Capital gains taxes are something every investor must contend with. But these taxes aren’t limited to just short and long-term gains. There’s another tax called the Medicare tax that can also get thrown in. It doesn’t happen to everyone, though. In this article, we’ll look at who the Medicare tax effects.
Long-Term Capital Gains Tax Rates
As a recap, short-term capital gains are treated just like ordinary income. These are gains on investments that are held for at least one year. Long-term capital gain taxes are more favorable and are taxed at less than the ordinary income tax rate.
The 2020 long-term capital gains tax rates are broken down into three different rates — 0%, 15%, 20%. The rate you fall under depends on your income and filing status. The table below outlines the 2020 long-term capital gains tax rates.
Status | 0% | 15% | 20% |
Single | Up to $40,000 | $40,001-$441,450 | Over $441,450 |
Married filing jointly | Up to $80,000 | $80,001-$496,600 | Over $496,600 |
Married filing separately | Up to $40,000 | $40,001-$248,300 | Over $248,300 |
Head of household | Up to $53,600 | $40,001-$269,050 | Over $269,050 |
Additionally, you’ll have to pay state long-term capital gains taxes. There may also be a 1-2% transfer tax at the local taxing level. With short and long-term taxes covered, we can now look at when the medicare tax comes into play.
Medicare Surtax
The Medicare tax is also known as the Medicare surtax or net investment income tax (NIIT). It is part of IRC Section 1411(c). The tax became effective in 2013 and is part of the Affordable Care Act of 2010. While it is a tax on investment income, funds from the tax are used for Medicare expansion. Hence the word Medicare in some of the tax’s terminology.
The Medicare surtax is a 3.8% tax. It is a tax on combined net investment income and modified adjusted gross income (MAGI) of more than $200,000 for single filers and more than $250,000 for married filing jointly. It applies to individuals, estates, and trusts. Of course, like other taxes, the Medicare surtax only applies after any losses/expenses have been factored in.
For example, if an investor had $180k in income from investments and MAGI, the investor would not incur Medicare surtax. However, if the investor then sold an additional $50k of long-term stock, putting total income at $230k, $30k of it would be subject to Medicare surtax.
The Medicare surtax applies to the following gross investment income types:
- Interest
- Dividends
- Capital gains
- Capital gains distributions from mutual funds
- Royalties
- Annuities
- Passive business activities
- Rents
The following don’t count as taxable income for the Medicare surtax:
- Muni bond income
- Income from non-passive business activities, i.e., actively participates in income (direct real estate, for example)
- Gains from dispositions of passive ownership interests in partnership or S-corp
- Income and gains from the business of trading in financial instruments and commodities
You don’t have to be a high-income earner to be hit with the Medicare surtax. Through a windfall, the middle class can be affected as well.
Don’t confuse the Medicare surtax with the Medicare payroll tax, which is also called the Additional Medicare Tax (AMT), Obamacare tax, and even the Medicare surtax. The AMT is a 1.45% (for 2020) payroll tax on wages. It’s easy to confuse these two taxes, but they are two different taxes.
Offsetting The Medicare Surtax
Besides selling investments for a loss, which will reduce taxable gains, there are a couple of other ways to potentially offset the impact of the Medicare surtax.
One is called tax-loss harvesting. Tax-loss harvesting is performed on equity portfolios and is generally automated. The strategy sells losing positions, takes those proceeds, and buys a replacement security, maintaining the portfolio’s target allocation in the process. Tax-loss harvesting also aims to avoid wash sales.
Planning the sale of any assets before year-end can be another strategic move to help offset gains. For example, you might plan to sell some losing positions in October or November rather than waiting until the very end of the year (i.e., December).
For the above strategies, you’ll always want to discuss your specific situations with your tax advisor.
The Medicare surtax affects high-income earners and is a static 3.8% tax. We’ve discussed how this tax is applied and a few ways to mitigate its impact, which is done best by working with your tax advisor.
FAQs
It applies to taxpayers above a certain modified adjusted gross income (MAGI) threshold who have unearned income including investment income, such as: Taxable interest. Dividends. Realized capital gains.
Does the 3.8 Medicare tax apply to capital gains? ›
What Types of Income Are Subject to the Medicare Surtax? Income sources like interest, dividends, capital gains, rental income, royalties, and even some other passive investment income will be counted.
Do you have to pay Medicare tax on investment income? ›
The 0.9 percent Additional Medicare Tax applies to individuals' wages, compensation, and self-employment income over certain thresholds, but it does not apply to income items included in Net Investment Income. For additional information on Net Investment Income Tax, see our questions and answers posted on IRS.gov.
How can we avoid the 3.8% Medicare surtax? ›
Look for ways to minimize your AGI. The lower your AGI (the number at the bottom of the TAX-FORM 1040) the lower the amount of your income will be subject to the 3.8% surtax.
What is Medicare tax on long term capital gains? ›
The Medicare tax is a 3.8% tax, but it is imposed only on a portion of a taxpayer's income. The tax is paid on the lesser of (1) the taxpayer's net investment income, or (2) the amount the taxpayer's AGI exceeds the applicable AGI threshold ($200,000 or $250,000).
What income is not subject to Medicare tax? ›
If you are a self-employed person, Medicare tax is not withheld from your paycheck.
What types of income does the 0.9 percent Medicare tax apply to and who is required to pay this Medicare tax? ›
A 0.9% Additional Medicare Tax applies to Medicare wages, self-employment income, and railroad retirement (RRTA) compensation that exceed the following threshold amounts based on filing status: $250,000 for married filing jointly; $125,000 for married filing separately; and.
Is capital gains tax based on gross income or adjusted gross income? ›
Gross income includes your wages, dividends, capital gains, business income, retirement distributions as well as other income. Adjustments to Income include such items as Educator expenses, Student loan interest, Alimony payments or contributions to a retirement account.
What income do you pay Medicare tax on? ›
Medicare is funded by a payroll tax of 1.45% on the first $200,000 of an employee's wages. Employees whose wages exceed $200,000 are also subject to a 0.9% Additional Medicare Tax on top of the 1.45%. Employers also pay a 1.45% tax on their employee's wages. They do not pay the additional tax.
What is Medicare tax on short term capital gains? ›
The 3.8% tax applies to the lesser of either your net investment income or the amount by which your MAGI exceeds $200,000 (or $250,000 for joint filers).
In addition to federal and possibly state income taxes, you will pay Social Security and Medicare taxes on any wages earned in retirement.
How do I get rid of Medicare surcharges? ›
If you earn above $90,000 as an individual or above $180,000 as a couple or family, there is a simple way to avoid the surcharge. Take out private hospital cover. It's that simple. You enter you private hostpial cover details on your tax return, and then the ATO will not apply the medicare levy surcharge to you.
What is the Medicare surtax for 2023? ›
Social security and Medicare tax for 2023.
The Medicare tax rate is 1.45% each for the employee and employer, unchanged from 2022.
What is the Medicare surtax threshold for 2022? ›
Will Additional Medicare Tax be withheld from an individual's wages? An employer must withhold Additional Medicare Tax from wages it pays to an individual in excess of $200,000 in a calendar year, without regard to the individual's filing status or wages paid by another employer.
Does everyone have to pay Medicare tax? ›
The Medicare tax is a percentage of gross wages that all employees, employers and self-employed workers must pay to fund Medicare.
What taxes do you pay on long term gains? ›
Long-term capital gains tax is a tax applied to assets held for more than a year. The long-term capital gains tax rates are 0 percent, 15 percent and 20 percent, depending on your income. These rates are typically much lower than the ordinary income tax rate.
Do long term capital gains count towards Irmaa? ›
Unfortunately, the answer is yes, as they, amongst many other forms of income do, affect IRMAA.
What income counts against capital gains? ›
Capital gains taxes are a type of tax on the profits earned from the sale of assets such as stocks, real estate, businesses and other types of investments in non tax-advantaged accounts. When you acquire assets and sell them for a profit, the U.S. government looks at the gains as taxable income.
What does Medicare tax apply to? ›
With the passage of the Affordable Care Act (ACA), the United States government mandated an additional Medicare tax for high-income earners. Additional Medicare Tax is a surtax applied to wages, railroad retirement (RRTA) compensation, and self-employment income.
What income is considered for capital gains tax? ›
Capital gains are profits from the sale of a capital asset, such as shares of stock, a business, a parcel of land, or a work of art. Capital gains are generally included in taxable income, but in most cases, are taxed at a lower rate.
The tax rate on most net capital gain is no higher than 15% for most individuals.
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Capital Gain Tax Rates
- The taxable part of a gain from selling section 1202 qualified small business stock is taxed at a maximum 28% rate.
- Net capital gains from selling collectibles (such as coins or art) are taxed at a maximum 28% rate.
Long-term capital gains cannot push you into a higher income tax bracket. Only short-term capital gains can accomplish that, because those gains are taxed as ordinary income. So any short-term capital gains are added to your income for the year.
Do capital gains increase your adjusted gross income? ›
Adjusted Gross Income (AGI) is defined as gross income minus adjustments to income. Gross income includes your wages, dividends, capital gains, business income, retirement distributions as well as other income.
What is the 0 capital gains bracket for 2022? ›
By comparison, you'll fall into 0% long-term capital gains bracket in 2022 with a taxable income of $41,675 or less for single filers and $83,350 or less for married couples filing jointly.
