Were you hit with additional Medicare Taxes on your tax return?Submitted by Desmond Wealth Management, Inc. on October 16th, 2015
Heading into our third year of this ‘new’ tax, more clients are beginning to understand the importance of planning to reduce the additional Medicare tax.
What are the additional Medicare Taxes?
Two new taxes, the Net Investment Income Tax and the Medicare Surcharge Tax, came into effect in 2013, and taxpayers are starting to feel the impact of these new taxes as the years move forward. Pro-active tax planning can play a big role in reducing these additional taxes especially if you are a business owner.
Net Investment Income Tax
The Net Investment Income Tax (NIIT) is a 3.8% tax (if you are over certain thresholds) on your net investment income, which includes interest, dividends, annuities, rental and royalty income, unless those items were derived from an active trade or business. Taxable net gain from dispositions of property, other than property held in an active trade or business, is also subject to the additional tax. Other gross income from a trade or business that is classified as passive activity is subject to the NIIT.
Net investment income does not include salaries, wages, operating income for a non-passive business, Social Security benefits, tax-exempt interest, self-employment income and distributions from certain qualified plans.
Medicare Surcharge Tax
The Medicare Surcharge Tax (MST) also went into effect in 2013 for high income earners and applies to wages, compensation, and self-employment income above certain threshold amounts. The additional Medicare Tax is 0.9 percent and only you (not your employer) is subject to the tax. Your employer is only required to withhold this tax if your wages exceed the threshold. The trouble comes in when you have multiple employers, or your spouse has compensation as well. The threshold is on your combined wages so it’s easy to get caught without enough withholding.
Planning Tips for Reducing Medicare Taxes
- Threshold limitations. When possible, plan your events in such a way that you AGI stays under the AGI thresholds that trigger the tax. This will eliminate the tax all together.
- IRA Strategies. Use Roth IRA conversion strategies to convert your taxable distributions into tax-free distributions. Monitor the AGI thresholds during the conversions. Also, by maximizing your current contributions to qualified accounts, you can reduce your AGI and monitor the thresholds.
- Capital Gains. Plan your investment sales to offset gains with losses or to sell in years where your other income will be lower. Use §1031 (like-kind exchanges) or installment sales where possible to defer the gain recognition of highly appreciated assets.
- Charitable Giving. Use long-term vehicles such as Non-Grantor Charitable Lead Trust (CLTs) and Charitable Remainder Trust (CRTs) to reduce taxable income.
- Life Insurance & Annuities. Both of these investments produce tax deferred earnings. Investing in whole life insurance can allow for tax-free withdrawals through policy loans and avoid the NIIT tax. Cash withdrawals from either life insurance or annuities are subject to NIIT, however the earnings are deferred, allowing you to plan these withdrawals to work within the threshold limits.
- Planning with Trusts. Trustees can help reduce taxes by learning about the beneficiaries’ income levels and plan whether to distribute or retain income early on in the year. Classification of business entities as material participation could also reduce NIIT.
- Investments. NIIT can be reduced with investment planning strategies that include using real estate, municipal bonds, and oil and gas investments in your overall wealth strategies.
- Real Estate. Monitor your amount of time and activity spent in your real estate activities to plan for being classified as a Real Estate Professional, if applicable.
Proactive planning is your best friend when it comes to reducing taxes. If you are considering the sale of highly appreciated assets this year, or maybe your income is significantly higher, contact our office and let us help you find the most tax-efficient way to structure your transactions.