higher individual threshold amounts apply.

How to Estimate Your Clients' Tax Exposure
It's not your job to calculate taxes for your clients, but if you spend a few minutes checking their potential Medicare tax for next year, you can provide a valuable service. This exercise is a guess at best, but it gets your clients thinking about the issues and can be very helpful for those who have some ability to control the timing of their income.

Let's use Jay and Eleanor as an example. Jay takes a salary of $350,000 from his S-corporation, which typically has $30,000 of net income reported on Jay's Schedule E. Eleanor has a part-time job earning $20,000, runs a small business with a profit of $6,000, and has taxable annuity income of $18,000 per year from an employer-sponsored retirement plan. They have interest and dividend income of $3,000 and $7,000, respectively, and capital gains from the sale of securities of $14,000. How much Medicare tax will they owe?

Sandi Atkins, CPA/PFS, is president of Focus Wealth Management, a fee-only registered investment advisor in Middleburg, Va. In 2008, she was named by Wealth Manager Magazine as one of the 50 Distinguished Women in Wealth Management.

Helen Modly, CFP, ChFC, is executive vice president and director of investment services for Focus Wealth Management, a fee-only registered investment advisor in Middleburg, Va. Modly has more than 20 years of experience providing wealth-management services. She is a member of NAPFA and FPA. She can be reached at info@focus-wealth.com.

The authors are not employees of Morningstar, Inc. The views expressed in this article are the authors'. They do not necessarily reflect the views of Morningstar.

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