Example 1 – Joe is a single filer who each year earns $100,000 in wages and $25,000 of net investment income. Because his MAGI does not exceed the $200,000 level, he doesn’t have to worry about the surtax. It applies to investment income only if his MAGI goes beyond the threshold.
Example 2 – Mary is a single filer who is retired and has no wages. Her entire MAGI comes from $225,000 of net investment income so she does have to pay the 3.8 percent surtax because her $25,000 that exceeds her threshold is less than her investment income of $225,000. Her bill for the Medicare surtax is $950 (3.8 percent of 25,000).
Example 3 – Harold and Barbara, a married couple, file jointly. They earn a total of $200,000 in wages and have $150,000 of net investment income. Their $350,000 MAGI exceed the threshold by $100,000. Because that’s less than their investment income, it’s their excess MAGI that is subject to the Medicare surtax. The couple must pay $3,800 (3.8 percent of 100,000) in surtax.
Example 4 – Stan is a retired single filer so has no wages. He does have $200,000 of net investment income but he will also receive a “required minimum distribution” (RMD) from his IRA of $125,000. The RMD doesn’t count for computing this tax but the RMD from his retirement plan does increase his MAGI to $325,000, exceeding his threshold by $125,000. The $125,000 is less than his $200,000 of investment income so his Medicare surtax bill is $4,750 (3.8 percent of $125,000).
For those who are at risk of paying this new tax, there may be strategies with advance planning to limit your tax bill. For example:
If you choose to sell property, consider selling it on an installment basis over several years thereby reducing capital gains if it will keep you below the threshold from triggering the 3.8 percent surtax.
Expand your holding of municipal bonds that pay tax-free interest that won’t increase your MAGI for the purposes of the surtax threshold.
If you invest in real estate, you can offset rental income with deductions for expenses, including a depreciation write-off under applicable IRS tables. Even if you show modest positive income, the depreciation deduction can limit your MAGI, making this a good way to avoid the surtax.
These opportunities may or may not work for you, and there could be other strategies that might help you limit your exposure to the new Medicare surtax. Work with your tax and financial advisors to choose a course of action that makes sense for your situation.
Mark S. Martel is a local independent investment advisor and principal with Martel Wealth Advisors Inc. He can be reached at 360.694.9940.