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Are You Ready for the New Medicare Tax?

After much wrangling and hand-wringing, and even a review by the Supreme Court, it’s time for the Patient Protection and Affordable Care Act (PPACA) [3] to continue following its timeline. The provisions of the PPACA (also called “Obamacare” informally) were laid out to take place over time, and not all at once. However, there are some changes coming in 2013 that will really start having an impact.

One of these changes is the addition of a Medicare tax. No matter what you think about the healthcare law [4], it’s been ruled Constitutional in all but one provision, and the Medicare tax is coming.

Who Will Be Affected by the New Medicare Tax?

Not everyone will be affected by the new Medicare tax. Indeed, it only affects those who have a modified adjusted gross income (MAGI) that exceeds $200,000 for those who are single, $125,000 for those who are married filing separately, and $250,000 for those married filing jointly.

Even if your MAGI (which for most taxpayers — but not all — is the same as AGI) exceeds these amounts for your filing status, you still may not have to pay the new Medicare tax. The surtax will not be charged on your earned income. Instead, it will be charged on your net investment income [5]. The types of income that will be subject to the Medicare tax include:

  1. Dividend, interest, annuity, royalty, and rent income (after applicable deductions).
  2. Income from passive activities.
  3. Gain from the sale of property other than that held in a trade or business the taxpayer is materially involved with.

If you think that you will be affected by the Medicare tax, now is the time to take some steps to minimize the impact.

What Can You Do to Reduce the Impact of the Medicare Tax?

There are some tax strategies you can use to help reduce your Medicare tax liability. One of the things you can do is to sell winning investments right now, before the end of the year. You avoid the surtax next year, and you can take advantage of the current top 15% rate on long-term capital gains, as well as the preferred 15% rate on qualified dividends [6]. Unless something changes, these tax advantages go away just as the Medicare tax is added.

You can also consider tax-exempt bonds. This is actually one of the few things you can do in the future to reduce the impact of the tax. Tax-exempt bonds are not part of your net investment income, so you can benefit by investing in these types of securities. You do need to weigh the yield you might get against your tax savings, though.

Another tactic, if you are earning money from a partnership or S corp that you are involved with, is to make sure that you remain a material participant. Earning this money passively is a dream for many, but once 2013 hits, that passive money is subject to the Medicare tax if your MAGI exceeds the threshold. Do what it takes to be considered a material participant, and you can maintain that the income you receive isn’t passive.

There are other ways that you can reduce your exposure to the Medicare tax. Consult with a tax professional, and plan ahead, and you might find that you won’t be paying as much as you thought.

(Photo: diekatrin [7])