The 3.8% Health Care Surtax: Your Questions, Our Answers

So far this year, we've received a lot of questions on the new 3.8% health care surtax, so we decided to take a few of the most frequently asked questions and answer them here, so that everyone can benefit from them.

In general, what is the 3.8% health care surtax? We have been writing about it (for our loyal readers) as far back as 2010. Here are links to a few other articles to well verse you on the topic before reading the questions and answers below.

3.8% Surtax: What You Need to Know
What the Supreme Court Ruling on Health Care Law Means For Your Taxes
10 Ways You Might Pay More Tax in 2013
An Open Letter of Retirement Planning Advice to President Obama

Question: Are my Social Security benefits subject to the 3.8% surtax?

Answer: No, although your Social Security benefits generally increase your MAGI (modified adjusted gross income), causing some or more of your other net investment income to become subject to the 3.8% surtax.

Question: I have net investment income from things like interest, dividends and capital gains. Do I automatically have to pay an additional 3.8% surtax on income from these sources?

Answer: No, not automatically, but you may have to. If you’re single and have MAGI over $200,000 or are married and file jointly with more than $250,000 of MAGI, then at least some of your net investment income will be subject to the surtax. However, if your MAGI is below these thresholds, then you will not owe any 3.8% surtax at all.

Question: Since the 3.8% surtax wasn’t effective until January 1, 2013, I don’t have to worry about it until I file my 2013 taxes next year, right?

Answer: Not necessarily, especially not if you are one of the millions of taxpayers that pay their tax liability through estimated payments throughout the year. The 3.8% surtax (as well as the new 0.9% Medicare surtax and the new top long-term capital gains and ordinary income tax rates) must be factored into your estimated tax payments. There are multiple ways you can set up estimated tax payments in order to avoid penalties, so it’s probably best to speak to your tax advisor to find out what’s best for you.

Question: Will any distributions from my IRA be subject to the 3.8% surtax?

Answer: No, but just like Social Security benefits, your traditional IRA distributions generally increase your MAGI, causing more of your net investment income that was previously not subject to the 3.8% surtax to become subject to the 3.8% surtax.

For example, suppose you are married and file a joint return and, in 2012, you had $230,000 of income, all from interest, dividends and capital gains. If your income is exactly the same this year, you won’t owe any 3.8% surtax because you would be below the $250,000 MAGI threshold.

However, let’s imagine things stay the same next year except for the fact that you turn age 70 ½ and take your first RMD (required minimum distribution) of $70,000. Now you are $50,000 over the threshold and even though you have no more investment income than you had this year, $50,000 of it will be subject to the 3.8% surtax, putting an extra $1,900 of your money into Uncle Sam’s pockets. Roth IRA distributions generally will not affect your MAGI.

Question: If I don’t owe any 3.8% surtax this year, is it safe to assume that I’ll probably avoid it in future years as well?

Answer: Nothing is safe to assume when it comes to taxes. You know the old saying, when you assume…Well it definitely applies here. Your income might change significantly from one year to the next, but even if it doesn’t, chances are as time passes more and more people will become subject to the 3.8% surtax. Why? Because the thresholds (other than for trusts and estates) are not adjusted for inflation each year, so as inflation takes effect and incomes increase, more and more people will be ensnared by the 3.8% surtax.

- By Jeffrey Levine and Jared Trexler

Posted in: Ed Slott,ed slott ira,financial,financial advisor,health care taxes,IRAs,Jeff Levine,Obamacare,surtax,Tax Planning