Obamacare Medicare Taxes -- Increasing Your 2013 Tax Bill

Holly Magister, for Forbes writes: Several years ago Warren Buffett made his opinion clear about how he felt wealthy Americans should pay more in federal income taxes. Specifically he cited income from investments, which are subject to a lower tax rate. He also held the opinion that it is unfair our tax code provides a tax break on earnings over the Social Security Wage Base Limit ($113,700 in 2013). Wage earners over the limit do not pay Social Security taxes on the excess. 

While Mr. Buffet’s suggestions have yet to be fully adopted by Congress, the need to fund the Affordable Care Act (ACA) mirrors his sentiments and has given rise to two new taxes collectively referred to as the Obamacare Medicare Tax.

I find the use of the term Medicare Tax for the new taxes confusing on several levels. First because Medicare taxes are withheld presently from an employee’s paycheck at the rate of 1.45% plus an employer matched rate of 1.45%, for a total tax rate of 2.9%. Whereas, what is widely referred to as the new Obamacare Medicare Tax is actually a tax on passive investment income and is known as the Net Investment Income Tax (NIIT). The second area of confusion is the new tax’s rate. It is 3.8%, not 2.9%.

To further complicate matters, there is another new tax referred to as the Obamacare Medicare Tax or Medicare Surtax. This one applies to the wages and self-employment earnings of high income taxpayers. This tax is 0.9% and is similar to the NIIT in that it is applied to wages and self-employment income when a taxpayer exceeds certain Modified Adjusted Gross Income thresholds.

To me it seems reasonable to assume the new Obamacare Medicare Tax would equal the current Medicare Tax rate of 2.9% and would be applied to the taxpayers’ passive investment and earned income if they exceed the income thresholds as defined in the new law. However, this is not the case. The two new Obamacare Medicare Taxes total 4.7% instead of 2.9%:  3.8% Tax on Net Investment Income plus 0.9% Tax on Wages and Self-Employment Income equals 4.7%.

If the new taxes were not referred to as Medicare Taxes, I wouldn’t have attempted to make mathematical sense of the new tax rate. However, my nature is to add things up and when I do and they total 4.7% instead of 2.9%, I wonder if I am the only taxpayer confused by the math and fuzzy language?
For these reasons, I personally would prefer to call the two new taxes the Buffett Tax. Nevertheless, for the purposes of this article and Infographic, we’ll stick with its commonly known name: the Obamacare Medicare Tax.

In part one of this two-part Infographic series, the expiring tax credits and tax deductions on December 31st, 2013 were summarized.

In this post, I summarize how the new Obamacare Medicare Taxes may apply to successful entrepreneurs and other taxpayers, and if so what exactly is included in its computation.

 
The New 3.8% Obamacare Medicare Tax May Apply
For successful entrepreneurs and other taxpayers who have Modified Adjusted Gross Income in excess of the “applicable thresholds” defined by the IRS, and have Net Investment Income, according to the definition set forth in the IRS Final Regulations, the 3.8% NIIT will apply when filing their 2013 personal income tax return. The Net Investment Income Tax Regulations were released on November 26th, 2013 giving taxpayers and their advisors very little time to fully understand the impact this new tax will have on the 2013 federal tax returns.

The new NIIT will apply to taxpayers in 2013 who report Net Investment Income on their federal tax return and have Modified Adjusted Gross Income (MAGI) in excess of their respective filing status thresholds:

• Married Filing Separate threshold for NIIT is $125,000.
• Single, Qualifying Widow(er) or Head of Household threshold for NIIT is $200,000.
• Married Filing Jointly threshold for NIIT is $250,000.
It’s important to note that if a taxpayer’s MAGI does not exceed the threshold noted above, they do not need to worry about the new Net Investment Income Tax.
Likewise, a taxpayer without Net Investment Income to report on their 2013 tax return may disregard this new tax altogether.

What is Net Investment Income?
In general terms, the new Net Investment Income Tax (NIIT) applies to income which is passive in nature. Included in the computation of Net Investment Income are the following forms of income:


• Interest, dividends, royalty income, non-qualified annuities and rental income
• Income from businesses trading financial instruments and/or commodities
• Income from Passive Activity Businesses
• Net gains from the sale of stocks bonds and mutual funds
• Capital Gain Distributions from Mutual Funds
• Gain from the Sale of Investment Real Estate and Interests in a Passive Income Business
• Gain from the taxable portion of the Sale of a Personal Residence subject to regular income tax

What is NOT Net Investment Income?
It’s worth clarifying for readers which forms of income are not considered to be Net Investment Income (NII):
• Wages earned and Self-Employment Income
• Income from an Active Trade or Business
• Unemployment Benefits and Alimony Income
• Excluded portion from regular income tax on the Sale of a Personal Residence
• Tax Exempt Interest Income
• Social Security Benefits
• Certain Qualified Pension Plan Distributions

The New 0.9% Obamacare Medicare Surtax May Apply
Taxpayers who are employees and/or have self-employment income with Modified Adjusted Gross Income in excess of the respective filing status thresholds below will be subject to the new 0.9% Medicare Surtax in 2013:

• Married Filing Separate threshold for 0.9% Medicare Tax is $125,000.

• Single, Qualifying Widow(er) or Head of Household threshold for 0.9% Medicare Tax is $200,000.

• Married Filing Jointly threshold for 0.9% Medicare Tax is $250,000.

Tax Planning is Not a DIY Project
The Obamacare Medicare Taxes are new in 2013 so properly planning for them by making adequate tax deposits, if sufficient federal tax has not been withheld by the taxpayer’s employer during 2013, is highly recommended. This is not a Do It Yourself Project! The complexity involved with the new Obamacare Medicare Taxes, particularly with respect to the proper classification of rental, passive and active income precludes most successful entrepreneurs and other taxpayers from planning for and filing their own income tax returns.

Furthermore, the additional taxes imposed by Obamacare give rise to the need for entrepreneurs to revisit with their advisors matters related to their business entity structure, their various entity and personal income and tax liabilities and last, but not least, their net cash flows in order to sustain a viable business in the future.