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The Medicare Tax on Investment Income

The Medicare Tax – also referred to as the Net Investment Income Tax (NIIT), the Medicare Surtax and several other names – is a tax on certain investment income for domestic workers in the U.S. The Medicare Surtax comes from Section 1411 of the IRC; this section lays out the structure of the tax and provides all of the relevant terminology. In effect since January 1, 2013, the Medicare Tax applies to investment incomes above certain thresholds; as per usual, there are different thresholds for different taxpayer categories – individual, married filing jointly, married filing separately and head of household.  

In this blog post, we will review the structure, terminology and purpose of the Medicare Tax and then work through some sample calculations. As you’ll see, calculating the Medicare Tax can be a bit tricky because it involves identifying your “modified adjusted gross income” (or MAGI) and working with the lesser of that amount or total net investment income.  

Medicare Tax Structure & Terminology

The Medicare Surtax consists of a 3.8% tax on income derived from investment sources. However, this rate applies to the lesser of two amounts: net investment income (NII), or the excess of modified adjusted gross income less the applicable threshold. The following thresholds currently apply: $200,000 for individuals, $250,000 for married couples filing jointly, $125,000 for married couples filing separately, $200,000 for heads of household and $250,000 for qualifying widow or widower with a dependent child.  

Net investment income is simply the total income from investment sources which an individual makes in the taxable year.  Modified adjusted gross income is equal to the adjusted gross income minus any available exclusions and deductions. To arrive at what is owed in a given situation, therefore, a taxpayer needs to determine his or her MAGI, subtract the applicable threshold from this amount, determine his or her NII, and then multiply the 3.8% Medicare Tax Rate by the lesser of the two amounts.  

The above structure applies to individual taxpayers (whether single or married). The situation for estates and trusts which have investment income is a bit different. For estates and trusts, a given entity’s undistributed net investment income (UNII) is compared with its adjusted gross income (AGI) and then the 3.8% rate is applied to the lesser of the two amounts, after the AGI has been reduced by the fixed threshold amount. The fixed threshold amount for estates and trusts is updated on a yearly basis to be consistent with the dollar amount beginning at the highest tax bracket. 

Medicare Tax Sample Calculations

Let’s now apply this information to a couple of real world scenarios. Suppose that a taxpayer, Taxpayer Z, earns investment income totaling $50,000. Also suppose that Taxpayer Z is unmarried and earns Form W-2 income, as an employee, of $180,000. Now further suppose that Taxpayer Z’s adjusted gross income is unaffected by any exclusions or deductions, so that his MAGI will be $230,000 at the close of the taxable year. Given that Taxpayer Z is an unmarried filer, his applicable threshold is $200,000, and so his taxable MAGI is $30,000. To compute his tax, Taxpayer Z would multiply 3.8% on $30,000, as it is less than his $50,000 of investment income. Hence, the tax owed by Taxpayer Z would be $1,140.  

Let’s now look at a different scenario. Taxpayer Y earns investment income in a given taxable year equal to $75,000. Taxpayer Y is also an unmarried individual and earns a salary of $100,000 during that same taxable year. In this case, Taxpayer Y also faces an applicable threshold of $200,000, which completely cancels out his MAGI of $175,000, assuming that his AGI is unimpacted by any exclusions or deductions. Since there is no excess amount over Taxpayer Y’s MAGI less the applicable threshold, there will be no tax owed because zero is lesser than Taxpayer Y’s net investment income.  

New York City Tax Attorneys

Though it’s a relatively small tax, the Medicare Tax will certainly show up on the radar of many high-earning investors and business people throughout the country. Many earners will pay little to nothing, but a few will be slapped with a substantial Medicare Tax. Hedge fund managers and others with sizable yearly investment income do well to plan ahead for this surtax. At the firm of Mackay, Caswell & Callahan, P.C., we consider it our professional duty to keep up with the complex workings of taxes such as the Medicare Tax. Understanding this tax helps us give our clients the best possible service and ensures that they achieve the optimal outcome when having their tax issue resolved. If you have a tax issue, such as a debt resolution dispute, pending U.S. Tax Court matter, or other matter, don’t hesitate to contact our tax attorney in NYC and we will promptly respond to your situation. 

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