Medicare Surtax on Net Investment Income (NII). HOW TO reduce the NEW MEDICARE SURTAX OF 3.8%

Medicare Surtax on Net Investment Income (NII). HOW TO reduce the NEW MEDICARE SURTAX OF 3.8% By Jeffrey Brooks, CPA, CFP, MBA for Jbrooks Wealth Advisors, PC, a Professional CPA and CFP Firm  602-292-2009  Please consult with your professional tax CPA regarding your specific circumstances!

We also specialize in preparing Arizona tax returns and 32 other state returns.

Recently I was able to save one of our wealthy clients over $70,000 per year in income taxes!!   How?  There is a new tax addition called the “Net Investment Income” under Section 1411 of the IRS Code.


The three thresholds mentioned above are:

  1. $250,000 for married couples filing jointly
  2. $125,000 for married couples filing separately
  3. $200,000 for everyone else

So if you are under these numbers, the 3.8% Medicare Surtax will not affect you.  If you are over these numbers, you need to work with a CPA who specializes in tax reduction to get your adjusted gross income below these numbers!


For individuals, the calculation of the 3.8% Medicare Surtax is dependent on two components: a taxpayer’s net investment income (‘NII’) and his or her modified adjusted gross income (‘MAGI’). For each taxable year, the MAGI, after being reduced by a fixed threshold, is compared to NII. The 3.8% Medicare Surtax is applied on the lessor of the two. This means that for individuals who have little or no net investment income, their 3.8% Medicare Surtax will be minimal if not zero.


You might be thinking that you were only taxed using the regular income tax and the Alternative Minimum Tax. Now you have a third method called the modified adjusted gross income!  So, although you have heard talk about tax simplification, taxes are becoming even more complex!


We have one client who I will call “John”.  John’s modified adjusted gross income is way over the numbers so John needs to worry about the Net Investment Income .


However, I found a way to reduce the tax on John.



Dear John: Here is an idea that will probably work and save you close $76K in 2013 income taxes.  I think there is a 90% chance it will work. 


FACTS:  John owns ABC.  ABC is a passive partner in JV, a joint venture.   ABC does not know what its 2013 partnership profit reported on a K-1 will be but was told it will be similar to 2012. In 2012, ABC received $1,871,250 of income.  Based on a tax planning program, the 3.8% New Medicare Surtax, John will owe an additional $71,107 in tax on his personal tax return for each year he owns ABC. If he owns ABC for 10 more years and the annual income is assumed to be the same, John will pay $710,070 in taxes that were not owed before 2013!


  1. 1.    John calls JV and JV agrees to pay ABC $20 per hour for 500 hours or $10,000 for John’s consulting through ABC.
  2. 2.    Write a check out of ABC for $25,000.  Please document this payment as “guaranteed payments”.
  3. 3.    Contact your broker to establish a SOLO 401K for you.
  4. 4.    Fund $23,000 SOLO 401K for 2013 and for each year thereafter.


TAX SAVINGS:  $76,000 in tax savings per year. John is actually paying $5,000 less in 2013 than he would have in 2012 because of the SOLO 401K being established.   I calculated the $76,000 tax savings as follows:

Medicare surtax (if 2013 K-1 income is the same from the JV was for 2012) LESS the 15.3% self-employment tax on $25,000  less 50% deduction for the SE Tax  plus   tax savings on Solo 401K of about $9,000 resulting in $76,113 tax savings for 2013.



There are four parts to Code Sec. 1411:

  1. Calculation of 3.8% Medicare Surtax for individuals
  2. Calculation of 3.8% Medicare Surtax for trusts and      estates
  3. General definition of terms
  4. Special exceptions and situations

To illustrate the effects of this tax on an individual, take the following example. Using Tony.  Tony, who is single, made $150,000 in salary for 2013. In addition, Tony also collected $75,000 of net investment income. Tony’s modified adjusted gross income  (MAGI) would be the sum of his salary and net investment income this year, or $225,000. Since he is not married, his threshold is $200,000, which means is MAGI after being reduced by a fixed threshold is $225,000 – $200,000 or $25,000. When compared to his $75,000 of Net Investment Income (NII), the 3.8% Medicare Surtax is applied to the $25,000. Therefore, for 2013, Tony’s taxes increase by $25,000 x 0.038 or $950 after taking into effect this new 3.8% Medicare Surtax.

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About Jeffrey Brooks

Jeffrey Brooks, CPA, CFP, MBA since 1976 has specialized in helping clients save significant taxes, help businesses increase their cash flow, revenues and profits while increasing their control and satisfaction. Jeff and his accounting firm sincerely cares about the happiness of his clients.

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Address: 4647 N 32nd Street, Suite B245
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Phone: 602-292-2009