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Federal Employees News Digest : Feb. 4, 2013
February 4, 2013 Vol. 62, No. 27 7 Visit us on the Internet at www.FederalDaily.com With so much attention focused on the recent tax law changes resulting in the passage of the American Taxpayer Relief Act of 2012, some employees may have forgotten about new Medicare surtaxes that took effect Jan. 1, 2013. Because of these new Medicare surtaxes, some upper-income federal employees will be required to pay additional taxes on their earned and investment income. The new Medicare surtaxes include: (1) a 3.8 per- cent surtax that is levied on the smaller of an individ- ual's "net investment" (NI) income or the excess of an individual's modified adjusted gross income (MAGI) above $200,000 for single/head of household/qualified widow individual tax filers, MAGI above $250,000 for married individuals filing jointly, or MAGI above $125,000 for married individuals filing separately; and (2) an additional 0.9 percent Medicare hospital insur- ance (HI) tax levied on the earned income---this includes salary and net self-employment income---above $200,000 for single/head of household/qualified widow individuals, earned income above $250,000 for married individuals filing jointly, or earned income above $125,000 for married individuals filing separately. Medicare surtax on net investment income Until Jan. 1, 2013, individuals were not required to pay Medicare tax on any type of investment income that was generated from capital gains, dividends or taxable interest. But effective Jan. 1, 2013, some individuals could owe a 3.8 percent Medicare surtax on some of their investment income. The amount of Medicare surtax owed is equal to 3.8 percent of the smaller of an individual's NI income or the amount of the indi- vidual's MAGI that exceeds $200,000 for singles, $250,000 for mar- ried filing jointly, or $125,000 for married filing separately. MAGI is defined as an individual's adjusted gross income (AGI) plus any for- eign earned income exclusion. NI income includes net gains from property held for investment and gross income from dividends, taxable interest, royalties, annuities, rents, passive business activities and business of trading in financial instruments or commodities. The following two examples illustrate. Example 1. Paul, single, has a MAGI during 2013 of $150,000 and NI income of $100,000. Paul does not owe the 3.8 Medicare tax because his MAGI is less than $200,000. Example 2. Ron and Susan are married with MAGI during 2013 of $275,000 and NI income of $100,000. They owe 3.8 percent Medicare tax of $950 calculated as the smaller of their MAGI in excess of the threshold ($275,000 less $250,000) or $100,000, times 3.8 percent, or $25,000 times 3.8 percent. Note that the 3.8 percent Medicare surtax is in addition to the other tax paid on investment income. This other tax includes the ordinary tax paid on taxable interest, royalties, rental income and short-term capital gains income, and the "preferential" tax (15 or 20 percent) paid on qualified dividend income and long-term capital gains. Medicare payroll tax increase on earned income The Medicare HI payroll tax is 2.9 percent, and applies only to earned income which includes wages or salaries paid by an employer. The 2.9 percent Medicare HI payroll tax is split equally between the employee and the employer: 1.45 percent of the employee's gross wages is deducted to pay the employee's portion and the employer pays the other 1.45 percent. Under the law that took effect Jan. 1, 2013, high- wage earners will pay an additional 0.9 percent Medicare HI tax above the MAGI thresholds pre- sented above. An employer will be required to withhold the entire 0.9 percent once an employee's wages exceed the $200,000 threshold for individuals. The following examples illustrate. Example 1. Joseph is single with W2 earnings during 2013 of $75,000 and $100,000 NI income. Joseph does not owe the additional 0.9 percent Medicare HI tax because his earned income is under $200,000. Example 2. John and Carol are married with combined earned income of $280,000 and $25,000 NI income. They owe the additional 0.9 percent Medicare HI tax based on their excess earned income over the MAGI threshold, equal to ($280,000 less $250,000) times 0.9 percent, or $270. Some planning considerations Reducing MAGI may be a challenge for higher-wage employees. One suggestion for employees to reduce MAGI is to maximize their contributions to the traditional Thrift Savings Plan. Traditional TSP contributions reduce an employee's gross salary, which in turn can reduce the employee's MAGI. During 2013, employees may contrib- ute a maximum $17,500 ($23,000 if age 50 or older as of Dec. 31, 2013) to the TSP. Qualified withdrawals from a Roth IRA or Roth TSP are not included in MAGI. Those employees who expect to be close to the MAGI threshold after they retire---especially after age 70.5, when they must begin taking minimum required distributions (MRD) from their traditional IRAs and TSP---should consider the effect future taxable traditional TSP distributions will have on their MAGI and possible exposure to the Medicare surtax on their NI income. One recommendation for dealing with the Medicare surtax on NI income is to shift some investments with taxable earnings into municipal bonds and municipal bond funds, whose earnings are excluded from MAGI. Edward A. Zurndorfer is a Certified Financial Planner and Enrolled Agent in Silver Spring, MD. He is also a registered representative with FSC Securities Corporation, branch address: 833 Bromley St. - Suite A, Silver Spring, MD 20902. Phone: (301) 681-1652. Securities offered through FSC Securities Corporation,member FINRA/SIPC. EZ Accounting and Financial Services and FSC are independent companies. Informed Investor Some employees may be affected by new Medicare taxes
Jan. 28, 2013
Feb. 11, 2013