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Federal Employees News Digest : Nov 25, 2013
This is fourth of five columns discussing how the Affordable Care Act (ACA) of 2010 affects feder- al employees examines the second of two "surtaxes" paid by higher-income individuals. Both surtaxes are designated as "Medicare taxes," but none of the tax revenue generated by the surtaxes are earmarked for Medicare or for health care purposes. The two surtaxes took effect Jan. 1, 2013. The first surtax, called the 0.9 percent Medicare Part A (hos- pital insurance) surtax, was discussed in the Nov. 18 column. This column discusses the 3.8 percent surtax on net investment income (NII). The 3.8 percent surtax on NII is computed as 3.8 percent of the lesser of: (1) NII; or (2) the excess of modified adjusted gross income (MAGI) over the threshold amount. The threshold amount depends on an individual's tax filing status, as summarized in the following table: MAGI is defined as adjusted gross income (AGI) excluding for- eign earned income. The threshold amounts shown in the table are not indexed to inflation. Note that the 3.8 percent surtax is in addi- tion to the other taxes paid on investment income such as capital gains tax. The surtax is reported on IRS Form 8960. NII is defined as gross investment income less any investment- related expenses such as brokerage fees. Gross investment income includes interest, dividend, capital gain, royalty, and non-qualified annuity income, and rental income if the rental activity is considered a "passive" activity. A rental passive activity means that a real estate investor is not in the business of selling or renting real estate such as a full-time real estate agent. A full-time federal employee who rents out a single rental property such as a house is an example of an individual engaging in a passive real estate activity. Individual citizens and resident aliens, but not nonresident aliens, are subject to the 3.8 percent surtax on NII. Both employees and retirees are subject to the surtax. Estates and trusts could be subject to the surtax if they have undistributed NII and the estate's or the trust's adjusted gross income exceeds the dollar amount at which the highest tax bracket for an estate or trust begins. For tax year 2013, this dollar amount is $11,950. To the extent that capital gains are not otherwise offset by capital losses, the following capital gains are common examples of items taken into account in computing NII: (1) gains from the sale of stocks, bonds and mutual funds; (2) capital gain distributions from mutual funds; (3) gains from sale of investment real estate, including second/vaca- tion homes; and (4) gains from the sale of interests in partnerships and S corporations. The following example illustrates the 3.8 percent surtax on NII: Mike and Michelle are married and both are fed- eral employees. Mike's annual salary is $130,000 and Michelle's annual salary is $110,000. Mike and Michelle have $15,000 of interest income during 2013 and sold some stock during 2013 resulting in a capital gain of $30,000. Their MAGI totals $285,000. Mike and Michelle will pay 3.8 percent on the lesser of (1) $45,000 (NII); or (2) $285,000 less $250,000 or $35,000. Their surtax on NII is therefore 3.8 percent of $35,000, or $1,330. What are the chances of a federal employee being subject to the 3.8 percent surtax on NII? Chances are slim that a new employee starting his or her first job will be subject to the surtax. This is because new employees have lower salaries and they prob- ably do not have much money to invest, resulting in a small amount of investment income. But more established employees---those in mid-career or close to retirement---have larger salaries, more invest- ment income and may be approaching the $200,000 threshold, perhaps more likely in the case of a married couple in which both working spouses have respectable salaries and investment income. What should employees do to minimize the chance of being subject to the 3.8 percent surtax on NII? Employees who think they may be subject to the 3.8 percent surtax on NII should reduce their MAGI and NII. The following are some suggestions to reduce MAGI: 1. Maximize contributions to the traditional TSP; 2. Reduce balances in taxable accounts; 3. Once retired, minimize withdrawals from the traditional TSP during high MAGI years; and 4. Convert traditional IRAs to Roth IRAs only in lower-income years to keep MAGI under the threshold. The following are suggestions to reduce NII: 1. Invest in municipal bonds; 2. Harvest capital losses in years with capital gains; 3. Invest in appreciating stock rather than income-producing investments; and 4. Use deductions and expenses that are allocable to items of gross income, thereby reducing NII. These deductions and expenses include investment interest expenses, investment advisory and bro- kerage fees, and expenses related to rental and royalty income. Learn how to select the right health plan for 2014 with Edward A. Zurndorfer's special series of weekly Federal Daily Open Season columns---appearing this month only at FederalDaily.com. 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 How employees are affected by the Affordable Care Act: Part IV November 25, 2013 Vol. 63, No. 19 7 Visit us on the Internet at www.FederalDaily.com Tax Filing Status MAGI Threshold Amount Married Filing Jointly $250,000 Married Filing Separately $125,000 Single $200,000 Head of Household (with qualifying person) $200,000 Qualifying Widow(er) (with qualifying child) $200,000
Nov 18, 2013
Dec 2, 2013