Update from WithumSmith+Brown’s Healthcare Services Group HEALTHCARE TAX TIP

October 17, 2012 3.8% MEDICARE TAX ON

As a result of the Supreme Court's decision in June of 2012 with respect to the validity of the Patient Protection and Affordable Care Act ("Act"), beginning on January 1, 2013, there will be an additional Medicare tax on unearned income in the form of a 3.8% surtax to which certain unearned income of individuals will be subject. The surtax is intended to raise a significant Questions or comments? amount of revenue to assist in raising the necessary funds to pay for the various costs E-mail us at [email protected] associated with the Act. The tax will apply to individuals, trusts and estates, if certain thresholds are met.

APPLICABILITY TO INDIVIDUALS

For individuals, the 3.8% tax is applied to the lesser of net investment income for the taxable year, or the excess, if any, of the modified adjusted gross income (defined below) for the year

over a threshold amount. The threshold amounts are as follows:

■ $200,000 for single filers;

■ $250,000 for married filing jointly; and

■ $125,000 for married filing separately.

For example, a married couple filing jointly with $350,000 of modified adjusted gross income,

$75,000 of which represents net investment income, will pay an additional 3.8% tax on the

$75,000 of investment income that exceeds the applicable $250,000 threshold.

APPLICABILITY TO TRUSTS AND ESTATES

For trusts and estates, the 3.8% tax is applied to the lesser of the undistributed net investment

income for the year, or the excess, if any, of the adjusted gross income for the year over the dollar amount at which the highest tax bracket begins for the year, which is expected to be approximately $12,000 in 2013. In essence, a trust with undistributed net investment income of $50,000 would pay an additional 3.8% tax on $38,000; the amount that exceeds the applicable threshold amount. Charitable remainder trusts and trusts in which all of the unexpired are devoted to a charitable purpose are exempt from the 3.8% tax. To ensure compliance with U.S. Treasury rules, unless expressly stated otherwise,

any U.S. tax advice contained in this MODIFIED ADJUSTED GROSS INCOME communication is not intended or written to be used, and cannot be used, by the Modified adjusted gross income is equal to adjusted gross income reflected on page one recipient for the purpose of avoiding Federal Form 1040, U.S. Individual Income Tax Return, plus any net foreign income exclusion penalties that may be imposed under the amount. Internal Revenue Code. © WithumSmith+Brown, PC 2012 PC 2012 WithumSmith+Brown, ©

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3.8% MEDICARE TAX ON UNEARNED INCOME (CONTINUED)

NET INVESTMENT INCOME DEFINED For more information on the topics discussed or services we can provide, Net investment income, as applicable to the Act, includes: please contact:

■ , dividends, royalties, annuities, rents; Scott Mariani, JD, Partner ■ Income derived from passive activities; Practice Leader ■ Trade or business is deemed to be a passive activity; 973.898.9494 ● [email protected] ■ Passive income generated by an interest in a partnership or S Corporation; ■ Trading financial instruments and commodities; and ■ Net capital gains from the disposition of (other than property held in an active trade or business).

Net investment income does not include:

■ Income generated from an active trade or business; ■ Distributions from individual retirement accounts and other qualified retirement plans; ■ Income taken into account for self-employment tax purposes; ■ excluded under Internal Revenue Code §121 Sale of Principal Residence; ■ Income from tax-exempt municipal bonds; ■ Tax deferred non-qualified annuities; and ■ Gain on sale of an active interest in a partnership or S corporation to the extent the gain is attributable to an active trade or business.

In computing net investment income, losses from passive activities should be included in the computation to the extent that the losses are deductible on the taxpayer's individual income tax return for that year. Basically, passive losses can be used to offset passive income for purposes of computing net investment income. Capital losses and loss carry-forwards are also available to offset any capital gains realized in the same tax year to which the 3.8% tax applies.

CONCLUSION

In addition to facing the uncertainty with respect to the current individual income tax rates set to expire at the end of 2012, this additional Medicare tax on unearned income will need to be taken into consideration for a large number of taxpayers. We recommend that individuals review the impact of additional tax for future consideration in their individual tax planning process.

On July 2, 2012, the Wall Street Journal ran a very informative article entitled "Get Ready for the New Investment Tax" whereby they discussed the implications of the 3.8% tax to the average taxpayer.

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