Medicare offers additional medical coverage for eligible Americans who are (mostly) 65 or older. It’s paid for by taxes, and higher income-earners face some additional taxes for Medicare services.
You know that Medicare costs come out of your paychecks, but did you know your investments are also affected? Earnings above certain thresholds get taxed as well. The 2019 limits and taxes are as follows:
A 3.8% Medicare surtax on the lesser of net investment income or excess of modified adjusted gross income (MAGI):
MAGI is your household adjusted gross income including any tax-exempt interest income and certain deductions added.
It’s different than your adjusted gross income (AGI), which adds up your annual earnings, and takes into account the deductions you’re allowed from your gross income. AGI includes your wages, dividends, capital gains, business income, alimony, retirement distributions and other income you might have received.
MAGI, on the other hand, can add those deductions back onto your taxable income, because as you reach certain income thresholds, you become ineligible for some deductions and credits.
The limits are more than $200,000 for individuals, $250,000 for couples filing jointly or $125,000 for spouses filing separately
Higher payroll taxes will affect individuals earning wages above $200,000, couples earning more than $250,000 and spouses filing separately who brought in more than $125,000.
Let’s break those down more:
Medicare Net Investment Income Taxes
Since 2013, the Patient Protection and Affordable Care Act has required some taxpayers to pay a Medicare tax on money earned from investments. That would include capital gains, taxable interest and dividends.
This is that 3.8% tax I mentioned earlier. It applies to the amount of your investment income that exceeds the thresholds, or MAGI that exceeds thresholds.
In the past, taxpayers weren’t required to pay Medicare tax on income generated from investments such as capital gains, dividends, and taxable interest. Since 2013, however, you could owe a 3.8% Medicare tax on some or all of your net investment income (as part of the Patient Protection and Affordable Care Act of 2010).
The amount you owe is based on the lesser of your total net investment income or the amount of your MAGI that exceeds $200,000 for individuals, $250,000 for couples filing jointly, or $125,000 for spouses filing separately.
In other words, you owe the 3.8% tax on the amount by which your investment income exceeds the income thresholds, or, if your wages alone already are higher than the income thresholds, you’ll owe tax on the lesser of net investment income or MAGI that exceeds the thresholds.
The tricky part is determining what is and is not net investment income, so if you’re unsure, work with a professional to help you determine that amount.
And if you’re looking to reduce your MAGI, see my post here about how to reduce your tax bill.
Medicare payroll tax on earned income
The Medicare payroll tax is 2.9%, which applies to earned income only. If you’re self-employed, you’ll pay the full amount. Otherwise, you pay 1.45% from each paycheck, and your employer pays the other 1.45%.
But let’s say you earn more than the thresholds – again, that’s $200,000 for individuals, $250,000 for couples and $125,000 for spouses filing separately. You will owe an extra 0.9% on earned income that is above those amounts.
How to Reduce Your Modified Adjusted Gross Income
If you can reduce your MAGI, you can reduce your amount of Medicare taxes that you owe.
Here are a few ways to do it:
- Structure your portfolio so that your earned income (dividends and interest) is mostly held in tax-deferred accounts (See my posts about lowering your tax bill and using more tax-deferred accounts.)
- Own lower income-producing funds in your taxable accounts
- Increase savings toward tax-deferred accounts (i.e. 401ks, IRAs, HSAs, etc.)
This is something I help my clients navigate every year at tax time. If you want more help cutting down on your Medicare taxes, contact me here.