Blog for Estate Planning Professionals

In an effort to help fellow advisors better understand the 3.8% HealthCare Surtax, nationally renowned CPA, Robert S. Keebler, has issued the examples below to help you. 

• John, single, has $100,000 of salary and $50,000 of net investment income.
  • The 3.8% surtax would not apply (MAGI <$200,000).
• Mary, single has $225,000 of net investment income and no other income.
  • The 3.8% surtax would apply to $25,000 of income (excess of $225,000 MAGI over $200,000 “threshold amount”).
• Terry and Tina, married filing jointly, have $300,000 of salaries and no other income.
  • The 3.8% surtax would not apply (no net investment income).
• Peter and Paula, married filing jointly, have $400,000 of salaries and $50,000 of net investment income.
  • The 3.8% surtax would apply to $50,000 of net investment income (lesser of rule).
• Scott and Sarah, married filing jointly, have $200,000 of salaries and $150,000 of net investment income.
  • The 3.8% surtax would apply to $100,000 of income (lesser of rule excess of $350,000 MAGI over $250,000 “threshold amount”).
• Randy, a single taxpayer, age 69, has investment income of $200,000 and is not subject to the surtax. In the following year, Randy has an RMD from his IRA of $125,000.  In this case, $325,000 of MAGI exceeds the $200,000 threshold and $125,000 is subject to the 3.8% surtax.                
• The John Smith Trust has investment income of $51,000 and no distributions.
  • $39,800 of income ($51,000 - $11,200 top bracket amount) will be subject to the 3.8% surtax.
• David and Veronica, age 75, have pension and IRA income of $750,000, $25,000 of tax-exempt income and no taxable investment income.  The 3.8% surtax does not apply regardless of income because they have no net investment income. 
  • A Roth conversion will be surtax neutral. 
• Jill, age 60, has wages and pensions of $200,000 and 2012 interest income from CDs of $300,000. She moves half of her investments into an annuity and purchases a life insurance policy with the remaining CDs.
  • In 2013 all of her interest is sheltered in either the annuity or the life insurance policy and she is not subject to the 3.8% surtax.
• Eliot, a widower, earns wages of $175,000 and owns an interest in a publicly traded real estate partnership which generates taxable income of $50,000.
  • $25,000 (excess of $225,000 MAGI over $200,000 “threshold amount”) will be subject to 3.8% surtax.
• Larry, a widower, earns wages of $175,000 and owns an interest in a closely-held real estate partnership which generates taxable income of $75,000.
  • His MAGI is $250,000 and $50,000 will be subject to the surtax (lesser of rule).
• Bruno, a single person, earns wages of $200,000 and receives royalties of $60,000 from an oil and gas limited partnership. 
  • $60,000 will be subject to the surtax (excess of $260,000 MAGI over $200,000 “threshold amount”).
• Mary and David earn wages of $260,000 and receive a trust distribution of $90,000 (100% dividends).
  • $90,000 (net investment income) will be subject to the 3.8% surtax.
• The estate of Jane Smith earned $111,200 of dividends and made no distributions. 
  • Assuming a threshold exemption of $11,200, $100,000 will be subject to the 3.8% surtax.
• The estate of Jane Smith earned $111,200 of interest and made a distribution of 100% of income.   
  • The income will be reported by the heirs and the estate will not be subject to the 3.8% surtax.
• Bob and Bonnie have interest income of $248,000 and no other income.  They convert Bob’s $300,000 IRA to a Roth IRA which increases AGI to $548,000.
  • Under the lesser of rule, $248,000 will be subject to the 3.8% surtax; this is the lesser of $298,000 of excess MAGI ($548,000 -$250,000) or $248,000 of investment income.
• In 2011, Randy converts a $1,000,000 IRA to a Roth IRA incurring $450,000 of state and federal income tax.   Randy pays the income taxes from his outside/taxable investment funds.  
  • Future investment income from the outside funds will no longer exist and avoid the 3.8% surtax.  
• Daniel and Donna have wages of $250,000 and investment income of $45,000.  Their employer creates a new deferred compensation plan allowing a contribution of up to 20% of income (i.e. $50,000).
• Gary and Barb, age 69, have pension income of $130,000 and investment income of $115,000 for a total MAGI of $245,000, just below the threshold amount.  In 2013, their Roth IRA withdrawal will be $50,000. 
  • No 3.8% surtax will apply because the $50,000 Roth IRA distribution does not count towards MAGI.
• Thor and Kristen, age 69, have pension income of $100,000 and net investment income of $75,000 for a total MAGI of $175,000, well below the $250,000 threshold amount. 
  • In 2013, their RMDs will be $50,000 bringing MAGI to $225,000, which is still below the threshold amount.
• Art and Patricia, age 69, have pension income of $130,000 and net investment income of $115,000 for a total MAGI of $245,000, just below the threshold amount.  In 2013, their RMDs from their IRAs will be $50,000, which brings their MAGI to $295,000. 
  • MAGI is $45,000 above the threshold amount ($295,000 less $250,000). 
  • The surtax will be imposed on the lesser of $45,000 or their net investment income of $115,000. (i.e., $45,000). 
  • A 2011 or 2012 Roth conversion would eliminate the RMDs and the surtax would not apply.  
• Same facts, except they convert in 2013 and the pension is $30,000.  The conversion would be added to MAGI of $195,000 and their entire net investment income of $115,000 will be subject to the surtax.
• Brian and Betty, age 69, have annual pension income of $260,000 and net investment income of $115,000 for a total gross income and MAGI of $375,000.   In 2013, their RMDs from IRAs will be $50,000 bringing MAGI to $425,000. 
  • Because their “fixed” non-investment income of $260,000 (e.g. pensions) is over the $250,000 threshold amount, their surtax reduction planning must focus on reducing net investment income, not on reducing MAGI. 
  • A Roth conversion will be surtax neutral; however, such a conversion may still be beneficial.

In particular, the application of the 3.8% surtax to estate and trusts needs your immediate attention.  The problem with trusts and estates is that the 3.8% surtax will apply to income in excess of approximately $12,000.

The key issues are:

• Timing of distributions to reduce the impact of the surtax
• The choice of year end to avoid the surtax for the first 11 months of 2013.
• Ensuring that trusts are funded in 2012 to avoid gains upon funding
• Making a proper and timely Section 645 election
• Reviewing the proper investments during the estate/trust administration.

You can also download Bob's updated 3.8% HealthCare Surtax Chart on our Free Resources Page.

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Source: Keebler & Associates, LLP, Robert S. Keebler, CPA, MST, AEP (Distinguished)