A portion of the health care law
could carry some unpleasant
surprises for high-income taxpayers.
By Ed Slott
If you haven’t done so already, you need to explain to clients, especially your high-income cli- ents, howportions of the Patient
Protection and Affordable Care Act
could add to their tax burden.
The crucial change will be a 3.8%
surtax on investment income. For
most clients, investment income
consists primarily of interest, dividends, capital gains, non-qualified
annuity distributions, and rental
and royalty income. Traditional
IRA distributions, as well as Roth
conversions and distributions from
company plans, are not considered
investment income — and yet these
distributions can trigger the 3.8%
The first point to keep in mind is that
this surtax affects only high-income
clients; let’s regard that as an individual with modified adjusted gross
income of more than $200,000,
or a married couple with modified
adjusted gross income of more than
$250,000 on a joint return.
Typically, this amount will be
the same as a taxpayer’s regular
adjusted gross income. Any clients
who exclude foreign income from
this figure, however, will have to
include that amount in their modified adjusted gross income.
The 3.8% surtax will be assessed
on the amount exceeding the modified adjusted gross income thresholds. The tax will be imposed on the
lesser of net investment income or
the amount of modified adjusted
gross income exceeding the applicable threshold. Clients with income
below these levels will not be subject to the surtax.
IRA and other retirement account
distributions are not considered
investment income for purposes of
the 3.8% surtax.
So where, then, do IRAs come
into this calculation? Simply put,
IRA distributions can cause other
net investment income to be hit
with the surtax when that income
otherwise would have avoided it.
Here are a couple of examples to
e XAm PLe: Ro Th conVe Rsion
A couple file a joint return and have
2013 modified adjusted gross income
of $240,000. They have $60,000 of
net investment income, but since
they are $10,000 below the joint filer
threshold of $250,000, they aren’t
concerned about the 3.8% surtax. It
does not apply to them.
But suppose the couple convert
a $100,000 traditional IRA to a Roth
IRA this year. Even though their net
investment income is unchanged,
they now have $340,000 in modified adjusted gross income, so
they exceed the joint threshold
by $90,000. Now the pair will be
required to pay the surtax on their
$60,000 of investment income for
2013, since the $60,000 of investment income is less than $90,000,
the amount more than the threshold. This creates an additional tax
liability of $2,280.