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High-Wage Individuals Face New Medicare Payroll Tax in 2013

The new Medicare contribution tax was created by healthcare reform legislation passed in 2010. The constitutionality of that legislation was upheld by the U.S. Supreme Court in a decision made on June 28, 2012. This video was made prior to the decision, but does explain what this tax means to you.

Beginning in 2013, high income individuals may be subject to a new 3.8% Medicare contribution tax on some or all of their unearned income. The new tax is assessed on the unearned income of single individuals with modified adjusted gross income exceeding $200,000. For married individuals filing a joint Federal income tax return the income threshold is $250,000. For married individuals filing separate returns, it's $125,000. If your income doesn't reach that level, you don't have to worry about the tax. If your income puts you over the threshold though, the tax equals 3.8 % of your net investment income, or if it's less, 3.8% of the amount by which your income exceeds your dollar threshold. So, if you're single and have modified adjusted gross income of $250,000, consisting of $150,000 in earned income and $100,000 in net investment income, the 3.8% Medicare contribution tax will only apply to $50,000 of your investment income.

We've said that the tax applies to net investment income, but what exactly does that mean? Net investment income generally includes net income from interest, dividends, capital gains, annuities, royalties and rents. It also includes income from a business that is considered a passive activity, or a business that trades financial instruments or commodities. Interest on tax-exempt bonds, and gain from the sale of a principal residence that is excluded from income are not included. Distributions you take from a qualified retirement plan or IRA are also not included in the definition of net investment income.