New in 2013 -- Net Investment Income Tax and the Additional Medicare TaxJanuary 7, 2013
In addition to the provisions of the American Taxpayer Relief Act (the “2012 Taxpayer Relief Act”) (described in our Tax Alert: Summary of Key Provisions of the American Taxpayer Relief Act), 2013 also ushers in two new tax provisions which will affect high-income taxpayers: the Net Investment Income Tax and the Additional Medicare Tax. The key features of the Net Investment Income Tax and the Additional Medicare Tax are described below.
The Net Investment Income Tax
What is the Net Investment Income Tax? The Net Investment Income Tax applies a 3.8% rate to certain “net investment income”. Investment income includes, but is not limited to: interest, dividends, capital gains, rental and royalty income, non-qualified annuities, income from businesses involved in trading of financial instruments or commodities, and businesses that are “passive” to the taxpayer. Net investment income is computed by subtracting deductions properly allocable to investment income, such as investment interest expense, investment advisory and brokerage fees, expenses related to rental and royalty income, and state and local income taxes. Certain remuneration, such as wages, operating income from a non-passive business, self-employment income, and the like are not subject to the Net Investment Income Tax.
Who is Subject to the Net Investment Income Tax? Only individuals, estates and trusts that have income above the following thresholds are subject to the tax.
Subject to certain exceptions (such as for “grantor trusts” and tax-exempt trusts) and certain computational rules for unique trusts (such as Charitable Remainder Trusts), an estate or a trust will be subject to the Net Investment Income Tax in a taxable year if it has undistributed net investment income and also has adjusted gross income over the dollar amount at which the highest tax bracket for an estate or trust begins for such taxable year (for tax year 2012, the dollar amount was $11,650; 2013 will be a dollar amount adjusted for inflation).
Generally, individuals will owe the net investment income tax if they have net investment income and modified adjusted gross income above the following thresholds (not indexed for inflation): $250,000 for persons married filing jointly or a qualifying widow(er) (with dependent child); $125,000 for persons married filing separately; and $200,000 for single persons and heads of household (with qualifying person).
How to Comply with the Net Investment Income Tax? For tax years beginning on (or after) January 1, 2013, individuals, estates and trusts will report and pay the Net Investment Income Tax in conjunction with their regular tax returns. Because the Net Investment Income Tax is subject to estimated tax, individuals, trusts and estates that anticipate owing the Net Investment Income tax should adjust income tax withholding or make estimated tax payments to avoid underpayment.
Additional Medicare Tax
What is the Additional Medicare Tax? The Additional Medicare Tax applies an additional 0.9% rate to wages, other compensation and self-employment income subject to the Medicare Tax (currently the Medicare Tax is 2.9%, 1.45% paid by the employee and 1.45% paid by the employer, with no wage base cap) to the extent in excess of certain thresholds.
Who is Subject to the Additional Medicare Tax? The Additional Medicare Tax applies to wages, compensation and self-employment income received in taxable years beginning after December 31, 2012 in excess of $250,00 for persons married filing jointly; $125,000 for persons married filing separately; and $200,000 for single persons, heads of household (with qualifying person) or qualifying widow(er)s (with dependent child). Individuals are liable for the tax in full (i.e., unlike the Medicare Tax which is paid ½ by the employee and ½ by the employer, there is no “employer match” for the Additional Medicare Tax).
How to Comply with the Additional Medicare Tax? Beginning in the pay period in which cumulative compensation subject to the Medicare Tax is paid by an employer to an individual for a calendar year exceeds $200,000, the employer must withhold the Additional Medicare Tax on such excess compensation, without regard to the individual’s filing status or wages paid by another employer. An employer who does not deduct and withhold the Additional Medicare Tax is liable for the tax unless the tax is paid by the employee; the employer may be subject to applicable penalties.
Individuals subject to the Additional Medicare Tax will report their liability and the amounts withheld by an employer on their individual income tax returns. An individual who owes Additional Medicare Tax that will not be satisfied through employer Additional Medicare Tax withholding should request additional income tax withholding and/or make estimated tax payments.
Morse, Barnes-Brown & Pendleton would be pleased to assist you in understanding and planning for the Net Investment Income Tax and the Additional Medicare Tax. Please feel free to contact any member of our Tax practice group for assistance.
To ensure compliance with U.S. Treasury Regulations governing tax practice, we inform you that any U.S. tax advice contained in this communication is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.