When you hear about Medicare taxes, you probably do not also consider how it affects investments. However, these new taxes can impose higher costs both on wages and net invested income. If you are concerned about how the Medicare tax may affect your estate or retirement plan, speak with an experienced estate planning attorney today.
Medicare Tax and Payroll Income
Medicare tax on payroll income is 2.9%. It applies to all earned income, which includes payroll from your employer in addition to any tips. Half of the tax is paid by you, and the other half is paid by your employer. For high wage earners, Medicare tax imposes an additional 0.9% tax on individuals who make over $200,000, $250,000 for couples filing taxes together, or $125,000 for spouses filing separately. Your employer is required to withhold the 0.9% from your paycheck once you exceed the $200,000 limit.
Medicare Tax and Net Invested Income
In the past, taxpayers were not required to pay Medicare tax on any net invested income generated from assets like capital gains, dividends, and taxable interest. However, since 2013 the rules have changed, and you could owe up to 3.8% Medicare tax on some or all of your net invested income.
The amount that you owe is based upon the lesser of two amounts: your total net invested income or the amount of your modified adjusted gross income (MAGI) that exceeds $200,000 for individuals, $250,000 for couples filing together, or $125,000 on spouses filing separately. You owe 3.8% on the amount of investment income that exceeds those thresholds. If your income wages alone already exceed the limits, you will owe the 3.8% Medicare tax on the lesser of net investment income or MAGI that exceeds the thresholds.
How to Prepare Wisely
The best thing for you do to prepare is to know the Medicare tax law or speak to someone who does. If you are married, filing jointly, and your income will exceed the limits you will want to make sure that your joint Medicare tax bill for the year is not higher than what you initially anticipated.
It is important to note that your employer will not take your spouse’s income into consideration when figuring your Medicare tax withholding, but you can use a W-4 form to have the additional amount deducted from your pay to cover the additional 0.9% tax on the amount over the limit for combined income.
Reducing your MAGI can be more difficult, but many people have used successfully reduced their amount owed by maximizing their investment in pretax retirement plans like traditional 401(k)s or 403(b)s. Also, qualified distributions from retirement accounts like a Roth IRA are not included in your MAGI.
The more complex challenges come from reducing the amount of net invested income, but there are ways to reduce the amount based on sound investment strategies. One option is to move some investment income into municipal bonds or municipal bond funds. Another option is to place investment income into a tax deferred account like an IRA. Investing in a permanent form of life insurance can also reduce the total of net investment income, as the cash value of the policy when withdrawn is not considered investment income anymore.