Background. As part of the Patient Protection and Affordable Care Act (Affordable Care Act), for taxable years beginning after December 31, 2012, individuals are now subject to a new tax (Medicare tax) on certain unearned investment income. The new Medicare tax is equal to 3.8% of the lesser of (a) their “net investment income” or (b) the excess of their “modified adjusted gross income” (as defined) over specified threshold amounts. The threshold amounts are: $250,000 for individuals filing a joint return or a surviving spouse; $125,000 for married taxpayers filing a separate return; and $200,000 in any other case.
Specific trusts and estates are also subject to the 3.8% tax on the lesser of their (a) undistributed net investment income or (b) “adjusted gross income” (as defined) over the dollar amount at which their highest applicable tax bracket begins ($11,950 in 2013).
For all applicable taxpayers, “net investment income” is the sum of (a) gross income from interest, dividends, annuities, royalties, rents, passive trade or business activities, and certain trading in financial instruments or commodities, plus all net gain from the disposition of property held in such businesses; minus (b) allowable deductions properly allocable to the gross income or net gain.
For individuals, the traditional Medicare tax on wages, salaries, and business or farming income has also increased starting in 2013, generally by 0.9% multiplied by the amount of wages over the thresholds noted above. Although the traditional Medicare tax is generally paid half by the employer and half by the employee, the 0.9% increase applies only to the employee’s portion. A self-employed individual with business or farming income is responsible for the entire amount of the Medicare tax.
Estimated Taxes. As enacted, the Affordable Care Act provides that these Medicare taxes are subject to estimated tax payment requirements. Many taxpayers raised concerns that these requirements present compliance burdens, particularly for investors in flowthrough entities, who may not know until year-end whether the investment will generate net investment income. Accordingly, it was suggested the estimated tax provisions exempt these taxes from their scope or, at a minimum, provide broad penalty relief.
On November 26, 2013, the Treasury Department filed its final regulations regarding the new tax on net investment income, addressing (in 217 pages) numerous aspects of the tax. In the introductory portion, the Treasury Department acknowledged the concerns expressed by taxpayers with respect to the estimated tax issue but declined to make any changes or provide other relief.
Accordingly, potentially impacted taxpayers should reassess their 2013 estimated tax position. If it appears a taxpayer may be in a potential penalty position due to the new tax (or otherwise), mitigation may be possible by making appropriate adjustments to fourth quarter estimates. In addition, for 2014 and beyond, taxpayers should take the Medicare taxes into account when determining the amount of their estimated tax payments.