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3.8% Medicare Tax on Investment Income

Stevenson G. Smith, CPA

September 20, 2012

There has been a lot of information and misinformation regarding the new 3.8 percent Medicare tax on investment income passed with the health care reform package. The tax applies to the lesser of net investment income or modified AGI (adjusted gross income) above $200,000 for individuals and heads of household, $250,000 for joint filers and surviving spouses, and $125,000 for married filing separately.

The tax is effective in 2013.

For purposes of this tax the 3.8 percent Medicare tax net investment income includes interest, dividends, annuities, royalties and rents and other gross income attributable to a passive activity. Gains from the sale of property that is not used in an active business and income from the investment of working capital are treated as investment income as well. However, the tax does not apply to nontaxable income such as tax-exempt interest or veterans’ benefits. Further, an individual’s capital gains income will be subject to the tax. This includes gain from the sale of a principal residence, unless the gain is excluded from income under Code Sec. 121, and gains from the sale of a vacation home.

Net investment income is gross income or net gain, reduced by deductions that are “properly allocable” to the income or gain. For passively-managed real property, allocable expenses will still include depreciation and operating expenses.

This law makes it imperative that records be kept of items that increase your property’s basis. It puts the focus on investment expenses that may reduce net gains: interest on loans to purchase investments, investment counsel and advice, and fees to collect income. Other costs, such as brokers’ fees, may increase basis or reduce the amount realized from an investment.

Example. Steve a single individual, has modified AGI of $220,000 and net investment income of $40,000. The tax applies to the lesser of (1) net investment income ($40,000) or (2) modified AGI ($220,000) over the threshold amount for an individual ($200,000), or $20,000. The tax is 3.8 percent of $20,000, or $760.

Please contact our office if you would like to discuss the tax consequences to your investments of the new 3.8 percent Medicare tax on investment income.  

Call us at (801) 234-4202 anytime during business hours (8 to 5 Mountain Standard Time) to set up a free consulation, or you can simply request a call from Steve using the convenient form below:

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