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How the new 3.8% tax on net investment income affects you

By Leigh A. Kaylor • Monday, August 19, 2013

3.8 percentThe Affordable Care Act (“ACA”) that became law in 2010 remains a hot topic as it continues to be phased in or, in some cases, delayed.  One part of the ACA that took effect this year is the new 3.8% tax on net investment income that may impact your estate planning.  The tax applies to taxpayers that have both adjusted gross income above a certain threshold amount and net investment income.  There are four different threshold amounts.

  • Unmarried Taxpayer – $200,000
  • Married Taxpayer Filing Jointly – $250,000
  • Married Taxpayer Filing Separately – $125,000
  • Estate or Trust – $11,950

Net investment income includes interest, dividends, annuities, royalties, rents, and other passive activity income.  Net investment income does not include the sale or disposition of an interest in a partnership or S Corporation as long as the taxpayer was actively involved in the business.  Net investment income also excludes active income from a trade or business, distributions from qualified retirement plans, and income exempt from tax, such as interest from municipal bonds.

The 3.8% tax will apply to the lesser of (1) the total amount of the taxpayer’s net investment income for the year or (2) the difference between a taxpayer’s modified adjusted gross income and the threshold amount.  The 3.8% tax does not apply to a taxpayer who does not have net investment income or who has an adjusted gross income below the threshold amount.  Here are a couple of examples:

  • Bob and Cindy, a married couple filing jointly, have combined salaries of $300,000, but no investment income.  Their adjusted gross income exceeds their $250,000 threshold amount, but the 3.8% tax will not apply since they have no investment income.
  • Dave and Ellen, another married couple filing jointly, have combined salaries of $300,000 and $50,000 of net investment income, for an adjusted gross income of $350,000.  Their adjusted gross income exceeds their $250,000 threshold amount and they have net investment income.  The 3.8% tax would apply to the $50,000 of investment income, which is less than the excess of their adjusted gross income over the threshold amount.

Although the tax is an income tax, it can affect your estate planning with respect to how you choose to structure your plan and what kinds of assets you might favor in the future.  Our next two installments will discuss how the new 3.8% tax on net investment income affects trusts, which are often an important part of an estate plan, and some planning ideas to minimize its effects.

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