• Higher Tax on Investment Income of High-Income Taxpayers
  • April 21, 2010 | Authors: Saba Ashraf; William "Wes" E. Sheumaker
  • Law Firm: Troutman Sanders LLP - Atlanta Office
  • Background. As discussed above, Medicare benefits are currently financed primarily through the HI tax, which currently is imposed on wages as opposed to investment income.

    New provision. The Act adds new Code Section 1411, which generally imposes an “Unearned Income Medicare Contribution” tax on certain investment income of individuals, estates, and trusts. With respect to individuals, the tax is equal to 3.8% of the lesser of (1) net investment income or (2) the excess of modified adjusted gross income over a threshold amount. Thus, effectively, the tax applies only to individual taxpayers who have net investment income as well as modified adjusted gross income over a threshold amount. A taxpayer’s modified adjusted gross income generally is the taxpayer’s adjusted gross income (“AGI”) adjusted by foreign earned income and deductions. The threshold amount is $250,000 for married taxpayers filing jointly, $125,000 for married taxpayers filing separately and $200,000 for other individuals.

    With respect to trusts and estates, the tax is equal to 3.8% of the lesser of (1) undistributed net investment income or (2) the excess of AGI over the dollar amount at which the highest income tax bracket applicable to an estate or trust begins (presently, $7,500). Thus, similarly to individual taxpayers, the tax effectively applies only to trust and estates that have undistributed net investment income and an AGI that exceeds the dollar amount at which the highest income tax bracket applicable to an estate or trust begins.

    For purposes of the tax, net investment income generally includes interest, dividends, annuities, royalties, and rents, gains from the sale of property (generally capital gains) excluding such types of income derived in the taxpayer’s ordinary course of a trade or business. For this purpose, income from a trade or business generally does not include income from a passive activity of the taxpayer or from a trade or business of trading securities or commodities. Importantly, distributions from qualified retirement plan are not included in the calculation of net investment income.

    Effective date. The Unearned Income Medicare Contribution is effective for tax years beginning after December 31, 2012.

    The table below generally summarizes (i) the tax rate under current law, (ii) what such tax rate is schedule to increase to absent new legislation in 2011 (which new legislation most are not expecting), and finally, what the rate would increase to in 2013 for taxpayers with modified adjusted gross income in excess of the threshold amounts described above:

    Type of Income

    Currently

    2011

    2013

    Long-term capital gains

    15%

    20%

    23.8%

    Diviends (qualifying)

    15%

    39.6%

    43.40%

    Interest, rent, royalty, annuities

    35%

    39.6%

    43.4%