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High-Income Individuals Face New Medicare Taxes in 2013

Two new Medicare-related taxes take effect in 2013: an additional 0.9% payroll tax on high-wage earners, and a 3.8% tax on the unearned income of high-income individuals. Here's what you need to know.

New additional Medicare payroll tax

Beginning in 2013, the employee share of the hospital insurance (HI), or Medicare, portion of the Federal Insurance Contributions Act (FICA) payroll tax will increase by 0.9% (from 1.45% to 2.35%) for high-wage earners. Will you be affected? The tax applies to the extent that your wages exceed $200,000 ($250,000 in combined wages if you're married and file a joint federal income tax return, $125,000 if you're married and file separately). So, in 2013, a single individual with wages of $230,000 will owe HI tax at a rate of 1.45% on the first $200,000 of wages, and HI tax at a rate of 2.35% on the remaining $30,000 of wages for the year.

The additional tax doesn't apply to the employer portion of the FICA payroll tax, but your employer is responsible for withholding your portion of the tax--the additional 0.9% will be withheld on any wages you receive over $200,000. Your employer won't account for any wages earned by your spouse, so if you are married, you may owe more (or less) tax than the amount that's withheld. In that case, you will pay any additional tax due (or claim a refund for taxes overpaid) on your federal income tax return for the year.

If you're self-employed, the additional 0.9% tax applies to self-employment income that exceeds the dollar amounts above (reduced, though, by any wages subject to FICA tax). If you're self-employed, you won't be able to deduct any portion of the additional tax.

New tax on investment income

Beginning in 2013, a new 3.8% Medicare contribution tax will generally be imposed on the unearned income of high-income individuals. The tax is equal to 3.8% of the lesser of:

  • Your net investment income
  • The amount of your modified adjusted gross income (basically, your adjusted gross income increased by an amount associated with any foreign earned income exclusion) that exceeds $200,000 ($250,000 if married filing a joint federal income tax return, $125,000 if married filing a separate return)

So, if you're single and have modified adjusted gross income of $250,000, consisting of $150,000 in earned income and $100,000 in net investment income, the 3.8% Medicare contribution tax will only apply to $50,000 of your investment income.

What is "net investment income"?

Net investment income generally includes all net income (income less any allowable associated deductions) from interest, dividends, capital gains, annuities, royalties, and rents. It also includes income from any business that's considered a passive activity, or any business that trades financial instruments or commodities.

Net investment income does not include interest on tax-exempt bonds, or any gain from the sale of a principal residence that is excluded from income. Distributions you take from a qualified retirement plan, IRA, IRC Section 457(b) deferred compensation plan, or IRC Section 403(b) retirement plan are also not included in the definition of net investment income.

Both taxes can apply

If you have high wages and investment income, you could be subject to both the 0.9% additional HI payroll tax and the 3.8% Medicare contribution tax on your investment income. So, you'll want to be sure to account for them in your overall tax plan.