2013 Year-End Tax Planning Opportunities [Part 2/7]

October 23, 2013 — Leave a comment


Surtax On Net Investment Income (NII)

Starting in 2013, higher-income taxpayers may be liable for a 3.8 percent NII surtax. The NII surtax on individuals equals 3.8 percent of the lesser of:

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The NII tax threshold amounts are not indexed for inflation. Although both the 39.6 percent ordinary income rate, the 20 percent capital gain/dividend rate, and the 3.8 percent rate are commonly referred to as affecting “higher income” taxpayers, the income threshold for being subject to the 3.8 percent NII tax is significantly lower than the others. Therefore, a greater number of taxpayers will be subject to the 3.8 percent rate for the NII surtax.


Depending upon the character of the NII income, combined NII tax and regular income tax rates can cause NII be taxed at 23.8 percent if long-term capital gain or qualified dividends, or at 36.8, 38.8, or 43.4 percent if short-term gains or passive activity income is involved. At the 23.8 percent level, the difference in tax paid on net capital gains and dividends between 2012 and 2013 is nearly a 60 percent increase.


Taxpayers should consider keeping threshold income below the $250,000/$125,000/$200,000 NII tax threshold levels if possible by spreading income out over a number of years or offsetting the income with above-the-line deductions. In particular, spikes in income should be carefully managed in connection with Roth IRA conversions, taxable sales of large assets (including primary residences, if gain is not fully protected by the Code Sec. 121 primary residence exclusion), and other “one-time” events. Taxpayers should also be aware that the threshold amounts are keyed to all income and not just net investment income.


All net investment income should be monitored for exposure to the NII surtax. Net investment income is more than simply capital gains and dividends. Principally, it also includes income from a business in which the taxpayer is a passive participant. Rental income may also be considered NII unless earned by a real estate professional. Taxpayers should also carefully weigh the impact of IRS regulations under Code Sec. 1411 on any year-end maneuvers, including the impact of the self-rental rule as well as passthrough income from an active owner of an S corporation or partnership.


Quarterly estimated tax payments may have required adjustment throughout 2013 because of the increase in rates for capital gains and other net investment income. The run up in the stock markets earlier this year may have contributed to this situation. Although make-up payments for fourth-quarter estimated tax may help lessen any eventual estimated tax penalties, they will not eliminate them. However, directing an employer to increase wage withholding for the balance of 2013 to make up the difference can eliminate any estimated tax penalty entirely and retroactively with respect to all 2013 quarters.

At the time this Briefing was prepared, the IRS had not finalized Form 8960, Net Investment Income Tax, nor its instructions, which taxpayers will use to report liability for the NII surtax.

Additional Medicare Tax

Effective for tax years beginning after December 31, 2012, the Additional Medicare Tax increases the employee-share of Medicare tax by an additional 0.9 percent of covered wages in excess of certain “higher income-level” threshold amounts. Similarly, the Additional Medicare Tax increases Medicare tax on self-employment income for any tax year beginning after December 31, 2012 by an additional 0.9 percent of self-employment income in excess of certain threshold amounts.

Threshold amounts. The Additional Medicare Tax is not imposed until an individual’s covered wages, compensation and/or self-employment income exceed the threshold amount for the taxpayer’s filing status. The threshold amounts are: $200,000 for single individuals (and heads of household); $250,000 for married couples filing a joint return; and $125,000 for married individuals filing separate returns.

The threshold amounts are not indexed for inflation and therefore will remain the same for 2014 and subsequent years as for 2013. All wages subject to regular Medicare Tax are subject to the Additional Medicare Tax.


Single individuals liable for Additional Medicare Tax after 2012 pay 1.45 percent Medicare tax on the first $200,000 of compensation plus 2.35 percent (1.45 percent + 0.9 percent) on compensation in excess of $200,000. Married couples filing a joint return pay 1.45 percent Medicare tax on the first $250,000 of compensation plus 2.35 percent (1.45 percent + 0.9 percent) on compensation in excess of $250,000. Unlike Social Security tax, there is no cap on the amount of compensation subject to Medicare tax.

The threshold amounts are identical to those set for the NII tax. However, despite some relationship between these two taxes, income that escapes the NII tax does not necessarily get caught by the 0.9 percent Medicare tax, or vice versa.


Taxpayers liable for Additional Medicare Tax will calculate Additional Medicare Tax liability on their individual income tax returns. Taxpayers who anticipate liability for Additional Medicare Tax may request that their employer(s) take out an additional amount of income tax withholding, which would be applied against taxes shown on the taxpayer’s individual income tax return, including any Additional Medicare Tax liability.


The IRS has cautioned that if an employee has amounts deferred under a nonqualified deferred compensation plan, and the nonqualified deferred compensation is taken into account as wages for FICA (Social Security and Medicare) purposes under a special timing rule, the nonqualified deferred compensation would likewise be taken into account under the special timing rule to determine the employer’s obligation to withhold Additional Medicare Tax.

Withholding. An employer is required to collect Additional Medicare Tax with respect to wages earned for duties performed by the employee for the employer only to the extent the employer pays wages to the employee in excess of $200,000 in a calendar year. This rule applies without regard to the employee’s filing status or other wages/compensation.


The employer’s obligation to withhold Additional Medicare Tax starts at $200,000. This is distinct (as explained above) from the threshold amounts for liability for Additional Medicare Tax. Individuals who receive wages from more than one employer, and who expect those wages to exceed the threshold amounts, should consider increasing their withholding or making estimated tax payments. Under proposed IRS regulations, interest-free adjustments of employer underpayments of Additional Medicare Tax generally may be made only if the error is ascertained in the same year the wages or compensation was paid.

Alternative Minimum Tax

Year-end planning was made more complicated in the past because of uncertainty over the reach of the alternative minimum tax (AMT). Congress had originally intended that the AMT operate so that very wealthy taxpayers could not escape taxation. Because the AMT had not been indexed for inflation, along with other factors, the AMT began to encroach on middle income taxpayers. To prevent this, Congress routinely “patched” the AMT by increasing the exemption amounts and making other changes. ATRA permanently patches the AMT for 2013 and subsequent years.

Under ATRA, the exemption amounts for 2013 are $51,900 for single individuals and heads of household and $80,800 for married couples filing a joint return and surviving spouses. ATRA provides that these amounts are indexed for inflation after 2013. Taxable income that exceeds the exemption amount is subject to a 26 percent AMT rate on the first $175,000 of alternative minimum tax income (AMTI) and a 28 percent on any AMTI above this $175,000 amount. ATRA also allows taxpayers to take all of the nonrefundable personal credits against regular and AMT liability.

CCH projects that, for 2014, the AMT exemption for married joint filers and surviving spouses will be $82,100 (up from $80,800 in 2013). For heads of household and unmarried single filers, the exemption will be $52,800 (up from $51,900 in 2013).


Taxpayers who were accustomed to reviewing their AMT liability versus regular tax liability in years before ATRA permanently patched the AMT should continue their analysis. Some taxpayers may find that their AMT liability and regular tax liability are roughly equal from year to year. Other taxpayers may find that they have had significant fluctuations in income from year to year and could explore the benefit from being able to shift some AMT-triggering items from an AMT year to a non-AMT year.


For many taxpayers, large amounts of certain items may trigger AMT liability. These include, but are not limited to, itemized deductions for medical expenses, the addition of certain income from incentive stock options, changes in income from installment sales, and more. Some taxpayers may benefit from participating in an employer’s pretax medical deduction plan, which could reduce their taxable compensation and AMT liability.


Taxpayers who discover they are not liable for AMT for 2013, but who had been liable for the AMT in a past year, may be eligible to take a minimum tax credit against their regular tax this year. This credit cannot, however, be used to reduce AMT liability in a future year. Additionally, the minimum tax credit is allowed only for the AMT caused by deferral items (such as depreciation) and not exclusion items (such as the standard deduction).

President Obama has proposed to replace the AMT with the so-called “Buffett Rule,” which would impose a minimum tax of 30 percent on taxpayers with incomes above $1 million. In April 2013, the Senate rejected the Buffett Rule as proposed in a bill sponsored by Democrats. Senate Democrats could reintroduce the bill in 2014.

JDKatz: Attorney's At Law

JDKatz, P.C. is a full-service law firm focused on tax lawbusiness and transactional lawestate planning and elder law. We are dedicated to minimizing your existing liability and risks while providing valuable tax planning to streamline your tax issues in the future. Please call us at 301-913-2948 to schedule an appointment to meet with one of our trusted attorneys, or visit http://www.jdkatz.com.


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