The 2013 3.8% Surtax

A new 3.8% surtax on certain investment income starts January 1, 2013, as part of the health care reform act. While that's a couple of years away, it is not too early to start planning for it, because there are steps clients can take this year that will help reduce or even eliminate it. This post explains the Surtax. 

The 3.8% investment income surtax, also called the health care surtax or the Medicare tax, applies to tax years ending after December 31, 2012. The surtax is:

For individuals, 3.8% of the lesser of:

1. net investment income for such taxable year, or
2. the excess, if any, of
1. the modified adjusted gross income for the year, over
2. the threshold amount.

For trusts and estates, 3.8% of the lesser of:

1. the undistributed net investment income for the year, or
2. the excess, if any, of
1. the adjusted gross income (as defined in Code Section 67(e)) for the year, over
2. the dollar amount at which the highest tax bracket in Code Section 1(e) begins for the year ($11,200 in 2010).

There are three numbers that determine how this surtax will affect you.


Net Investment Income

This is the sum of gross investment income over allocable investment expenses. For purposes of this surtax, investment income includes interest, dividends, capital gains, income from annuity payments, rents, royalties and passive activity income.

Investment income does not include active trade and/or business income; any of the income sources listed above (e.g., interest, dividends, capital gains, etc.) to the extent it is derived in active trade and/or business; distributions from IRAs and other qualified retirement plans; or any income taken into account for self-employment tax purposes.

For the sale of an active interest in a partnership or S-corporation, gain is included as investment income only to the extent net gain that would be recognized if all of the partnership/S-corporation interests were at fair market value.

Modified Adjusted Gross Income (MAGI)

Here, MAGI is the sum of adjusted gross income (the number from the last line on page 1 of Form 1040) plus the net foreign income exclusion amount.

Threshold Amount

Married taxpayers filing jointly . . . $250,000
Married taxpayers filing separately . . . $125,000
All other individual taxpayers . . . $200,000
Trusts and estates . . . Beginning of the top bracket (which, for reference purposes only, is $11,200 for 2010)