A Simple Guide to Medicare Surtaxes: Part One


If you have clients who are dealing with Medicare surtaxes, you are well aware of how complicated things can get. In the first of a multi-part series, expert Julian Block explains exactly what you and your clients need to know.

Aug 28th 2020
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I devoted a recent column to the highlights of 2020’s seven graduated tax brackets and the Medicare surtaxes. I ended it with a promise, Dear Readers, to tell you, as Garrison Keillor of A Prairie Home Companion would say, more than you ever wanted to know about the surtaxes.

I will use this column and several subsequent ones to make good on that promise. Let’s start with the top graduated bracket. It’s 37 percent.

Which filers fall into that bracket? The answer depends on their taxable income—what remains after compensation and other kinds of reportable income are offset by all allowable deductions and credits are claimed.

The 37 percent bracket kicks in only when income surpasses these three amounts: $622,051 for married persons filing joint returns and qualifying widows/widowers (surviving spouses who qualify for the same breaks as married couples for two years after a spouse dies); $518,401 for heads of households and single persons; and $311,026 for married persons filing separate returns.

Medicare surtaxes. While the official rates top out at 37 percent for ordinary income from sources like salaries and pensions, the surtaxes of 0.9 percent on earned income and 3.8 percent on investment income could cause the unofficial rates to go higher.

I advise targeted taxpayers to ask their advisors about surcharge rules. I explain that when they’re liable for surtaxes and their top official rate is, say, 37 percent, their unofficial rate could become 41.7 percent.

What about state income taxes? States like California and New York (and New York City) impose hefty levies that could cause their top rate to surpass 50 percent.

The surtax on earned income. It applies only to individuals whose wages, other kinds of employment income and net earnings from self-employment surpass thresholds that are based on their filing status. The thresholds are: $250,000 for joint filers; $125,000 for married couples filing separate returns; and $200,000 for single persons, heads of household and qualifying widows/widowers.

The surtax on investment income. The 3.8 percent tax kicks in only when investors’ MAGI numbers top specified amounts.

(A reminder for, I hope, only a few of my Dear Readers: Don’t confuse MAGI with the Three Wise Men mentioned in the Gospel of Matthew who visited Jesus after his birth, bearing gifts of gold, frankincense and myrrh.)

MAGI is IRS lingo for modified adjusted gross income. It’s the same as AGI for almost all individuals. The MAGI rules require expatriates to add back certain amounts that the law allows them to exclude from U.S. income taxes.

The tax code authorizes a measure of relief for investors. It imposes the surcharge on the smaller of a person’s net investment income or the amount by which MAGI exceeds the applicable threshold.

“Indexing.” The IRS annually adjusts the tax brackets, just as it does the standard deduction amounts that are available for filers who decide not to itemize on Form 1040’s Schedule A for such outlays as medical expenses, charitable contributions, state and local income taxes and property taxes,  and interest payments on mortgages for residences.

The rationale for indexing: It provides relief from “bracket creep,” which enriches Uncle Sam at the expense of individuals who get pushed into higher brackets, despite their incomes merely keeping pace with inflation, thereby eroding their actual, after-tax incomes.

Unlike indexing for the tax brackets and the standard deduction amounts, there’s no indexing for the surtax thresholds. They’ve been fixed since their introduction in 2013 by the Affordable Care Act, popularly known as Obamacare.

I began this column, Dear Readers, with a promise to devote some subsequent columns to more detailed explanation of the surtaxes. I won’t disappoint you.

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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