ACA’s NIIT And Medicare Taxes Pose Planning Challenges

Key provisions of the Affordable Care Act (ACA) have changed several times since late last year. Most notable was the delay in the employer mandate until Jan. 1, 2015, giving “large” businesses an extra year to plan for how they’ll meet the law’s requirements.

But one important component of the law that hasn’t changed will affect many high-income earners. Two new taxes — the net investment income tax (NIIT) and the additional Medicare tax — apply to certain types of income for those whose income exceeds specified thresholds.

Nuts and bolts

The NIIT is a flat tax of 3.8% on certain types of investment income, including interest, dividends, annuities, capital gains, royalties, rents, and pass-through income from S corporations and partnerships. It’s assessed based on certain modified gross income (MAGI) thresholds. The NIIT is paid on top of the income tax rates that otherwise apply.

The additional Medicare tax is a 0.9% flat tax on earned income that applies to wages or self-employment income in excess of certain thresholds, which are based on filing status. Interestingly, employers are required to withhold on Medicare wages in excess of $200,000 regardless of the employee’s filing status.

Thus, if a married couple filed jointly and each spouse earned exactly $200,000 in Medicare wages, they’d have no additional Medicare tax withheld. Yet they’d owe tax on their combined earnings in excess of the threshold — $250,000 — for their filing status.

In some situations, however, a couple that has withholding may not be subject to the tax.  For example, if one spouse earned $250,000 in Medicare wages, and the other didn’t earn any Medicare wages, no additional Medicare tax would be due. The amount of tax withheld ($50,000 × 0.9%) would be claimed as additional withholding when the couple filed its joint tax return.

While the thresholds for the NIIT and additional Medicare tax are the same — $250,000 for married couples filing jointly, $200,000 for unmarried filers and $125,000 for married individuals filing separately — the methods for determining those thresholds differ.

It’s also important to understand that, for trusts and estates, the NIIT applies at just $12,150 of MAGI. Income that is passed through from a trust or estate to an individual, however, will be included on the individual’s tax return.

Planning strategies

If your income exceeds the thresholds, there are a number of strategies that could help you minimize the impact of the NIIT and additional Medicare tax. These include:

  • Shifting income-producing investments into tax-deferred retirement plans, such as IRAs or 401(k)s
  • Investing in tax-exempt municipal bonds instead of taxable bonds, because interest from municipal bonds is exempt from the NIIT
  • Adjusting your salary and bonuses to fall below the applicable thresholds

Neither the NIIT nor the additional Medicare tax appears to be going away anytime soon, so it’s important to consider these and other ideas.

Expert guidance

Contact us about how these taxes might affect you. We can help you get an early jump on your potential liability.