Starting in 2013, that tax situation is going to get a little more interesting. While some items, like the Bush-era tax cuts, are on the table and may be changed, the 3.8% Medicare surtax on investment income is coming for sure, since it is part of the health care bill passed in 2010 (Patient Protection & Affordable Care Act).
What is the Medicare Tax on Investment Income?
There are actually two new Medicare taxes coming in 2013. The first is an extra 0.9% on income earned by high earners. (those making $200k or more filing single or married couples filing jointly making $250k or more). The second is a 3.8% tax on investment income. Investment income includes the money you receive from dividends and interest, as well as income from a business that you have ownership in, but in which you are not an active participant.
Strategies to Reduce Your Medicare Surtax Liability
If you are concerned that you will meet the income threshold that means that your investment income will be subject to the 3.8% Medicare surtax, there are some steps you can take to reduce your exposure. Here are 5 strategies to consider:
- Manage your income: One of the best things you can do is properly manage your income. Thresholds are based on your Modified Adjusted Gross Income (MAGI), so take steps to manage that income. Whether you sell some losing stocks to offset income, or qualify for some deductions, or ask to put off receiving a bonus until next year, look for ways to manage your income.
- Participate in your business: If you have “retired” from material participation in your business, maybe it’s time to come back. If you have a partnership or S corp, you need to be a material participant, or the money you receive will be considered investment income and subject to the tax. Find out about the minimum amount of participation you can have to qualify as a material participant, and meet that threshold.
- Give some of your investments to your children: As long as you don’t mind giving control of some of your income investments to your minor children, this can be a viable option for avoiding the 3.8% tax. The income might be subject to kiddie tax rules, but it won’t end up with the 3.8% surcharge. Remember, though, that those assets are now in your child’s name, and when he or she reaches the age of majority control comes with it.
- Consider tax-exempt bonds: You can consider moving some of your portfolio into tax-exempt bonds. If the federal government doesn’t collect taxes on the interest from the bonds (many state and municipal bonds fit this description), the Medicare surtax isn’t collected on it, either.
- Be a real estate professional: Do you receive rental income? If it is considered passive in nature, you are required to pay the Medicare surtax on it. However, if you are involved enough with your property to be considered a real estate professional, the income is no longer classified as passive, and it is no longer subject to the 3.8% tax. Find out what it takes to be considered a real estate professional, and do the minimum.
There are other strategies you can use as well. Before you adopt any strategy, though, it’s a good idea to consult with a tax professional, and make sure that you are on the right track. With a little planning, you can reduce the amount you pay in Medicare taxes on your investments, while still taking advantage of the income.