By Mark E. Battersby
Many of those in the pet industry woke up on Jan. 1, 2013, to face two new taxes. Thanks to the Health Care and Education Reconciliation Act of 2010, many individuals, beginning in 2013, are subject to a 3.8 percent net investment income (NII) tax and a 0.9 percent percent additional Medicare tax.
While both of these so-called surtaxes are aimed at “wealthy” individuals, the floor isn't all that high. The new surtaxes apply to single taxpayers with a modified adjusted gross income (MAGI) in excess of $200,000 and to married taxpayers with a MAGI in excess of $250,000, if filing a joint return, or $125,000, if filing a separate return.
Net investment income includes interest, dividends, annuities, royalties and rents, as well as amounts other than income derived in the ordinary course of a trade or business. NII also includes income from a so-called “passive” activity, or a trade or business trading in financial instruments or commodities. Not included are distributions from qualified pensions, profit-sharing, annuities, stock bonus plans or individual retirement plans.
Investors who are not active in the business and attempt to argue that the operation is not passive in order to avoid the Medicare surtax will end up subject to self-employment tax. This is also the case for an investment in an LLC or a partnership.
Any income, gain or loss that is attributable to an investment of working capital will be treated as not derived in the ordinary course of a trade or business. Of course, interest, dividend and royalty income earned in the normal course of a trade or business would not be subject to this surtax.
Also effective in 2013 is the 0.9 percent additional Medicare tax, which applies to individuals' wages, compensation and self-employment income over certain thresholds, although it does not apply to income items included in the NII. This new surtax also might result in complications for employers, as well as employees and the self-employed, as it is in addition to the regular 1.45 percent Medicare rate on wages received by employees. The tax only applies to the employee portion of the Medicare surtax. The employer Medicare tax rate remains at 1.45 percent, and the employer and employee Social Security tax remain at 6.2 percent.
Employers must begin withholding the additional Medicare surtax once an employee's wages exceed $200,000, even if the employee is not ultimately liable for the additional tax—for example, when an employee earning $210,000 and a spouse earning $25,000 file a joint return.
Adding insult to injury, the net investment income tax is subject to the estimated tax provisions. Every business owner, retailer, dealer, distributor and manufacturer who expects to be subject to the surtax in 2013 or thereafter is required to adjust his or her income tax withholding or estimated tax payments to account for the tax increase to avoid underpayment penalties.
Needless to say, professional assistance will be required to ensure compliance or to develop legitimate strategies for avoiding or minimizing the potentially expensive pitfalls. <HOME>
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