Find out more about the new Medicare tax on unearned income.
Under the Patient Protection And Affordable Care Act ("Obamacare"), high income taxpayers are subject to a new Medicare tax on their "unearned income." Here's how it works.
The Medicare Tax Only Affects High Income Taxpayers
The tax applies only to people with relatively high incomes. If you’re single, you must pay the tax only if your adjusted gross income (AGI) is over $200,000. Married taxpayers filing jointly must have an AGI over $250,000 to be subject to the tax. Your adjusted gross income is the number on the bottom of your IRS Form 1040. It consists of your income from almost all sources, including wages, interest income, dividend income, income from certain retirement accounts, capital gains, alimony received, rental income, royalty income, and unemployment compensation, reduced by certain “above the line” deductions such as IRA contributions and one-half of self-employment taxes.
What Income Is Taxed?
The tax applies only to investment income. This includes:
- gross income from interest, dividends, annuities, royalties, and rents other than those derived from an active business
- the net gain earned from the sale or other disposition of investment and other non-business property, and
- any other gain from a passive trade or business.
This includes just about any income not derived from an active business or from employee compensation.
The Tax Is Imposed Only On a Portion of Investment Income
The Medicare tax is a 3.8% tax, but it is imposed only on a portion of a taxpayer’s income. The tax is paid on the lesser of (1) the taxpayer’s net investment income, or (2) the amount the taxpayer’s AGI exceeds the applicable AGI threshold ($200,000 or $250,000).
Example: Phil and Penny are a married couple who file a joint return. Together they earn $200,000 in wages. They also earn $200,000 in net rental income and $150,000 in other investment income. Their AGI is $550,000, including $350,000 in net investment income. They must pay the 3.8% Medicare tax on the lesser of (1) their $350,000 of net investment income, or (2) the amount their AGI exceeds the $250,000 threshold for married taxpayers—$300,000. Since $300,000 is less than $350,000, they’ll have to pay the 3.8% tax on $300,000. Their Medicare contribution tax for the year will be $11,400 (3.8%
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