New 3.8% Medicare Surtax on Unearned Income

Posted by Keith Codron | May 12, 2010 | 0 Comments

The Health Care Care and Education Reconciliation Act of 2010 (H.R. 4872), was passed by Congress on March 25, 2010, and signed into law by President Obama on March 30, 2010. H.R. 4872 amended the previously enacted Patient Protection and Affordable Care Act of 2010 (Public Law 111-148), which President Obama signed on March 23, 2010. Taken together, the two laws represent a massive overhaul of the nation's health insurance and delivery systems, and include more than $400 billion in new taxes on employers and individuals. In this posting I will examine one of the more controversial provisions of the health care reform package, namely, the 3.8% surtax on unearned income which is to be used to help fund Medicare benefits in the future. It is estimated that, when the 3.8% unearned income Medicare surtax is added to the new law's additional 0.9% Medicare payroll tax, fully $210.2 billion in extra taxes will have been raised by the federal government over the period, 2013 to 2019, inclusive. The new provision, which takes effect in 2013, is officially known as the Unearned Income Medicare Contributions Tax ["UIMCT"].

The UIMCT broadens the Medicare tax base for higher-income taxpayers by imposing a 3.8% surtax on the lesser of: (1) "net investment income"; or (2) the excess of adjusted gross income [AGI], increased by any foreign earned income otherwise excluded from AGI, over the taxpayer's threshold amount. For single and head-of-household taxpayers the threshold amount is $200,000. For married couples filing a joint return, and surviving spouses, the threshold amount is $250,000.  For a married person filing a separate return the threshold amount is $125,000. Neither the $250,000 threshold amount nor the $200,000 threshold amount is indexed for inflation.

The term, "net investment income," includes interest, dividends, royalties, rents and capital gains, less deductions properly allocable thereto. However, the term does not include income earned from a trade or business unless the business is considered a passive activity for income tax purposes. Furthermore, net investment income does not include distributions from qualified retirement plans, such as employer-sponsored defined benefit plans, profit sharing plans, money purchase plans, ESOPs, 401(k) plans, 403(b) plans or 457(b) plans, nor does such term include distributions from an individual retirement account (IRA) or tax-exempt municipal bond.

Inasmuch as the UIMCT applies only to taxable income, the tax-deferred nature of annuities and cash value life insurance will not be affected by the new law until such time as the taxpayer receives a distribution from the annuity contract or insurance policy which would otherwise constitute taxable income, and may not be subject to the UIMCT at all if the individual's income does not exceed the applicable threshold amount.  By contrast, income from savings accounts or portfolio investments which are not tax-deferred will be impacted immediately to the extent that interest, dividends or capital gains cause an individual's AGI to exceed the applicable threshold amount.

The UIMCT will also apply to estates and trusts, except for charitable remainder and other tax-exempt trusts. Taxable estates and trusts will pay the 3.8% UIMCT on the lesser of: (1) their undistributed net investment income for the tax year; or (2) any excess of their AGI over the dollar amount at which the highest tax bracket for estates and trusts begins for the tax year (currently $11,200), but subject to inflation adjustment each year.

For additional information please contact the writer, Keith Codron, toll-free, at (800) 497-0864, or via email at [email protected]. Mr. Codron, whose main offi

About the Author

Keith Codron

Keith Codron is an Orange County attorney with more than 40 years of experience in the field of trusts and estates. He has been certified as a specialist in estate planning, trust and probate law by the Board of Legal Specialization of the State Bar of California. Mr. Codron's practice is focused...


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