What is the 3.8% Surtax?

When the Affordable Care Act was passed it included a tax to offset the cost of providing subsidies for health insurance and the expansion of Medicaid.  This tax is a 3.8% surtax on “net investment income” above certain thresholds. The threshold is based on your tax filing status. The following are the threshold amounts:

• Single- $200,000
• Head of Household- $200,000
• Married Filing Joint- $250,000
• Married Filing Separate- $125,000
• Trust and estates- threshold is top bracket, which is $12,150 in 2014

The 3.8% surtax will apply to the lesser of the investment income, or the amount by which your Adjusted Gross Income (AGI) exceeds the threshold amount listed above.

So what is considered investment income? Investment income is made up of:

• Rents
• Royalties
• Dividends
• Interest
• Annuity Distributions
• Passive Activity Income
• Net Capital Gain Income on disposition

The following are not considered investment income:

• W-2 Income such as salary and wages
• Social Security Income
• Distributions from IRA’s and Qualified Plans
• Self-Employment Income
• Gain and Active Interest in Partnerships/S-Corps
• Any Income that is not otherwise taxed under the Internal Revenue Code such as Tax Exempt Bonds

In order to illustrate how this 3.8% surtax applies, here’s a quick example:

Let’s say that Joe and Susie file a married joint tax return. They have the following income:

• $300,000 from their Salaries
• $100,000 from Dividends
• $20,000 from Interest in their Bank Accounts
• $45,000 from Oil and Gas Royalties

Because Joe and Susie are married and filing a joint return their threshold amount for the 3.8% surtax to apply is $250,000.  Their AGI is $300,000. Their investment income is $165,000.  The amount that their AGI exceeds the threshold amount of $250,000 is $50,000.  The 3.8% surtax applies to the lesser of the AGI that exceeds the threshold amount or the investment income.  In our case the amount by which the AGI exceeds the threshold amount is $50,000; and the amount of the investment income is $165,000; which creates a tax bill of $1,900. ($50,000 x 3.8% surtax = $1,900).

Contributed by MH Arrowhead, Scottsdale and Phoenix Estate Planning Attorney and Partner, David T. Eastman.

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This blog should be used for informational purposes only.  It does not create an attorney-client relationship with any reader and should not be construed as legal advice.  If you need legal advice, please contact an attorney in your community who can assess the specifics of your situation.