Investment income Medicare tax tricky / Question: I’m confused about the new Medicare tax. Does it only apply to income from investments?

Mary Baldwin for FloriaToday.com writes: Answer:  The short answer is yes, and only above a certain level of income. This can be tricky.

The Affordable Care Act of 2010 established a 3.8 percent Medicare “surtax” that started Jan. 1. If you owe this surtax, it will be added to your regular tax.

The surtax applies to singles with annual modified adjusted gross income (MAGI) over $200,000, and married folks with annual MAGI over $250,000 — another marriage penalty. If you don’t earn this much, you can stop reading.

To calculate the surtax, estimate your net investment income (NII) by adding your interest, dividends, capital gains, rental and royalty income, non-qualified annuities, along with a couple other income categories. Don’t include your wages, salaries, Social Security, self-employment income, tax-exempt interest, and distributions from qualified pension or retirement plans.

And don’t be concerned with capital gains that are currently excluded from gross income, like the sale of a principal residence.

The surtax is 3.8 percent of the amount of your MAGI that exceeds your income threshold, or NII, whichever is less. For instance, let’s assume that you’re single and your income is $150,000 and your NII is $75,000. Your MAGI is $225,000. You’re $25,000 over the threshold ($225,000-$200,000). Since your $25,000 over the threshold is less that your NII, your surtax is $25,000 times 3.8 percent, or $950.

Tax-smart strategies may reduce your surtax by the smart placement of investments. For example, municipal bonds are typically placed in taxable and trust accounts since their earnings are excluded from both MAGI and NII calculations. Growth stocks often don’t pay large dividends and are also more tax-efficient for taxable and trust accounts.

Retirement accounts can hold tax inefficient investments like Treasury Inflation Protected Securities (TIPS) and dividend paying stocks. Tax-deferred accounts, like IRAs, 401(k)s, and SEPs are taxed only when there are withdrawals.

It’s usually better to maximize contributions to retirement accounts and lower your MAGI if you won’t need the money before age 59½. If you’re close to your threshold, consider some tax-smart actions. Consult a tax adviser.