We wrote last week that the new Medicare tax on unearned income was not quite a done deal.  It has now been passed by Congress and will become law.  Here's a summary:

FICA taxes.

The Federal Insurance Contributions Act (FICA) imposes two taxes, the Old Age, Survivors and Disability Insurance (OASDI) tax and the Medicare Hospital Insurance (HI) tax. These taxes, which finance Social Security and Medicare benefits, are imposed on employers on wages paid with respect to employment and on employees on wages received with respect to employment.

The OASDI tax rate is 6.2% on wages up to an annually-adjusted "wage base" ($106,800 for 2010). The HI tax rate is 1.45% on all wages, regardless of amount.  Employers must match these amounts.

Under pre-2010 Reconciliation Act law, there was no Medicare tax on unearned income.

SECA taxes.

As a parallel to FICA taxes, the Self-Employment Contributions Act (SECA) imposes OASDI and HI taxes on the net income from self-employment of self-employed individuals. The OASDI tax rate is 12.4%, and the HI rate is 2.9%. The self-employment income subject to the OASDI tax is limited to an annually-adjusted ceiling ($106,800 for 2010) minus the wages that the individual receives in the tax year.

New Law

The 2010 Reconciliation Act imposes an unearned income Medicare contribution tax on individuals, estates, and trusts.

The tax is generally levied on income from interest, dividends, annuities, royalties, rents, and capital gains.

For individuals, the tax is 3.8% of the lesser of net investment income or the excess of modified adjusted gross income (MAGI) over the threshold amount.

Net investment income is investment income reduced by the deductions properly allocable to such income.

MAGI is adjusted gross income (AGI) increased by the amount excluded from income as foreign earned income, net of the deductions and exclusions disallowed with respect to the foreign earned income.

The threshold amount is $250,000 for joint returns or surviving spouses, $125,000 for separate returns, and $200,000 in other cases.

This all means that the Medicare tax is now imposed on investment income.  There is no equivalent of the OASDI tax on investment income.

Example: For 2013, a single taxpayer has net investment income of $100,000 and MAGI of $220,000. The taxpayer would pay a Medicare contribution tax only on the $20,000 amount by which his MAGI exceeds his threshold amount of $200,000, because that is less than his net investment income of $100,000. Thus, taxpayer's Medicare contribution tax would be $760 ($20,000 × 3.8%).