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3.8% “Unearned” Investment Income Medicare Tax

Posted By Jim On 04/11/2012 @ 7:10 am In Investing | 2 Comments

I’m a big fan of dividends because of the favorable tax treatment so this article on Smart Money [3] about the impending spike in tax rates on dividends caught my eye. It’s a little sensationalist in the sense that the cited increased rate, 43.4%, applies mostly to “high income” individuals in the highest tax bracket [4] and subject to the new 3.8% “Unearned” Investment Income Tax, established by the health care reform law.

If you aren’t interest in gory details, basically it’s a 3.8% on unearned income for single filers whose AGI exceeds $200,000 ($250,000 for married filing jointly) starting in 2013 and it’ll be used to help fund Medicare. If you’re like me and want to see the details, here they are:

How did they get to 43.4%? Two things – first, once dividends lose favorable tax treatment, they’d be taxed at the short term capital gains rate which mirrors your marginal tax rate. Next, assuming the broader tax brackets are not extended and they increase to pre-Bush era tax rates, that highest bracket would be 39.6%. Add 3.8% to 39.6% and you get to 43.4%.

Who is considered a “high income” taxpayer?

  • Single Filers: If your adjusted gross income (AGI) exceeds $200,000.
  • Married Filing Jointly: If your AGI exceeds $250,000.
  • Married Filing Separately: If your AGI exceeds $125,000.

These values are not indexed to inflation. Surprising, since I’d expect Congress to be wise to that oversight by now (it does guarantee that the issue will come up again, and again, and again… likely solved with stop gap measures as they do with AMT these days).

What is considered unearned income? Typically refers to capital gains, rent, dividends, interest, and other sources of income that are not the result of your active effort. For capital gains, you’d only be subject to the additional tax when you sold an asset and the $250,000/$500,000 exclusion on capital gains for the sale of your principal residence is not included (when you sell, you actually don’t even include the capital gain on your taxes). For everything else, it’s the net income after any expenses.

The reason it’s also commonly called the Medicare tax is because the revenue is earmarked for the Medicare Trust Fund.

As you can see, it affects people with really high AGIs (the poverty line [5] for a single person is at $10,890) and tacks on a surcharge for Medicare. I’m curious to see how much this will raise for Medicare.


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[2] Email: mailto:?subject=http://www.bargaineering.com/articles/38-unearned-investment-income-medicare-tax.html

[3] article on Smart Money: http://www.smartmoney.com/invest/strategies/preparing-for-taxes-on-dividends-to-increase-1332723167618/

[4] highest tax bracket: http://www.bargaineering.com/articles/federal-income-irs-tax-brackets.html

[5] poverty line: http://aspe.hhs.gov/poverty/11fedreg.shtml

Thank you for reading!