Taxable Social Security Benefits

If you are currently receiving social security (or equivalent railroad retirement) benefits, you may have to include in income a portion of the net benefits you receive during the year. If you receive either of these benefits during the year, you should receive a Form SSA-1099, Social Security Benefit Statement, or Form RRB-1099, showing the gross amount and net amount of benefits you received.

Generally, if you are a U.S. citizen or resident, you are subject to federal income tax on a portion of your social security benefits only if the sum of the your modified adjusted gross income (MAGI) plus 50 percent of the social security benefits you received exceeds a base amount. Your base amount is (1) $32,000 if you are married filing jointly, (2) $0 if you are married filing separately and lived with your spouse at any time during the tax year, or (3) $25,000 in any other case. If you are married and file a joint return, you and your spouse must combine your incomes and benefits to figure whether any of your combined benefits are taxable, even if only one of you received social security benefits.

If your social security benefits are taxable, the amount of such benefits you must include in your gross income is generally equal to the lesser of (1) 50 percent of the social security benefits you received, or (2) 50 percent of the amount by which the sum of your MAGI and 50 percent of the social security benefits received exceeds your base amount. In some cases, however, you may have to include in income up to 85 percent of your benefits. Special rules apply if you receive a lump-sum distribution of social security benefits; if you have repaid social security benefits and your repayments exceed the gross benefits you receive; or if you receive social security benefits, have taxable compensation, contribute to a traditional IRA, and are covered (or your spouse is covered) by an employer retirement plan.

Taxable social security benefits are included in the gross income of the person who has the legal right to receive the benefits. Thus, for example, if you and your child receive social security benefits but the check is made payable to you, then you use only your portion of the benefits to determine if and how much of the benefits are taxable to you. Your child must use his or her portion of the benefits to determine if and how much of the benefits are taxable.

Under tax treaties, if you are a U.S. citizen who is a resident of Canada, Egypt, Germany, Ireland, Israel, Italy, Romania, or the United Kingdom, you are exempt from U.S. tax on your social security benefits (if you are a resident of Italy, you must also be Italian citizen to qualify for exemption).

If you are a nonresident alien, the rules discussed here do not apply to you. Instead, 85 percent of your benefits are taxed at a 30 percent rate, unless exempt (or subject to a lower rate) by treaty. Under tax treaties, residents of Canada, Egypt, Germany, Ireland, Israel, Italy, Japan, Romania, and the United Kingdom are exempt from U.S. tax on their benefits.

Please call us at your convenience so that we can discuss the rules for the taxation of social security benefits as they apply to your particular situation.

Medicare Contribution Tax

Beginning in 2013, as part of the Patient Protection and Affordable Care Act (PPACA), an additional tax is imposed on income over a certain level in the case of an individual, estate, or trust. This tax is referred to as the "unearned income Medicare contribution tax." Others have referred to it as a tax on investment income, although it can apply to individuals, estates, and trusts that do not have investment income.

For an individual, the tax is 3.8 percent of the lesser of net investment income or the excess of modified adjusted gross income over a threshold amount. The threshold amount is $250,000 in the case of taxpayers filing a joint return or a surviving spouse, $125,000 in the case of a married individual filing a separate return, and $200,000 in any other case.

Modified adjusted gross income is adjusted gross income increased by any amount excluded from income as foreign earned income (net of the deductions and exclusions disallowed with respect to the foreign earned income).

The tax is subject to the individual estimated tax provisions and is not deductible in computing any income tax. Thus, for example, there is no deduction allowed for this tax when calculating the self-employment tax.

For purposes of the unearned income Medicare contribution tax, net investment income is investment income reduced by the deductions properly allocable to such income. Investment income is the sum of:

(1) gross income from interest, dividends, annuities, royalties, and rents (other than income derived in the ordinary course of any trade or business to which the tax does not apply);

(2) other gross income derived from any trade or business to which the tax applies; and

(3) net gain (to the extent taken into account in computing taxable income) attributable to the disposition of property other than property held in a trade or business to which the tax does not apply.

Investment income does not include distributions from a qualified retirement plan or amounts subject to self-employment tax.

In the case of a trade or business, the tax applies if the trade or business is a passive activity with respect to the taxpayer, or the trade or business consists of trading financial instruments or commodities. The tax does not apply to other trades or businesses. Income, gain, or loss on working capital is not treated as derived from a trade or business.

Net investment income DOES NOT INCLUDE items that are excludible from gross income under the tax rules, such as interest on tax-exempt bonds, veterans' benefits, and any gain excludible from income when you sell a principal residence.

This law could affect you if you dispose of a partnership interest or stock in an S corporation. In such cases, gain or loss is taken into account to the extent gain or loss would be taken into account by a partner or shareholder if the entity had sold all its properties for fair market value immediately before the disposition.

In the case of an estate or trust, the tax is 3.8 percent of the lesser of undistributed net investment income or the excess of adjusted gross income over the dollar amount at which the highest income tax bracket applicable to an estate or trust begins.

The unearned income Medicare contribution tax does not apply to a nonresident alien; a trust, all the unexpired interests in which are devoted to charitable purposes; a trust that is exempt from tax under Code Sec. 501; or a charitable remainder trust exempt from tax.

If you believe you may owe this tax, we will need to prepare estimated taxes in order to avoid a penalty. Please call us at your convenience if you wish to discuss this further or have any other questions regarding health insurance.