The Health Care and Reconciliation Act of 2010, which amends the Patient Protections and Affordable Care Act, imposes a new 3.8% Medicare contribution tax on the investment income of higher-income individuals and goes into effect January 1, 2013. This means that taxpayers with incomes or adjustable gross income (measure of income used to determine how much of your income is taxable and is calculated as your gross income from taxable sources minus allowable deductions) over $200,000 who file as individuals or $250,000 for married couples filing jointly could be subject to this tax.
The provision imposes a 3.8% percent tax on income from interest, dividends, annuities, royalties, and rents which are not derived in the ordinary course of trade or business. However, the tax does not apply to nontaxable income, such as tax-exempt interest or veterans’ benefits. Although there is no sales tax on home sales in the Reconciliation Act, there is a tax that includes capital gains, rents, dividends and interest income that will apply if a home sale may result in a capital gain that increases the net investment income or that increases the taxpayer’s adjusted gross income. The tax also applies to estates and trusts, on the lesser of undistributed net income or the excess of the trust/estate adjusted gross income (AGI) over the threshold amount ($11,200) for the highest tax bracket for trusts and estates, and to investment income they distribute.
Income received from investment assets (net investment income) is nonetheless reduced by deductions that are properly allocable to the income or gain. This means for passively managed real property allocable expenses will still include depreciation and operating expenses and indirect expenses such as tax preparation fees may also qualify. For capital gain property this increases the importance of keeping accurate records of amounts expended on acquisition costs and improvements that increase the property’s basis (the cost of an asset which includes the purchase price, shopping, installation, and other services associated with the asset).
Finally, net investment income for purposes of the additional 3.8% Medicare contribution tax does not include distributions from certain tax-favored retirement plans and accounts. These include 401(k) plans, tax-sheltered annuities, individual retirement accounts (IRAs), and eligible 457 plans. Additionally, the tax does not apply to income from the sale of an interest in a partnership or S corporation, to the extent that gain of the entity’s property would be from an active trade or business. Nor does the tax apply to business entities (such as corporations and limited liability companies), nonresident aliens (NRAs), charitable trusts that are tax-exempt, and charitable remainder trusts that are nontaxable.
Taking measures now can lessen the impact of this new tax.