Tax Traps for the Unwary Coming in 2013

Otten Johnson Alert June 2012

Beginning in 2013, certain high-income taxpayers may find themselves subject to additional Medicare taxes on their employment and/or investment income as a result of the Patient Protection and Affordable Care Act of 2010 and the Health Care and Education Reconciliation Act of 2010 (which, together, are colloquially referred to as "Obamacare").

Under Section 3101(b)(2) of the Internal Revenue Code (the "Code"), individual taxpayers will be subject to an additional 0.9% Medicare payroll tax on their wages with respect to employment in excess of $200,000 ($250,000 for married filing jointly; $125,000 for married filing separately), in addition to the 1.45% Medicare tax individual taxpayers currently pay on wages (and in addition to the 2.9% Medicare tax currently paid by self-employed individuals). Since the additional 0.9% Medicare tax is a function of a taxpayer’s wages, little can be done to reduce future tax liability short of the taxpayer and his or her employer restructuring the taxpayer's compensation. Additionally, there is a marriage penalty built into the 0.9% Medicare tax. For example, an unmarried couple, each with wages of $200,000, would avoid the tax entirely. If the same couple were married, $150,000 of their combined wages would be subject to the tax.

Of likely greater concern to high-income taxpayers in 2013 will be Section 1411(a)(1) of the Code, which imposes another additional Medicare tax of 3.8% on the lesser of an individual taxpayer’s (i) modified adjusted gross income (“MAGI”) in excess of the threshold amount ($200,000 if single; $250,000 if married filing jointly; $125,000 if married filing separately), or (ii) net investment income for the taxable year. In most instances, MAGI is a taxpayer’s adjusted gross income.  Similar to the new 0.9% Medicare tax, the new 3.8% Medicare tax imposes a marriage penalty.

Additionally, it is worth noting that the new 3.8% Medicare tax is subject to estimated tax payments, which will require taxpayers who are or may be subject to the tax to make estimated tax payments quarterly, and failure to make such payments may result in additional interest and penalties. Moreover, the new 0.9% Medicare tax will only be withheld from an employee’s wages by the employer once the employee has earned over the threshold amount during the tax year. As a result, employees who do not have wages in excess of the threshold amount for any single job, but do have wages in excess of the threshold amount when totaling their wages from all jobs and/or the wages of their spouse (if married, filing jointly), will also be subject to estimated tax payments, unless those employees revise their Form W-4s to request greater withholding by their employers.

Based on the foregoing, taxpayers who believe they will have MAGI in excess of the threshold amount and income from trade or business activities in 2013 will have an incentive to arrange their affairs in order to prepare for the new Medicare taxes and to avoid or minimize the new 3.8% Medicare tax.

Otten Johnson's attorneys have substantial experience counseling clients on their business and tax estate matters. For more information on this Client Alert please contact any of the attorneys in the Business Transactions & Capital Markets practice group (for a listing, click here).