The Health Reform law added a new IRC § 1411 that imposes an additional tax (the “Unearned Income Medicare Contribution Tax”) on higher income individuals, estates and trusts. Previously, Medicare tax has been assessed only on earned income: wages earned by employees and self-employment income. The new Medicare contribution tax provisions apply to tax years beginning after Dec. 31, 2012.
The new tax is equal to 3.8% of the lesser of the individual’s net investment income for the year or the amount the individual’s modified adjusted gross income (MAGI) exceeds a threshold amount. For estates and trusts, the tax equals 3.8% of the lesser of the entity’s undistributed net investment income or adjusted gross income over the dollar amount at which the highest trust and estate tax bracket begins.
For married individuals filing a joint return and surviving spouses, the threshold amount is $250,000; for married taxpayers filing separately, it is $125,000; and for other individuals it is $200,000. Using current tax brackets, the threshold amount for estates and trusts would be set at only $11,650.
"Net investment income" is rather broadly defined to include many types of investment income (reduced by deductions allocable to that income), such as dividends, interest (but not tax-exempt interest), rents, royalties, and net gain from the disposition of property (capital gains). Income derived from an active trade or business is not included, but passive activity income is included.
The tax does not apply to distributions from tax-deferred plans described in IRC section 401 (a), 403 (a), 403 (b), 408, 408A, or 457 (b). (Note that IRC section 408 describes traditional IRAs and section 408A describes Roth IRAs). Special rules apply to gain from the disposition of interests in S corporations and partnerships.
This new tax may unexpectedly hit seniors and others who sell property (including their residence to the extent the sale proceeds exceed the IRC Section 121 exemption) and thereby generate capital gain. Taxpayers who may be subject to the tax may wish to consider accelerating the receipt of investment income into the current 2012 year. Executors and trustees may want to consider how to best balance the tax consequences between their entities and beneficiaries.
The text of § 1411 is available at http://www.law.cornell.edu/uscode/text/26/1411