# The 3.8% Surtax on Investment Income - Individuals

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7 THE THRESHOLDS The threshold amount ( Threshold ) for a tax year depends on your filing status, as set forth in the chart below. Filing Status Married filing jointly, or Qualifying Widow[er] Threshold \$250,000 Single, Head of Household \$200,000 Married filing separately \$125,000 These Thresholds are not indexed for inflation. As a result, each year more taxpayers will become exposed to the surtax because other items that enter into the calculation will inflate, but these Thresholds will not. UNDERSTANDING THE RELATIONSHIP BETWEEN NII, MAGI AND THE THRESHOLD The surtax is imposed on the lesser of: (i) NII and (ii) the excess of MAGI over the Threshold. These three numbers, NII, MAGI, and the Threshold, are inter-related, as illustrated in the chart below. This chart contains eight examples/columns. In each case there is \$100,000 of NII represented by the white rectangle. All other income that is not NII but goes into MAGI (e.g., salary) is represented by the shaded rectangle ( Other Income ), which increases from column 1 to column 8. The horizontal line at \$250,000 represents the Threshold applicable to taxpayers filing jointly. Columns 1-4: Even though NII is \$100,000, until the combined Other Income and NII (which together are MAGI) reaches the Threshold, the surtax is not triggered. Columns 5-7: Once you have sufficient Other Income, you will begin incurring the surtax because the Other Income will push the NII above the Threshold. When that happens, only the NII over the Threshold is subject to the surtax. Columns 5 through 7 also illustrate a useful warning, illustrated as follows. Consider the following question: Is my taxable Required Minimum Distribution (RMD) from a traditional IRA going to be subject to the 3.8% surtax? One answer would be that no, it is not included in NII, which is true. However, that overlooks the relationship between NII and Other Income such as the RMD. If your surtax situation before the RMD is described by Column 4 but after the RMD is described by Column 7, the RMD will cause more of your NII to be pushed over the Threshold, triggering the surtax. Column 8: After a certain amount of Other Income, your NII might be fully exposed to the surtax. For example, assume a Husband and Wife have a fixed amount of NII, \$100,000. Both work and their combined salaries are \$275,000, represented by the shaded rectangle in Column 8. That level of salary will push their NII fully above 7

8 the Threshold, meaning they have exposed 100% of their NII to the surtax. In that case, it is useful to know that exposure to the surtax has maxed out and additional Other Income will not generate additional exposure. The chart above assumes that NII was fixed at \$100,000 and Other Income varies. Now assume the reverse: Other Income is fixed at \$100,000 and NII varies. PLANNING: OVERVIEW Columns 1-4: Until the combined Other Income and NII (which together are MAGI) reach the Threshold, the surtax is not triggered. This is the same dynamic as in the previous chart. Columns 5-11: Once the surtax applies (when enough NII has been recognized to cause MAGI to exceed the Threshold), the dynamics here are very different than in the prior example. Here, the amount of NII exposed to the surtax does not hit a maximum. Rather, as NII increases, the amount of income exposed to the surtax increases, without a limit. In this case, the straightforward planning would be to reduce your NII so that MAGI does not exceed the Threshold. The two preceding charts illustrate the important relationship between NII and Other Income (which together comprise MAGI). These two categories also suggest how to approach planning: you can minimize NII and/or you can minimize Other Income. When planning to minimize the 3.8% surtax, it is important to keep in mind that there are two other similar taxes. You don t want to avoid this 3.8% surtax only to trigger a different 3.8% tax, for no net benefit. 3.8% tax on wages. Wages are subject to payroll taxes that consist of two parts: 6.2% for Old-Age, Survivors, and Disability Insurance, and 1.45% for Hospital Insurance. The \$113,700 wage base limit (for 2013) only applies to the first component; there is no cap for the 1.45%. Employers also pay these taxes, so the Hospital Insurance tax totals 2.9%. Beginning in 2013, the employee s portion of the Hospital Insurance tax increases by 9/10ths of a percentage point to 2.35% for wages in excess of \$250,000 (married filing jointly); \$200,000 (single); or \$125,000 (married filing separate). Thus, the total combined Hospital Insurance tax imposed on wages is 1.45% % + 0.9% = 3.8%. 3.8% tax on self-employment income. A self-employed individual pays both the employer and employee components of these payroll taxes. As a result, beginning in 2013 self-employment income will also be subject to a 3.8% Hospital Insurance tax. 8

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