pre-tax retirement

Helping Wealthy Clients Reduce Medicare Surtaxes


During the busy season, accounting professionals and their clients are looking for all possible ways to reduce taxes legally. In the final part of his series on tax brackets, financial guru Julian Block discusses a few ways high net worth clients can reduce their Medicare surtaxes and explains why it's crucial for you as their financial advisor to provide advice on this subject.

Mar 4th 2021
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Part one discussed seven graduated tax brackets for Form 1040s for calendar year 2021 that will be filed in 2022. It explained the first five brackets—10, 12, 22, 24 and 32 percent.

Part two covered the top two brackets—35 and 37 percent. It also provided an example of how the IRS determines tax tabs for filers whose incomes fall into several brackets.

Part three reminds high-income individuals why it’s important for them to remind their advisers to answer their questions (or, even better, Dear Readers, when advisers are preemptive and anticipate queries) on how to select and implement strategies that enable them to completely avoid or, at least, reduce Medicare surtaxes.

True, advisers can assure clients that their official rates for 2021 can’t go higher than 37 percent for ordinary income from sources like salaries and other types of compensation; pensions; and funds they remove from IRAs, 40l (k)s, and other tax-deferred retirement accounts.

But advisers who don’t want to be second-guessed ought to caution clients that 2021’s unofficial rates could surpass 37 percent if they’re in top brackets above 22 percent (taxable income between: $40,526 and $86,375 for singles and marrieds filing separately; between $81,051 and $172,750 for joint filers; and between $54,201 and $86,350 for heads of household).

Why is advance planning prudent? Because clients might be liable for the Medicare surtaxes of 0.9 percent on earned income and 3.8 percent on certain kinds of investment income.

Both surtaxes were introduced by the Affordable Care Act, legislation better known as Obamacare. They help pay for health care reform.

The 0.9 percent levy targets high-income individuals who receive salaries, other kinds of employee compensation, such as severance arrangements and golden parachutes, and net earnings from self-employment ventures.

The 3.8 percent levy is imposed on NII, short for net investment income. The tax applies, among other things, to all capital gains from sales of, say, stocks and bonds.

Both surtaxes are keyed to MAGI, short for modified adjusted gross income. Both kick in when MAGIs exceed the thresholds discussed below.

(For most persons, MAGI and AGI are the same. “Modified” applies only to individuals who live outside the United States and qualify under Code Section 911 for the earned income exclusion (2021’s indexed number is as much as $108,700, up from 2020’s $107,600) for wages, salaries and other amounts paid for personal services. Expatriates have to add back excluded amounts when they calculate MAGI.)

The threshold amounts are keyed to filing status. $250,000 for joint filers; $125,000 for marrieds filing separate returns; and $200,000 for single persons and heads of household.

Some likely questions from clients. Does the 3.8 percent tax affect someone without investment income? No.

What about someone whose entire income is from investments? Is that person affected? No, provided that person’s NII is below the thresholds.

What happens when individuals have MAGIs above their thresholds? Do they become liable for the 3.8 percent tax on their entire NII? Congress told the IRS to figure the tax on the lesser of (A) NII or (B) the excess of (1) MAGI over (2) the applicable threshold amount.

To illustrate, Rudolph and Flavia are joint filers. NII is $100,000; MAGI is $300,000; threshold is $250,000. Their 3.8 percent tax punches in at $1,900—3.8 percent of $50,000 ($300,000 MAGI minus $250,000 threshold).  Why $50,000? Because $50,000 is less than $100,000 NII.

For a deeper dive into the surtaxes, see “How Additional Medicare Taxes Affect Home Sellers,” Oct. 29th, 2020.

Additional articles. A reminder for accountants who would welcome advice on how to alert clients to tactics that trim taxes for this year and even give a head start for next year: Delve into the archive of my articles (more than 350 and counting). 

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