Starting with the year 2013, individuals may be subject to the Unearned Income Medicare Contribution surtax of 3.8% on their net investment income. This surtax is also called the Net Investment Income Tax. This is a surtax in the sense that it is a tax responsibility in addition to the federal income tax.
What is the Net Investment Income Tax?
The net investment income tax is a surtax at a rate of 3.8% on a base of income that is the lesser of one's:
- Modified adjusted gross income over the threshold amount, or
- Net investment income.
How is the Net Investment Income Tax Calculated for Individuals?
Calculating the Net Investment Income Tax for individuals is a four-step process.
- Calculate by how much modified adjusted gross income (MAGI) exceeds the relevant threshold.
- Calculate net investment income for the year.
- Take the lesser of the amounts in step 1 or in step 2.
- Multiply the amount in step 3 by 3.8% (the net investment income tax rate).
Who is Subject to the Net Investment Income Tax?
The Net Investment Income Tax is imposed on individuals, estates and trusts.
For individuals, the net investment income tax applies to U.S. citizens and resident aliens. The net investment income tax does not apply to non-resident aliens unless a non-resident alien elects to be treated as a resident of the U.S. for tax purposes.
The net investment income tax also applies to estates and trusts if the estate's or trust's adjusted gross income for the year exceeds the dollar amount at which the highest tax bracket begins. For the year 2013, the highest tax bracket for estates and trusts begins at $11,950. This article focuses on the net investment income tax for individuals. For more information about how this tax applies to estates and trusts, see Applying the New Net Investment Income Tax to Trusts and Estates (The Tax Adviser).
When does the Net Investment Income Tax Apply?
The Net Investment Income Tax applies if modified adjusted gross income for the year exceeds the following thresholds:
Net Investment Income Tax Thresholds
Modified Adjusted Gross Income
Married Filing Jointly or Qualifying Widow(er)
Single or Head of Household
Married Filing Separately
These threshold amounts are not indexed for inflation. These amounts will stay the same from year to year, unless Congress specifically changes these amounts through new legislation.
Modified Adjusted Gross Income
Modified adjusted gross income (MAGI) for the purpose of the net investment income tax is adjusted gross income for the year with the foreign earned income exclusion added back in, less any deductions that were disallowed under the rules for the foreign earned income exclusion.
Taxpayers who invest in controlled foreign corporations and passive foreign investment companies may need to make further modifications to adjusted gross income.
Net Investment Income
Net investment income consists of three categories of income and their associated deductions.
- royalties, and
- rents (other than rents received as part of a trade or business).
- Income derived from a trade or business that is passive income, or
- Income from a business trading financial instruments or commodities.
- Net capital gains (except gains on property held in a trade or business).
Deductions that reduce net investment income are:
- Deductions related to producing rental and royalty income
- Deductions related to producing business income
- Penalty on early withdrawal of savings
- Investment Interest expenses
- Miscellaneous investment expenses
- The portion of state income tax that relates to net investment income
- Casualty and theft losses related to property that was sold or disposed of
Some of these deductions are already included in the investment income figures. Rental income, royalty income, business income and net capital gains will already be a net amount of income after deductions or losses have been taken into account.
Other deductions, however, aren't included in these net figures, and so they will need to be deducted against investment income to arrive at net investment income. These separate deductions include the penalty on early withdrawal of savings, investment interest, investment expenses, state income tax allocated to investment income, and casualty and theft losses related to investment property.
The Unearned Income Medicare Contribution Tax was legislated as part of the Health Care and Education Reconciliation Act of 2010, which along with the Affordable Care Act, reformed the health care market by requiring individuals to obtain health insurance or pay a tax penalty. This tax was included as a revenue raiser in that legislation. At the time the legislation was passed, the Joint Committee on Taxation estimated that the Unearned Income Medicare Contribution Tax together with the Additional Medicare Tax would generate an additional $20.5 billion in tax revenue in the year 2013, the first year that the surtax would be in effect. Over the ten-year period from 2010 to 2019, the Joint Committee on Tax estimates this surtax will generate an additional $210.2 billion in tax revenues. (Source: JCX-17-10 [pdf].)
Where Does the Tax Revenue from the Unearned Income Medicare Contribution Tax Go?
The official name of the tax is the Unearned Income Medicare Contribution Tax. This suggests that the tax revenue will be used to fund Medicare. However, this does not appear to be the case. In their summary of the new Medicare surtax, the Joint Committee on Taxation points out, "No provision is made for the transfer of the tax imposed by this provision from the General Fund of the United States Treasury to any Trust Fund" (General Explanation Of Tax Legislation Enacted In The 111th Congress, JCS-2-11, pdf, page 363).
The IRS further reiterates this point in their proposed regulations interpreting this new tax law. In their preamble to the regulations, the IRS states, "Amounts collected under section 1411 are not designated for the Medicare Trust Fund" (REG-130507-11, pdf, page 5).
Thus the word "Medicare" in the name of this tax provision is misleading. A better name for this tax provision would be the Net Investment Income Tax, which is the phrase used by the IRS on tax form 8960.
Forms, Instructions and Information about the Net Investment Income Tax
Net investment income and the net investment income tax are calculated using Form 8960.
- Form 8960 (pdf)
- Instructions for Form 8960 (pdf)
- Internal Revenue Code Section 1411
- Final Treasury Regulations (T.D. 9644) (issued December 2, 2013, FederalRegister.gov)
- Proposed Treasury Regulations (REG-130843-13) (issued December 2, 2013, FederalRegister.gov)
- Proposed Treasury Regulations (REG–130507–11), which discusses a wide variety of definitions, calculations, and special rules of the net investment income tax (pdf, 42 pages, issued December 5, 2012, GPO.gov)
- Questions and Answers on the Net Investment Income Tax (IRS.gov)
- IRS Releases Final Regulations on Net Investment Income and Additional Medicare Taxes (pdf, 14 pages, CCHgroup.com)
- J.K. Lasser's Your Income Tax 2014, chapter 28.3, pages 507-509.
- EY Tax Guide 2014, page 736-737.
- How to Pay Zero Taxes, pages 600-601.