25 May 2011

3.8-Percent Medicare Contribution Tax Generates Confusion, Misinformation and Questions

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Congress passed a number of revenue-raisers to fund health care reform and one revenue provision has recently generated confusion, misinformation and questions. After 2012, a new Medicare contribution tax will apply to qualified unearned income of higher income taxpayers.

Tax Changes 

The Health Care and Education Reconciliation Act (HCERA) (P.L. 111-152), through Code Sec. 1411, imposes a 3.8-percent Medicare contribution tax on qualified unearned income on higher income individuals for tax years beginning after December 31, 2012. The 3.8-percent Medicare tax is imposed on the lesser of an individual’s net investment income for the tax year or any excess of modified adjusted gross income (MAGI) in excess of $200,000 for single individual. The threshold for married couples filing joint returns is $250,000 ($125,000 in the case of a married taxpayer filing separately). 

HCERA also imposes a 0.9-percentage-point increase in the 1.45-percent Medicare payroll tax, raising it to 2.35 percent, beginning in 2013, on single individuals with earned income over $200,000 per year and married joint filers with earned income over $250,000 per year. The employer Medicare tax rate remains unchanged at 1.45 percent. 

Since passage of HCERA, confusion has arisen over the impact of the Medicare contribution tax, particularly on home sales. However, HCERA makes no changes to the existing home sale exclusion rules. Single individuals may be eligible to exclude up to $250,000 from the sale of a principal residence; married couples filing a joint return up to $500,000, generally subject to ownership and use tests. 

“Claims of a 3.8-percent home sales tax in the health care reform act are false,” Rep. Earl Blumenauer, D-Ore. said in a written statement. “Under existing law, up to $500,000 in gain from the sale of a principal residence is tax-free for married couples. The health care reform act did not change this law.” The National Association of Realtors®also reiterated on its website that the $250,000/$500,000 exclusion on the sale of a principal residence will continue to apply. Additionally, the Congressional Research Service (CRS) recently described the Medicare contribution tax in a report (“The 3.8% Medicare Contribution Tax on Unearned Income, Including Real Estate Transactions,” on September 15, 2010; TAXDAY, 2010/09/23, O.2). 

An important exception to the home sale exclusion is the sale of a second home. If taxpayers sell a second home (for example, a vacation home), they must pay taxes on the entire capital gain, Melissa Labant, CPA, technical manager, American Institute of Certified Public Accountants (AICPA), told CCH.

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