How does new Medicare tax on investment income apply?

Everything I've read suggests this is a cliff.

There's another cliff, in that the affordability credits kick in suddenly if you're under 400% of the poverty level. You might gain a $5K or $10K credit by having a dollar less income.

Note that the political environment has made it (and will continue to make it) very difficult to make technical fixes to the legislation, hence stuff like this may stay in.

Steve

(a) Investment Income-

(1) IN GENERAL- Subtitle A of the Internal Revenue Code of

`CHAPTER 2A--UNEARNED INCOME MEDICARE CONTRIBUTION

`Sec. 1411. Imposition of tax.

`SEC. 1411. IMPOSITION OF TAX.

`(a) In General- Except as provided in subsection (e)--

`(1) APPLICATION TO INDIVIDUALS- In the case of an individual, there is hereby imposed (in addition to any other tax imposed by this subtitle) for each taxable year a tax equal to 3.8 percent of the lesser of--

`(A) net investment income for such taxable year, or

`(B) the excess (if any) of--

`(i) the modified adjusted gross income for such taxable year, over

`(ii) the threshold amount.

So if married and you make 220k in W2 and 40k in investment income, then only min(40,260-250)k of the investment income will be subject to subject to this medicare tax. No cliff.

Instead if you make 220k in W2 and 20k in investment income, there is no medicare tax because min(20,240-250)

|> (a) Investment Income- | |> (1) IN GENERAL- Subtitle A of the Internal Revenue Code of |>1986 is amended by inserting after chapter 2 the following new |>chapter: |>

|>`CHAPTER 2A--UNEARNED INCOME MEDICARE CONTRIBUTION |>

|> `Sec. 1411. Imposition of tax. |>

|>`SEC. 1411. IMPOSITION OF TAX. |>

|> `(a) In General- Except as provided in subsection (e)-- |>

|> `(1) APPLICATION TO INDIVIDUALS- In the case of an |>individual, there is hereby imposed (in addition to any other tax |>imposed by this subtitle) for each taxable year a tax equal to 3.8 |>percent of the lesser of-- |>

|> `(A) net investment income for such taxable year, or |>

|> `(B) the excess (if any) of-- |>

|> `(i) the modified adjusted gross income for |>such taxable year, over |>

|> `(ii) the threshold amount.

Thanks for this information.

So there's no cliff, but there is something a little odd going on here: if the taxpayer has (as in your example above) a combination of earnings and investment income that together place them above the threshold, then an increase in either type of income will incur the new 3.8% Medicare tax... even though the earnings have already incurred the usual 2.9% Medicare tax. So in this situation, marginal income from earnings incurs a combined

Or so it appears to me. It's a little late.

Steve

Only the investment income is subject to the 3.8% tax, so I don't see how you came up with 6.7%. Just say before this bill your total tax on 280k of income was 30% (after deductions, etc) and your marginal rate was 35% -- after the Bush tax cut expires I think the marginal rate will be 35% on this amount of income. Now just add 3.8% of 20k (as your investment income was 20k). You have two marginal rates -- for regular income it is 35%, and for rents interest etc it is 38.8%. And your total rate is ((0.3)(280k)+(0.038)(20k))/

It's true that other normal income (like conversion income or W2 income) will make your investment income subject to the higher tax. It's similar to long term capital gains in the AMT. They are not subject to AMT, but they increase your AGI and thus decrease your AMT exemption and increase your AMT phaseout, and thus add to your AMT tax.

Who knows, maybe the Republicans will extend the Bush tax cut in November, or lower the tax rate for investment income by 3.8% :).

The situation only arises if a combination of earnings and investment income places the TP above threshold, but neither of these individually would place the TP above threshold.

Yes, because in your example immediately above, the earnings alone would place them above threshold, so the 6.7% marginal Medicare rate does not appear.

Here's an example where it does appear:

Single TP has 180K income from Schedule C and 40K income from investments. Threshold is 200K.

If TP has 10K additional Schedule C income, he pays 2.9% medicare tax on it on his Schedule SE, and also pays 3.8% new medicare tax on an additional 10K. There is no increase in investment income, but the increase in Schedule C earnings sees 6.7% Medicare tax.

You could say the increased Schedule C earnings subject more of the investment income to Medicare tax, but the marginal effect is that of 6.7% Medicare taxes on the additional earnings.

Steve