Posted by: Barbara Theofilos, CPA
The 3.8% Medicare tax on net investment income, or NIIT took effect for individuals, trusts and estates for tax years beginning on or after January 1, 2013.
Individual taxpayers will be affected by this new tax if their modified adjusted gross income (MAGI) exceeds one of the following thresholds:
- $200,000 for an unmarried taxpayer
- $250,000 for a married couple filing jointly or a qualifying widow or widower
- $125,000 for those married individuals filing separately
MAGI is regular adjusted gross income adjusted for certain excluded foreign-source income of U.S. citizens as well as residents living abroad. This particular add-back is very narrowly targeted and will not affect many taxpayers. Unfortunately, the above MAGI thresholds are not slated to increase with inflation after the 2013 tax year, so this additional tax will begin to affect even more taxpayers in future years.
If this isn’t complicated enough, the amount of income actually subject to NIIT is a bit convoluted; it is the lesser of (1) net investment income or (2) the amount by which MAGI exceeds the thresholds listed above.
Individuals aren’t the only taxpayers affected by this new tax. Trusts and estates will also be subject to it on the lesser of the following:
- The trust’s or estate’s undistributed net investment income, or
- The portion of its adjusted gross income (AGI) that exceeds the threshold for the top trust federal income tax bracket. (This threshold is only $11,950 for tax year 2013.)
The following trust types are exempt from NIIT:
- Charitable trusts
- Retirement plan trusts
- Grantor trusts that are disregarded for federal income tax purposes
- Real estate investment trusts
Those taxpayers and trustees planning for their 2013 tax obligations need to be aware that this tax will have an effect on their estimated taxes, because it needs to be considered when calculating quarterly estimated tax payments. Failure to do so could result in interest and penalty charges on underpayments of tax.
Examples of income that are considered net investment income include the following:
- Gross income from interest (excludes tax-free interest)
- Gross income from dividends
- Capital gains from the sale of stocks, bonds and mutual funds
- Capital gain distributions from mutual funds
- Gains from selling investment real estate
- Gains from selling personal residences to the extent that the gain is taxable
- Gains from selling interests in partnerships and S corporations if the taxpayer is a passive owner
- Gross income from rents
- Gross income from royalties
- Gross income from annuities
- Gross income and gains from passive business activities
- Gross income and gains from the business of trading in financial institutions or commodities
The above items may be reduced by appropriately allocated deductions including investment interest expense, brokerage fees, investment advisory fees, and expenses related to rent and royalty income.
Capital gains may be offset by capital losses within the guidelines for regular federal income tax purposes. Net capital losses are only permitted to offset other income to a maximum of $3,000. Any remaining capital loss for regular tax purposes is permitted to be carried forward to offset gains in future years.
Examples of items exempt from NIIT include the following:
- Wages and self-employment income
- Operating income from nonpassive business activities
- Distributions from retirement accounts (401(k) plans, pension plans, stock bonus plans, traditional and Roth IRAs)
- Social security benefits
- Tax-exempt interest, unemployment compensation and alimony
The NIIT has the potential to affect many individuals as well as trusts and estates, especially since the 2013 reporting threshold for trusts and estates is so low. The rules and exceptions can be complicated but it is important to be knowledgeable about this tax and the rules associated with it. Please contact a Zinner professional if you have any questions and to find out how this new tax may affect you.
Posted by: Colleen Kaminsky, CPA
Both employees and self-employed business owners are very familiar with the Medicare tax. They certainly should be, since it has been in effect since 1966. Congress modified the tax in 1986, imposing a 1.45% Medicare tax rate on wages, for both employees and employers. That change affected self-employed folks too. Beginning January 1, 2013, a couple of additional changes took effect, which could impact you.
First, for individuals earning more than $200,000, and for couples filing jointly earning more than $250,000, the Medicare tax rate has increased by 0.9% on wages exceeding those thresholds. For employees earning more than these amounts, their total Medicare tax rate will be 2.35% for the portion of their wages exceeding those thresholds; however, the employer rate will remain capped at 1.45%. Self-employed individuals meeting the thresholds will also be subject to the additional tax.
But that's not all that's changing! Historically, Medicare taxes have only been assessed against wages. Beginning on January 1, 2013, for the first time Medicare tax is being assessed on unearned investment income. Investment income includes: interest, dividends, capital gains, rental income, royalty income and passive activity business income. For individual filers with a modified adjusted gross income (MAGI) over $200,000, and for couples filing jointly with an MAGI in excess of $250,000, net investment income exceeding those thresholds is subject to a 3.8% Medicare tax. This tax was part of President Obama's Affordable Care Act and is projected to bring in an estimated $210 billion of additional revenue.
Are there any opportunities to effectively plan one's tax and financial life to reduce exposure to either of these new Medicare taxes? In many cases, there are such opportunities, but identifying those opportunities and taking advantage of them will require some proactive and creative planning.
If you would like to understand how the new taxes affect you and to explore any planning opportunities, please contact a Zinner professional to review your personal circumstances.
Posted by: Barbara Theofilos, CPA
Are severance payments subject to Federal Insurance Contributions Act (FICA) taxes? A simple "yes" or "no" answer would be too simple. The answer to this question depends upon who you ask.
The Sixth Circuit Court of Appeals concluded that severance payments made to terminated employees from Quality Stores are not subject to Social Security and Medicare, also known as FICA taxes. This determination was made in September 2012 and contradicts the Federal Circuit Court of Appeals' conclusion arrived at in 2008 for CSX Corp.
The Sixth Circuit ultimately determined that these payments are not considered wages if they meet the criteria of "supplemental unemployment benefits." These payments must meet all of the following criteria:
1.) Paid to an employee
2.) Pursuant to the employer's plan
3.) Due to the recipient employee's involuntary separation from employment
4.) Directly due to a reduction in force, discontinuance of a plant or operation, or other similar conditions
5.) Included in the recipient employee's gross income
On the other hand, the Federal Circuit of Appeals had the exact opposite opinion when they concluded that "supplemental unemployment benefits" following the same criteria listed above actually are considered wages and therefore subject to FICA taxes.
The Internal Revenue Service has consistently taken the same stance as the Federal Circuit of Appeals that the severance payments are considered wages. According to the IRS, the only situation in which these payments are not subject to FICA taxes is when the payments are linked to state unemployment compensation benefits.
While this issue is still being resolved, Quality Stores and their employees have the ability to enjoy the benefits of not paying the additional FICA taxes on the future severance payments. Both the employer and employees are also allowed to request refunds for any FICA taxes that were paid in previous years. The IRS will likely hold onto those refunds until a final decision is made by the Supreme Court. In the meantime, the employers and employees of Quality Stores will continue to reap the benefits of avoiding the additional FICA taxes on their future severance payments.
Effective September 23, 2012, businesses that provide health coverage to staff MUST provide a summary of the coverage to all employees. The Department of Labor shows what the summary must look like.
Insurance companies will create these summaries if the coverage is through them. If you make changes in the plan mid-year, you must provide notice to employees at least 60 days before the changes will take effect.
For more information, contact Howard J. Kass, CPA - Partner, at firstname.lastname@example.org