Other Tax Questions
Questions and comments on other topics covered in Fairmark.com, such as UTMA accounts, and any tax questions that don't fit our other categories.
Medicare Tax
Posted by: sscminc, July 3, 2012 02:10PM
The new 3.8% Medicare tax applies to the lesser of an individual's net investment income or MAGI in excess of $250,000 (married, filing joint). So, can someone explain how this situation would work:

Couple has $400,000 MAGI, including $100,000 of investment income.

So, would the 3.8% tax only apply to the $100,000 rather than the $150,000 that exceeds the $250,000 threshold?

Thank you in advance for your clarification.

Re: Medicare Tax
Posted by: kaneohe, July 3, 2012 03:35PM
[money.cnn.com]

that's my impression too.

Re: Medicare Tax
Posted by: Kaye Thomas, July 3, 2012 07:11PM
With $400,000 MAGI on a joint return that includes $100,000 of net investment income, the tax applies to $100,000 (limited to the amount of net investment income). With $300,000 MAGI on a joint return that includes $100,000 of net investment income, the tax applies to $50,000 (limited to the amount above $250,000).

Kaye Thomas
Fairmark.com

Re: Medicare Tax
Posted by: DeeDee, July 3, 2012 08:30PM
Some good examples here...[online.wsj.com]

Re: Medicare Tax
Posted by: kaneohe, July 4, 2012 12:11AM
the wsj article talks about AGI. The other reference and Kaye mention MAGI. Which is it and if it is MAGI, what is the definition?

Re: Medicare Tax
Posted by: Kaye Thomas, July 4, 2012 12:31AM
AGI with any excluded foreign income added back. Our first take on this was a while back:

[fairmark.com]

Kaye Thomas
Fairmark.com

Re: Medicare Tax
Posted by: kaneohe, July 4, 2012 12:40AM
Kaye, thanks for the clarification......so basically AGI for most folks, including me.

Re: Medicare Tax
Posted by: cpw, July 4, 2012 01:52AM
I thought Medicare's MAGI included tax-exempt income.

Re: Medicare Tax
Posted by: kaneohe, July 4, 2012 02:41AM
cpw Wrote:
-------------------------------------------------------
> I thought Medicare's MAGI included tax-exempt
> income.

You might be thinking of the formula for determining Medicare premiums
[www.ssa.gov]
Your MAGI is the total of your adjusted gross income and tax-exempt interest income.

The topic OP is talking about is the new Medicare tax starting ? next yr ?

I would like to have IRS number the various MAGIs so we could know how many there are.

Re: Medicare Tax
Posted by: cpw, July 4, 2012 07:36PM
kaneohe...precisely my point; now Medicare has two tax-related MAGIs floating around. Or is a "premium" not a tax? Maybe a mandate?

Re: Medicare Tax
Posted by: Art, July 4, 2012 07:58PM
The Medicare Part B premium surcharge is calculated by SSA based on information from the tax return.

The 3.8% Medicare surcharge that applies to investment income for high AGI taxpayers is calculated by 1040 tax preparers.

Re: Medicare Tax
Posted by: Snargle, July 6, 2012 09:50PM
"I would like to have IRS number the various MAGI..." [kaneohe's post #10 above]

Okay, there's one, two, and three: Caspar, Melchior, and Balthazar.

**I can't believe all you guys let this one fly right past you.**

And, they were dressed in firemen's outfits; they had come from afar ["a fire"]...

Re: Medicare Tax
Posted by: dcd0c, July 17, 2012 11:55AM
I am confused by the more than one type of "Medicare" tax, in particular the 1.45% going to 2.35% one.

The new Medicare tax that comes to us a stealth component of Obamacare (PPACA) is 3.8% on "unearned income." (I don't think "unearned income" is the way to describe income which comes through investments, nor is "passive," but those are the terms we are stuck with.) That one is what it is and requires no "matching" by an employer or the taxpayer if the tax payer is self-employed. And it is calculated in the way explained above.

What about the 1.45% going to 2.35% one, though? That requires a "match," right, and hence in reality is >2.35%, even if the taxpayer isn't paying more out of his/her own pocket? And this Medicare tax is paid only on "earned" income, as opposed to the 3.8% one that is paid on "unearned" income, or this one is paid on all income no matter whether "earned" or "unearned"? I think it is the former, that is only on "earned" income, but I am sure of nothing in this regard.

The added .9% will have to be "matched" too, just like the already in place 1.45%?

How do we designate these different Medicare taxes calculated in different ways to keep them straight? I'm clueless here.

And if your income is high enough that you must pay extra in premiums for Medicare B and/or Medicare D coverage, that feels like a "tax" to me, but it isn't one, is it?

Thanks in advance to anyone who can straighten me out as to these rather basic questions. (And sorry if all this has been explained before.)

Re: Medicare Tax
Posted by: Kaye Thomas, July 17, 2012 08:10PM
The 3.8% tax is paid on net investment income. The added 0.9% is not matched. The concept (imperfectly implemented) is that income above the threshold will bear a 3.8% Medicare tax. For wages it consists of 1.45% employee, 1.45% employer, and 0.9% additional tax. For net investment income it is simply 3.8%.

Kaye Thomas
Fairmark.com

Re: Medicare Tax
Posted by: dcd0c, July 18, 2012 03:53AM
Forgive me for being obtuse, but I am a bit confused.

For "earned" income, it has been a Medicare tax of 1.45% from the employee and 1.45% from the employer for a total of 2.9% on "earned" income. In 2013, this Medicare tax will bump up by an additional .9%, making it 2.35% from the employee and 1.45% from the employer, for a new total of 3.8%? But that 3.8% in Medicare taxes is a different 3.8% from the 3.8% Medicare tax on "unearned" income above $250K for married couples that is to kick in next year? Does this mean that there can't be more than 3.8% in Medicare taxes, and it would be less if there is "earned" income of less than $250K plus "unearned" income?

Re: Medicare Tax
Posted by: Alan S., July 18, 2012 04:29AM
The additional taxes would be less if all the excess income was earned. For example, if the joint income is 350k, the excess amount is 100k. The portion of that 100k that is investment income is taxed at 3.8% in addition to other taxes. The portion that is earned income is taxed at .9% more than it would have been, but that .9% brings the total up to 3.8%.

The ACA additional tax rate is therefore much less on excess earned income than it is on investment income because 2.9% was already going to Medicare prior to the ACA.

Re: Medicare Tax
Posted by: dcd0c, July 18, 2012 11:20AM
In 2012, Joe has $1M of "earned" income, no "unearned" income. In addition to what must be paid by him and his employer in FICA, he must pay $145K in Medicare taxes and his employer must also kick in $145K, for a total of $290K.

Meanwhile, Joe's friend Tom also has $1M of income in 2012, but all of Tom's 2012 income is "unearned" (investment), none of it "earned." There is neither any FICA or any Medicare taxes for him to pay. Tom will only have to pay regular income tax on his $1M, while Joe and his employer must pay both FICA and between them a total of $290K in Medicare taxes. (Much better to have all one's income "unearned" than "earned.")

Comes 2013 and both Joe and Tom again have $1M each of income from the same sources. Joe and his employer will pay exactly the same amount in FICA as they did in 2012 (unless the cap is going up), but Joe will owe $90K more in Medicare taxes than he did in 2012, so now it will be $235K, while his employer's share will remain the same $145K that it was in 2012. Between Joe and his employer, the Medicare tax tab will be $380K.

In 2013, Tom will still owe $0 FICA, and he will owe $0 in Medicare taxes on his first $250K of "unearned" income, but then for the first time will be on the hook for 3.8% of $750K, or 285K in addition to the regular income taxes he must pay. So still better to have "unearned" income than to have "earned" income, but not nearly as great an advantage as it was prior to 2013.

Am I correct about all of this? And if the Bush tax cuts are not extended, and the treatment of dividend income and long-term income are both less favorable than they have been previously, that will mean a further reduction in the tax advantage that "unearned" income has enjoyed over "earned" income, right?

Re: Medicare Tax
Posted by: dcd0c, July 18, 2012 01:01PM
BTW, how do the Medicare taxes pertain to Roth and non-Roth retirement accounts, both going in and coming out?

If one is going straight into a Roth, not first coming out of a non-Roth by way of a conversion, then they will have paid taxes on all of their earned income in the same way everyone else pays taxes on earned income. So no Medicare taxes await the Roth account holder when he/she takes distributions, and I presume none when he/she leaves this mortal coil and the money goes to a spouse or heirs. What about non-Roth accounts that hold a combination of untaxed contributions and untaxed earnings on those untaxed contributions, what happens with respect to Medicare taxes? Would any distinction be made between $$$ attributable to contributions and $$$ attributable to earnings that accumulated within the retirement account?

Re: Medicare Tax
Posted by: Sven, July 18, 2012 02:03PM
There's a math error that probably does not change the question being posed in the most recent long hypothetical, but for the record the employer and employee each would pay $14,500 in medicare tax, not $145,000.

There certainly are "benefits" earned income has over unearned income. One is that you collect quarters of social security coverage for earned income on which "payroll taxes" were imposed. You get nothing in that regard for unearned income. And you can do all sorts of creative retirement account things with your earned income, whereas with unearned income, you can't do much, if anything. How big these "benefits" are is certainly subject to debate, and your view may depend on whether you are 25 and think SS is not going to be there for you, or are 62.

Re: Medicare Tax
Posted by: dcd0c, July 18, 2012 02:53PM
Thanks for pointing out that 10-fold(!) error of mine.

As for the "benefits" of "earned" income over "unearned" income, I don't think paying FICA is a boon, unless you will just be contributing the minimum amount necessary to qualify for SS and Medicare. For those who put in the minimum amount over the course of their working careers, there will be a relatively small benefit awaiting them in the end, but they will have gotten an excellent return on what they did pay in FICA. For those higher up the food chain, especially those max'ing out each year for 35+ years, a bigger benefit awaits them, but they will be getting a pretty lousy rate of return on their much more substantial FICA contributions.

As far as the other part ("all sorts of creative retirement account things with your earned income, whereas with unearned income, you can't do much, if anything."), I do hear you, but I don't know how to compare the extra cost of "earned" over "unearned" income (FICA, Medicare taxes, no long-term capital gains or other favorable tax treatment) with the putative benefits to which you allude. (If you have in mind the opportunity for tax deferral, I would remind you that at the other end it's going to come out as ordinary income. Roth accounts may be a different story, and added wrinkles if you are thinking of leaving money/assets in pre-tax retirement accounts for spouse or heirs.)



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