Investment Income Tax and Additional Medicare Tax

<div class="Section1">Trusts not subject to the net investment income tax include charitable trusts exempt from tax under IRC Section 501<a href="#_ftn1" name="_ftnref1">¹</a> or IRC Section 664<a href="#_ftn2" name="_ftnref2">²</a> (charitable remainder trusts) and trusts that are not classified as “trusts” for federal income tax purposes.<a href="#_ftn3" name="_ftnref3">³</a> Moreover, if all of the remaining interests in a trust are designated for certain qualified purposes, the trust is not subject to the net investment income tax. These qualified purposes described in IRC Section 170(c)(2)(B) include religious, charitable, scientific, literary or educational purposes.<a href="#_ftn4" name="_ftnref4">⁴</a></div><br /> <div class="Section1"><br /> <br /> Finally, grantor trusts such as revocable trusts are not subject to the net investment income tax. This is because the income of a grantor trust is taxed directly to the grantor. As a result, any net investment income generated by the trust is included in the grantor’s net investment income – potentially subject to the 3.8 percent tax at the individual level.<a href="#_ftn5" name="_ftnref5">⁵</a><br /> <br /> </div><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.  Treas. Reg. § 1.1411-3(b)(1)(ii).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.  Treas. Reg. § 1.1411-3(b)(1)(iii).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.  Treas. Reg. § 1.1411-3(b)(1)(iv).<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>.  Treas. Reg. § 1.1411-3(b)(1); IRC § 170(c)(2)(B).<br /> <br /> <a href="#_ftnref5" name="_ftn5">5</a>.  Treas. Reg. § 1.1411-3(b)(1)(v).<br /> <br /> </div>

<div class="Section1">There are several possible ways that an employer might fail to withhold the additional Medicare tax an employee is liable to pay. For example, this scenario might occur if each spouse individually earns wages under the mandatory $200,000 withholding amount. Therefore, if one spouse has wages of $100,000 and the other spouse has wages of $199,000, neither spouse’s wages are subject to mandatory withholding. However, because the couple’s combined wages of $299,000 exceed the $250,000 applicable threshold by $49,000, they must pay the additional Medicare tax on that amount. Thus, on Form 8959, the couple would compute the additional Medicare tax of 0.9 percent on $49,000 – reporting it on line 60 of Form 1040.<a href="#_ftn1" name="_ftnref1">¹</a></div><br /> <div class="Section1"><br /> <br /> On the other hand, an employer obligated to withhold the additional Medicare tax on wages in excess of $200,000 may simply fail to do so. Under those circumstances, the employer remains obligated to pay the tax to the IRS unless and until the employer can prove that it was paid by the employee. However, even if the employee ultimately pays the tax, it does not relieve the employer of its liability for any interest or penalties assessed as a result of its failure to withhold the additional Medicare tax.<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> </div><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.  Treas. Reg. § 31.3102-4(b), Example J.<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.  Treas. Reg. § 31.3102-4(c).<br /> <br /> </div>

<div class="Section1">Although the additional Medicare tax is a separate tax, the IRS considers it to be part of the taxpayer’s overall tax liability. So, if the taxpayer’s withholdings are not sufficient to cover the entire tax liability, there may be a penalty imposed on the failure to make an estimated tax payment. For that reason, it may benefit a taxpayer who does not increase the amount withheld by the employer to make estimated payments to cover any shortfall.<a href="#_ftn1" name="_ftnref1">¹</a></div><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.  IRS Q&amp;A on the Additional Medicare Tax, available at: http://www.irs.gov/Businesses/Small-Businesses-&amp;-Self-Employed/Questions-and-Answers-for-the-Additional-Medicare-Tax (last accessed September 23, 2024).<br /> <br /> </div>

<div class="Section1">Yes.&nbsp;The value of any taxable noncash employee fringe benefits is added to an employee&rsquo;s cash wages to determine whether the taxpayer&rsquo;s overall wage income exceeds the applicable threshold (<em><em>see</em></em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="8657">8657</a>). If so, the excess amount will be subject to the additional Medicare tax.<a href="#_ftn1" name="_ftnref1">¹</a> Moreover, similar to the payment of only cash wages, if the combined amount of cash wages and taxable noncash fringe benefits exceeds the mandatory wage withholding amount of $200,000 (<em><em>see</em></em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="8658">8658</a>), the employer must withhold the additional Medicare tax on the excess amount of combined wage income.<a href="#_ftn2" name="_ftnref2">²</a><div class="Section1"><br /> <br /> <em><em>See</em></em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="8887">8887</a> to Q <a href="javascript:void(0)" class="accordion-cross-reference" id="8919">8919</a> for a discussion of the tax treatment of various noncash fringe benefits.<br /> <br /> </div><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp; IRS FAQ, <em>Questions and Answers for the Additional Medicare&nbsp;Tax</em>, available at http://www.irs.gov/Businesses/Small-Businesses-&amp;-Self-Employed/Questions-and-Answers-for-the-Additional-Medicare-Tax (last accessed September 23, 2024).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp; IRS FAQ, <em>Questions and Answers for the Additional Medicare&nbsp;Tax</em>, available at http://www.irs.gov/Businesses/Small-Businesses-&amp;-Self-Employed/Questions-and-Answers-for-the-Additional-Medicare-Tax (last accessed September 23, 2024).<br /> <br /> </div></div><br />

<div class="Section1">Any taxpayer who has net investment income (in any amount) and modified adjusted gross income (MAGI) in excess of the applicable threshold amount is subject to the 3.8 percent net investment income tax. The applicable thresholds are MAGI in excess of $200,000 for single taxpayers, $125,000 for married taxpayers filing separately and $250,000 for married couples filing jointly. Unlike many other income threshold amounts, these thresholds are not indexed annually for inflation.<a href="#_ftn1" name="_ftnref1">¹</a><div class="Section1"><br /> <br /> In addition to individuals, the net investment income tax applies to certain trusts and estates (<em><em>see</em></em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="8654">8654</a>).<a href="#_ftn2" name="_ftnref2">²</a> Nonresident aliens are not subject to the tax.<a href="#_ftn3" name="_ftnref3">³</a><br /> <br /> </div><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp; <em><em>See</em></em> Preamble to notice of proposed rulemaking, REG-130507-11, 77 Fed. Reg. 72611, 72615.<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp; IRC &sect;&nbsp;1411(a).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.&nbsp; IRC &sect;&nbsp;1411(e).<br /> <br /> </div></div><br />

<div class="Section1">For most taxpayers, MAGI is the same as their AGI. This is because the only adjustments made to AGI in arriving at MAGI relate to foreign earned income. Specifically, in arriving at MAGI, AGI is increased by the excess of (1) any amounts excluded under IRC 911(a)(1) (foreign earned income) over (2) the amount of deductions and exclusions disallowed under IRC 911(d)(6) (which disallows certain deductions and exclusions that would otherwise be properly allocable to an amount excluded from gross income because it is foreign earned income).<a href="#_ftn1" name="_ftnref1">¹</a> Thus, absent any foreign earned income, AGI and MAGI are the same amount.</div><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.  IRC § 1411(d).<br /> <br /> </div>

<div class="Section1">In addition to actual retirement plan distributions (<em><em>see</em></em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="8639">8639</a>) that are excluded from net investment income, the final regulations also make it clear that deemed distributions from retirement plans are excluded. For example, a rollover of funds from a traditional IRA into a Roth IRA, where the funds are never actually received by the taxpayer, is nonetheless treated as a distribution for income tax purposes. Similar to actual retirement distributions, the IRA/Roth conversion deemed distribution is excluded from net investment income; and, thus, is not subject to the net investment income tax.<a href="#_ftn1" name="_ftnref1">¹</a><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp; Treas. Reg. &sect;&nbsp;1.1411-8(b)(2).<br /> <br /> </div></div><br />

<div class="Section1">Although federal income tax credits set forth in Subtitle A of the IRC can offset any tax liability, the final regulations state that income tax credits are allowed only against regular income tax (Chapter 1 of Subtitle A) and may not reduce net investment income tax.<a href="#_ftn1" name="_ftnref1">¹</a> Examples of this type of tax credit include the foreign income tax credit and the general business tax credit.<a href="#_ftn2" name="_ftnref2">²</a></div><br /> <div class="Section1"><br /> <br /> The denial of tax credits as an offset of the net investment income tax is reflected by the sequence of reporting tax and tax credits on Form 1040. To this point, regular income tax is reported on line 46 of Form 1040. All tax credits reducing that regular income tax are taken lines 47-53. Beginning on line 56, “other taxes,” including the net investment income tax (reported on line 60), are reported. So logistically, all tax credits that reduce regular income tax are taken <em>before</em> the entry for the net investment income tax. Moreover, none of those credits are refundable credits (meaning the credits can only reduce the regular tax to zero and not generate a refundable overpayment). Thus, they are of no consequence with regard to the net investment income tax reported on line 60.<br /> <br /> </div><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.  Treas. Reg. § 1.1411-1(e).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.  IRC §§ 27, 901, 38.<br /> <br /> </div>

<div class="Section1">Certain trusts and estates may be subject to the 3.8 percent net investment income tax. Basically, the tax is imposed on any net investment income that remains in the estate or the trust and, thus, is not distributed to beneficiaries, otherwise referred to as “undistributed net investment income.” Unlike individual taxpayers, the threshold amount is the amount at which the highest regular income tax bracket begins. Additionally, unlike the applicable threshold amount for individuals, the applicable threshold is adjusted for inflation.<a href="#_ftn1" name="_ftnref1">¹</a> For example, in 2024, the amount at which the highest income tax bracket begins is adjusted gross income in excess of $14,450.<a href="#_ftn2" name="_ftnref2">²</a> Since this amount is relatively low, many estates and trusts should expect to be subject to the tax.</div><br /> <div class="Section1"><br /> <br /> The following examples are used to demonstrate the computation of the net investment income tax for a trust.<br /> <blockquote><em>Example</em>: In 2024, the Dinosaur trust has AGI of $16,000 and undistributed net investment income of $6,000.<br /> <br /> The net investment income tax is imposed on trusts and estates on the lesser of:<br /> <br /> 1)  Undistributed Net Investment Income, $6,000; or<br /> <br /> 2)  The excess of (i) AGI of $16,000, over (ii) $14,450, the amount at which the highest regular tax bracket begins, or $1,550.</blockquote><br /> Even though there is $6,000 of undistributed net investment income, because the lesser of the two amounts is $1,550, only that amount is subject to the 3.8 percent net investment income tax.<br /> <blockquote><em>Example</em>: In 2024, the Dinosaur trust has AGI of $25,000 and undistributed net investment income of $6,000.<br /> <br /> The net investment income tax is imposed on trusts and estates on the lesser of:<br /> <br /> 1)  Undistributed Net Investment Income, $6,000; or<br /> <br /> 2)  The excess of (i) AGI of $25,000, over (ii) $14,450, the amount at which the highest regular tax bracket begins, or $10,550.</blockquote><br /> Because the lesser of the two amounts is the undistributed net investment income of $6,000, the entire amount of undistributed net investment income is subject to the 3.8 percent net investment income tax.<br /> <br /> </div><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.  IRC § 1411(a)(2)(B)(ii).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.  Rev. Proc. 2022-38.<br /> <br /> </div>

<div class="Section1">No. Pursuant to IRC Section 3102(a), once an employee’s wages exceed $200,000 (the mandatory wage withholding amount), the employer must withhold 0.9 percent of the excess amount even if the employee does not actually owe any additional Medicare tax. So for wages in excess of $200,000, the employer must withhold the additional Medicare tax even if those wages combined with his or her spouse’s wages do <em>not</em> exceed the applicable threshold for a married couple filing jointly ($250,000).<a href="#_ftn1" name="_ftnref1">¹</a> To the extent the amount withheld exceeds the employee’s liability, the employee’s remedy is to apply it as a payment against other tax he or she may owe or receive a refund for the excessive withholding.</div><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.  IRS FAQ, <em>Questions and Answers for the Additional Medicare Tax</em>, available at http://www.irs.gov/Businesses/Small-Businesses-&amp;-Self-Employed/Questions-and-Answers-for-the-Additional-Medicare-Tax (last accessed September 23, 2024); Treas. Reg. § 31.3102-4(a).<br /> <br /> </div>