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Planning for the Medicare Tax on Unearned By Ronald F. Pavlovich, CPA, CAPPM J ANUARY 1, 2013 marks the effec- tive date for a major funding piece of the Patient Protection and Affordable Care Act of 2010. The funding comes in the form of a Medicare surtax of 3.8% charged on unearned income of high earning individuals, estates and trusts. Now is the time for individuals and fiduciaries to take action in order to mitigate some or all of the impact of this new tax. The tax is charged on the lesser of net investment income for the tax year or the amount by which modified adjusted gross income (MAGI) exceeds a threshold. That threshold is $200,000 for single filers, $250,000 for married filing jointly and $125,000 for married filing separately. Net investment income includes interest, dividends, capital gains, annuities, and rents and royalty income from passive activities, net of allocable deductions. Net investment income does NOT include tax exempt income, active trade or business income, self-employment income, and distribu- tions from IRAs or other qualified retirement plans. The effect of the Medicare surtax can be reduced or even eliminated by implementing certain planning strategies before the end of this year and in future years. These strategies include reducing your taxable investment income, your MAGI, or both, without actually reducing your real income. Shift your taxable investment portfolio from taxable investments to tax-exempt bonds. The result of this move will reduce both your taxable investment income and your MAGI. Shift your portfolio from dividend producing investment to long-term growth investments. This strategy would trade current dividend income for long-term growth, thus deferring any tax until the investment is sold. If your MAGI is below the threshold when the invest- ment is sold, perhaps during retirement, the tax savings becomes permanent. Sell investments in a capital gain position before the end of 2012 in order to lock in the gain before the surtax becomes effective. If it makes sense to hold the investment in the future, you may immediately buy back the investment since wash sales rules only apply to investments sold for a loss. This strategy might also save future income tax considering capital gain rates may increase next year if the Bush tax cuts are allowed to expire. Consider oil and gas investments whereby royalty income is partially Income 3.8% offset by depletion deductions without expending cash. Consider real estate investments whereby your income is partially offset by depreciation deductions annually. Also, passive losses can be used to offset other passive income thereby reducing the MAGI for individuals having other passive income. Increase your contributions to qualified retirement plans, such as 401K, 403B and 457 plans. Also, consider establishing an alternative defined ben- efit plan whereby retirement deferrals can be significantly increased, thereby reducing MAGI. Changing your investment portfolio, however, should include much more planning than just considering the effect on reducing the Medicare sur- tax. Consult your financial advisor to evaluate how making portfolio changes effects your overall investment strategy in addition to avoiding or reducing the Medicare surtax. Ron Pavlovich is a CPA and CAPPM (Certified Administrator in Physician Practice Management obtained from the American Academy of Medical Management). He is a senior manager in the Medical Practice Management Group of CBIZ MHM, LLC, in Akron, Ohio. ■ 36 | Cleveland-Akron-Canton MD NEWS ■ MDNEWS.COM ■ SEPTEMBER-OCTOBER 2012