Understanding the new 3.8% Medicare Tax
Various posts, twitts, emails and other confusion communications about the 3.8% Medicare tax in the health care reform law continue to circulate in the internet. You might read something about it. The messages usually say that the 3.8% tax is imposed on unearned income that includes the sale of a principle residence.
However, the tax that's being referenced is far narrower and only has the potential to impact a small sliver of high income households who receive investment income. The $250,000-$500,000 capital gains exclusion remains in place.
According with the National Association of Realtors:
Applies to:
Individuals with adjusted gross income (AGI) above $200,000
Couples filing a joint return with more than $250,000 AGI
Types of Income:
Interest, dividends, rents (less expenses), capital gains (less capital losses)
Formula:
The new tax applies to the LESSER of Investment income amount
Excess of AGI over the $200,000 or $250,000 amount
"Understand that this tax WILL NOT be imposed on all real estate transactions, a common misconception. Rather, when the legislation becomes effective in 2013, it may impose a 3.8% tax on some (but not all) income from interest, dividends, rents (less expenses) and capital gains (less capital losses). The tax will fall only on individuals with an adjusted gross income (AGI) above $200,000 and couples filing a joint return with more than $250,000 AGI.
A second new tax, also dedicated to Medicare funding, is imposed on the so-called "earned" income of higher income individuals. This earned income tax has a much lower rate of 0.9% (0.009). Like the tax described in this brochure, this additional or alternative tax is based on adjusted gross income thresholds
of $200,000 for an individual and $250,000 on a joint return. Like the 3.8% tax, this 0.9% tax is imposed only on the excess of earned income above the threshold amounts.
Another way of thinking about these new taxes is to think of the 3.8% tax as being imposed on a portion of the money that you make on your money - your capital (sometimes referred to as "unearned income").
The 0.9% tax is imposed on a portion of the money you make on your labor - your salary, wages, commission and similar income related to earning a livelihood."
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