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The most noteworthy difference between the 2013 individual tax filing season which is drawing to a close (excepting returns requiring an automatic six month extension) and prior years is the addition of Forms 8959 and 8960 to compute the expanded Medicare tax which partially funds the comprehensive 2010 health care legislation.

Form 8959 is for unmarried individuals with wages and self-employment income in excess of $200,000 and for married individuals filing jointly who together have wages and self-employment income in excess of $250,000. The additional Medicare tax of 0.9 percent above the combined employer-employee rate / self-employed rate of 2.9 percent is computed on the excess earned income and is netted with withholdings of the additional Medicare tax which commences at $200,000 of wages from an employer irrespective of filing status.

Form 8960 is for individuals and couples with modified adjusted gross income (“MAGI”) in excess of the above thresholds who have “net investment income.” The full Medicare tax of 3.8 percent applies to the lesser of net investment income or the excess MAGI over the $200,000/$250,000 floor.

Investment income generally includes interest, dividends, rents and annuities (but not retirement plan distributions). It also includes passive income from a business or activity where the hours for material participation are not satisfied. It encompasses gain on the disposition of portfolio assets (stocks, bonds, etc.) and assets used in a passive activity. Allocable expenses and losses are subtracted in determining net investment income.

Opportunities exist to minimize the sting of the expansion of the Medicare tax. Most significantly, using an S corporation to operate your business in which you materially participate (generally at least 500 hours) excludes the flow through income from the Medicare tax as well as the social security tax. This saving is not available in the case of partnerships and limited liability companies and remains such a “loophole” that Congress regularly considers legislation to eliminate this opportunity.

Maximizing investments in tax-exempt bonds can reduce the investment income subject to the Medicare tax. So can converting traditional IRAs to Roth IRAs as MAGI after the year of the conversion may be significantly reduced because Roth distributions are tax free.

Under a complex test, “real estate professionals” may be able to avoid application of the Medicare tax to their rental properties.

Finally, be sure to subtract all allocable investment expenses from investment income. Instructions to Form 8960 indicate that deductions such as state income tax may be apportioned to investment income.

If you have any questions concerning the expanded Medicare tax, choice of business entity or other tax issues, please call a member of our tax law department at 301-340-2020.


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