The Patient Protection and Affordable Care Act of 2010 created a new 3.8% Medicare tax on passive investment income of higher earners. Higher earners are those taxpayers with a modified adjusted gross income (MAGI) exceeding $200,000 for single taxpayers, and $250,000 for married taxpayers filing jointly. The tax is assessed on the lesser of the taxpayer’s net passive investment income, or the amount the taxpayer’s MAGI exceeds the foregoing thresholds.
In addition to the new tax levied, passive investment income is also defined more broadly to include income streams not traditionally taxed for Medicare. For example, passive rental income is included. Trusts and estates are also subject to the new tax.
This new tax could affect a significant number of individuals. For a typical Stark & Knoll client who may have an operating company that leases its facility from a related real estate holding company, the income earned by the real estate holding company is passive investment income that may be subject to the new tax. Similarly, trusts earning a significant amount of passive income may be subject to the tax.
Now is a great time to meet with your accountant and Stark & Knoll attorney to review whether you can minimize your new Medicare tax liability. For example, it may be advisable to amend the lease with your real estate holding company to reduce the rent and minimize your passive investment income. Similarly, this could allow you to keep more of your income in your active operating company, which might not be subject to the new Medicare tax. Reducing your salary and increasing shareholder distributions from your active entity may help minimize your Medicare tax liability as well.
Furthermore, modifying your estate planning documents to pass through passive income to family members with lower MAGI may be advisable to reduce exposure to your trust. Permitting additional income distributions to trust beneficiaries who do not meet the MAGI thresholds could help minimize the tax. The use of a family limited partnership or other similar entity could also help transfer passive income to lower MAGI taxpayers. Overall, it is a good time to sit down with your accountant and your Stark & Knoll attorney to plan for these changes.