Chapter 28
Additional Medicare Tax and Net Investment Income Tax

An Additional Medicare Tax of 0.9% applies to wages, other employee compensation, and self-employment income to the extent such income exceeds a threshold of $250,000 for married persons filing jointly, $200,000 if single, head of household, or a qualifying widow/widower, or $125,000 if married filing separately. Figure liability for the additional tax on Form 8959. If the tax was withheld from your 2017 wages, you show the amount on Form 8959 and add it to your regular withholdings on Form 1040. See 28.2 for details on the 0.9% tax.

A 3.8% tax (Net Investment Income Tax) applies to some or all of your net investment income if your modified adjusted gross income exceeds the applicable threshold of $250,000 for joint filers and qualifying widows/widowers, $200,000 if single or head of household, or $125,000 if married filing separately. The 3.8% tax is figured on Form 8960. See 28.3 for details on the 3.8% tax.

In your planning for 2018, you may need to increase your withholdings or estimated tax installments to account for these taxes.

28.1 Higher-Income Taxpayers May be Subject to Additional Taxes

Higher-income taxpayers may be subject to one or both of two taxes that took effect in 2013 to help pay for health care reform, one on earned income and the other on investment income.

If you have wages and/or self-employed earnings over $200,000 if single, or $250,000 if married filing jointly, you are subject to the 0.9% Additional Medicare Tax on the earnings over the threshold. If you have modified adjusted gross income over the $200,000 or $250,000 thresholds, you are subject to a 3.8% tax on some or all of your net investment income (Net Investment Income Tax (NIIT)). The 0.9% Additional Medicare Tax is computed on Form 8959 and the 3.8% NIIT tax is computed on Form 8960.

Details on the thresholds and tax computations are in 28.2 for the 0.9% Additional Medicare Tax and in 28.3 for the 3.8% NIIT. Note that the thresholds for both of these taxes are fixed by statute; there is no annual cost-of-living adjustment for the thresholds. Take this into account in estimating your tax liability for 2018. The lack of an inflation adjustment means that taxpayers who are now slightly below the thresholds may become subject to the taxes in upcoming years.

If withholdings or estimated tax payments were not made in 2017 to cover these taxes, you could be subject to an estimated tax penalty (27.1). The 0.9% tax may have been withheld from your 2017 wages, but as discussed in 28.2, you may not be subject to the tax even though the tax was withheld, or you may not have been subject to withholding but may still owe the tax when you file your 2017 return.

28.2 Additional 0.9% Medicare Tax on Earnings

Wages, other employee compensation (tips, taxable fringe benefits), and net earnings from self-employment are combined to determine if you exceed the threshold for the 0.9% Additional Medicare Tax. The 0.9% tax, if applicable, is on top of the basic Medicare tax otherwise due (1.45% on all wages and salary; 2.90% on net self-employment earnings). Liability for the 0.9% tax does not depend on your adjusted gross income but only on your earnings. The 0.9% tax applies only to earnings above the following thresholds:

• $250,000 for married persons filing jointly
• $200,000 for single persons, heads of households and qualifying widows/widowers
• $125,000 for married persons filing separately

The tax is figured on Form 8959. If in 2017 you had wages (and tips or other taxable employee compensation treated as wages) but not self-employment earnings, the 0.9% tax applies on Part 1 of Form 8959 to the excess of the wages over your filing threshold. For example, if your 2017 wages are $225,000 and you are single, the tax applies to the $25,000 of wages over the $200,000 threshold, for a tax of $225 ($25,000 excess wages x 0.9% (0.009)). The $225 tax must be entered on Line 62 of Form 1040 as an “Other Tax.” Even if withholdings were taken from your pay to cover the 0.9% tax, they do not reduce liability for the tax on Form 8959. In the previous example, the $225 tax is reported as an additional tax whether or not your employer withheld the 0.9% tax. Withholdings for the 0.9% tax are separated out from regular Medicare withholdings on Part V of Form 8959 and then added to your federal income tax withholdings on Line 64 of Form 1040.

Self-employed. If you had only self-employment earnings in 2017, and no wages, you would figure liability for the 0.9% tax on Part II of Form 8959. If you had wages and also net self-employment earnings in 2017, you first determine if the 0.9% tax applies to your wages (Part I of Form 8959), and then you reduce your threshold amount by your wages to get a reduced threshold that is used to determine if the tax applies to the self-employment income; see the Examples below. A net loss from self-employment does not offset wages. The above-the-line deduction for 50% of self-employment tax liability (45.3-45.4) does not apply to the 0.9% Additional Medicare Tax.

Employer withholding for the 0.9% tax. Although the additional tax applies to the portion of earnings over the threshold ($250,000, $200,000, or $125,000), an employer will only withhold the additional Medicare tax once wages for the year (including tips, bonuses, and other taxable compensation) exceed $200,000. This means that some taxpayers will be subject to withholding but not owe the tax, while others will owe the tax but not be subject to withholding.

For example, assume that the combined wages of a married couple filing jointly do not exceed the $250,000 threshold, but one of the spouses has wages from one employer exceeding $200,000, In that case, the employer of the higher-earning spouse will withhold the 0.9% tax from the wages over $200,000. On Form 8959, there will be no liability for the tax because total wages do not exceed the threshold, but Form 8959 will have to be filed to show the additional withholding so it can be claimed on Form 1040.

On the other hand, an unmarried employee with several jobs could have wages well over the $200,000 threshold but not have the tax withheld by any employer because the wages from each job do not exceed $200,000. Similarly, for a married couple filing jointly, combined wages may exceed the $250,000 threshold but unless one spouse has wages exceeding $200,000 from a single employer, the additional tax will not be withheld from either spouse’s pay. Thus, if one spouse has wages of $180,000 and the other has wages of $170,000, the 0.9% tax will not be withheld from either of them although their combined wages are $100,000 over the $250,000 threshold and they will owe additional tax of $900 (0.9% x $100,000 excess) on Form 8959. Finally, a married person filing separately with wages between $125,000 and $200,000 will not have the 0.9% tax withheld from his or her pay, but the tax will apply on Form 8959 to the wages over $125,000, the threshold for married persons filing separately.

If you (or you and your spouse on a joint return) owe the 0.9% but it is not withheld from your wages, you could face an estimated tax penalty (27.2) if the liability is not covered by regular income tax withholdings (Form W-4) or estimated tax installments.

28.3 Additional 3.8% Tax on Net Investment Income

If you have net investment income and you have modified adjusted gross income (MAGI) exceeding the applicable threshold for your filing status, some or all of the net investment income will be subject to a 3.8% tax on Form 8960. The tax is called the Net Investment Income Tax (NIIT) on Form 8960. The thresholds for the tax are:

• $250,000 for married persons filing jointly and qualifying widows/widowers
• $200,000 for single persons and heads of households
• $125,000 for married persons filing separately

If your MAGI exceeds the applicable threshold, the 3.8% tax applies to the lesser of (1) your net investment income, or (2) your MAGI exceeding the threshold. Thus, if you have net investment income of $50,000, but your MAGI exceeds your threshold by only $20,000, the 3.8% tax applies to the lesser amount of $20,000. Also see the Examples below.

Estates and trusts may also be subject to the net investment income tax; see below.

MAGI thresholds. The thresholds are based on modified adjusted gross income, which is the same as adjusted gross income (AGI) unless the foreign earned income exclusion (36.1) is claimed. If the foreign earned income exclusion is claimed, add back the excluded income (minus any above-the-line deductions or exclusions that were disallowed as allocable to the excluded foreign earned income) to get modified adjusted gross income.

Investment income and net investment income. Investment income subject to the 3.8% tax is entered on Part I of Form 8960. Investment income includes taxable interest, dividends, payments from commercial annuities (but not employee annuities), rents and royalties, capital gains from sales of stocks, bonds, mutual funds, or investment real estate including a vacation home, capital gain distributions from mutual funds, and passive income from partnerships and S corporations, including gain from the sale of a partnership or S corporation interest if you were a passive owner.

Do not count as investment income the following: tax-exempt interest, distributions from traditional IRAs, Roth IRAs, 401(k) plans and other qualified retirement plans such as pension plans, 403(b) plans and qualified annuity plans, and income from businesses, including partnerships and S corporations, in which you materially participate. Also excluded are Social Security benefits, life insurance, alimony and nontaxable veterans benefits.

A homeowner who sells his or her principal residence at a gain treats the gain as investment income for purposes of the 3.8% tax only to the extent that it exceeds the applicable home sale exclusion (usually $250,000 for singles and $500,000 for joint filers; see 29.1). If the gain is excluded from income, it is not subject to the 3.8% tax; see Examples 2 and 3 below.

Check the instructions to Form 8960 for further exceptions to the investment income category and details on items includible as investment income.

Note that a taxable distribution from a traditional IRA (8.8) or a qualified retirement plan, although excluded from the investment income category, is part of your MAGI, and the distribution, by increasing your MAGI, could push you over the threshold for the 3.8% tax or increase the tax if you are already over the threshold. This would not be true for a qualified Roth IRA distribution (8.24), tax-exempt interest, or other item excluded from MAGI.

Investment expenses that are allocable to investment income are entered on Part II of Form 8960 and subtracted from investment income in Part III to arrive at net investment income. Allocable investment expenses include brokerage fees, investment advisor fees, investment interest, rental and royalty activity expenses, and state and local income taxes allocable to items included as investment income: see the Form 8960 instructions for details on qualifying investment expenses.

Estates and trusts may also be subject to the 3.8% tax. For an estate or trust, the 3.8% tax generally applies to the lesser of its undistributed net investment income for the year or the excess of its AGI over the annual threshold for the 39.6% bracket for an estate or trust. For 2017, the 39.6% bracket threshold is $12,500. Grantor trusts and certain charitable trusts are exempt from the 3.8% tax. See the Form 8960 instructions for details.