Additional Medicare taxes are set to go into effect January 2013

Additional Medicare taxes are set to go into effect January 2013 as a result of the 2010 healthcare legislation.

To summarize, these provisions have the effect of (a) imposing an additional 0.9% tax on an individual earned income when such income exceeds $200,000 ($250,000 for married taxpayers filing jointly) and (b) imposing an additional 3.8% tax on the lesser of an individual (i) net investment income or (ii) the excess of the taxpayer modified adjusted gross income in excess of a threshold amount - $200,000 for single taxpayers and $250,000 for married filing jointly.

For example, a married couple with earned income (i.e. W-2 wages, income from a sole proprietorship, income from a flow through entity in which one or both of the spouses is an active partner, etc.) of $325,000 and investment income of $100,000 would be subject to an additional $4,475 of tax, (a) 0.9% on the $75,000 of earned income in excess of the $250,000 threshold plus (b) 3.8% on the lesser of the (i) $100,000 of net investment income or (ii) the excess of the modified adjusted gross income ($325,000 + $100,000) over the $250,000 threshold, which totals $175,000.

The constitutionality of the healthcare legislation is being debated by the Supreme Court and, as a result, this legislation may be struck down. However, assuming the legislation is deemed unconstitutional, in order for the above tax provisions to go away, the court would likely have to reach the conclusion that these tax provisions are not severable from the portion of the legislation deemed unconstitutional.

Combining these provisions with the expiration of the Bush tax cuts at the end of the year could result in having a top marginal tax rate on investment income, including qualified dividends, at 43.4% (39.6% regular tax + 3.8% Medicare tax) beginning in 2013.

With the right amount of foresight and planning, exposure to these provisions may be minimized.