This year higher-income taxpayers may need to factor additional Medicare taxes into their planning. Not only will the Medicare tax increase on earned income above certain levels, but also a new tax will apply to certain investment income.
The traditional Medicare tax has been 2.9% of earned income for self-employed people and 1.45% for employees (with an additional 1.45% paid by employers on their employees’ wages). Under the new law, both self-employed people and employees owe an additional 0.9% on annual earnings above $200,000 for singles or $250,000 for joint filers. Employers don’t owe additional taxes on their employees’ earnings, but they’re responsible for withholding the 0.9%.
If your investment income exceeds certain thresholds, you may owe a 3.8% Medicare tax on the excess. The taxable amount would be the lesser of (a) your net investment income, or (b) the excess of your “modified adjusted gross income” (MAGI) above $200,000 for singles, $250,000 for spouses filing jointly, or $125,000 for spouses filing separately.
“Net investment income” includes interest, dividends, capital gains, rents, royalties, nonqualified annuities, and income from passive activities. It excludes earned income, social security benefits, tax-exempt interest, and distributions from qualified retirement plans. MAGI is adjusted gross income increased by certain deductions and exclusions.
To help minimize these two new taxes, consider the following strategies:
On earned income
- If your earnings fluctuate and you’re approaching the threshold, try to defer excess compensation to the following year.
- If you’re married, consider increasing your withholding to cover your joint Medicare liability.
- The tax applies to net income, so if you’re self-employed, consider accelerating large deductible expenditures into high-income years.
On net investment income (NII)
- Where possible, use capital losses to offset capital gains.
- Consider investing in tax-deferred annuities, municipal bonds, or other vehicles that don’t generate taxable income.
- Maximize deductible contributions to traditional IRAs, 401(k) plans, or similar sheltered investments. Earnings in these accounts are not included in NII, and the contributions will reduce your MAGI.
- Donate appreciated stocks to charities rather than generating capital gains by selling them.
- Make normally taxable investments through a Roth IRA to the extent possible. The earnings won’t be part of NII, and subsequent tax-free withdrawals won’t count toward the thresholds.
The new rules for Medicare taxes are complicated and still evolving. If you think you’ll be affected, call us soon at (813) 514-8273 for a planning appointment.