Planning for the ACA Net Investment Income Tax

Chad L. Reyes and Cliff C. Keeling
Published Date:
Jan 1, 2014

Somewhat overlooked in the Supreme Court’s decision upholding the Patient Protection & Affordable Care Act—“Obamacare”—is the fact that individuals, trusts and estates will be subject to a new 3.8 percent healthcare surtax on “passive investment income” effective as of Jan. 1, 2013. Because the 3.8 percent surtax is based on a mathematical formula, it can be somewhat difficult to understand, but there are some simple steps you can take to minimize or eliminate your client’s exposure. Here's a general overview of how the surtax works along with planning strategies to minimize surtax exposure to the clients you serve.

Planning for Individuals

The tax for individuals is 3.8 percent of the smaller of the following:

  • Your clients' net investment income.
  • Your clients' modified adjusted gross income that exceeds $200,000 if they are filing their tax return as single; $250,000 if they and their spouse are filing a joint return or if they are a surviving spouse; or $125,000 if they are married but filing separately.

Modified adjusted gross income (MAGI), for purposes of the surtax, is your client’s adjusted gross income found on line 38 of their federal income tax return, plus certain amounts of foreign earned income that were excluded from income. The following chart clarifies the thresholds.

Filing Status
Threshold Amount
Married filing jointly $250,000
Married filing separately $125,000
Single $200,000
Head of household (with qualifying person) $200,000
Qualifying widow(er) with dependent child $250,000

Planning for Trusts and Estates

The tax for trusts and estates is 3.8 percent of the smaller of the following:

  • Undistributed net investment income.
  • Adjusted gross income over the amount at which the highest trust and estate income tax bracket begins.

Estates and trusts are subject to the 3.8 percent surtax if they have undistributed net investment income and also have adjusted gross income over the dollar amount at which the highest tax bracket for an estate or trust begins for such taxable year under Rev. Proc. 2013-35 section 1(e). For the tax year 2013, this threshold amount was $11,950. For 2014, the threshold amount is $12,150 (See Rev. Proc. 2013-35).

Estate Planning Considerations

Several estate planning techniques help to reduce MAGI because of the ability to spread or defer income over time:

If your clients are charitably inclined, charitable remainder trusts and charitable lead trusts will allow them to reduce taxable income. Charitable remainder trusts (CRTs) provide the donor with a stream of income from the trust, but at the end of the trust term the balance of the trust passes to the designated charity. This strategy permits your clients to defer income over the life of the trust term. Depending upon the design of the CRT, they may even be able to defer income to a period when they may be in a lower income tax bracket, such as retirement age.

On the other hand, charitable lead trusts (CLTs) permit the shifting of investment income to the charity. A CLT is the reverse of a CRT: The stream of income goes to the charity for the term of the trust. At the end of the trust term, the balance of the assets passes to your client’s beneficiaries. This lead income interest to charity will not be included in their net investment income or MAGI.

Potential 3.8 percent Surcharge Tax Exposure

Example # 1

Entity Type Individual
Marital Status Married - Filing Jointly
Modified Adjusted Gross Income $1,200,000
Net Investment Income $500,000

Threshold Amount $250,000
Excess Income $950,000
Surcharge Taxable Amount $500,000
Surchage Percentage 3.8%
Surcharge Tax $19,000
Is Surcharge Applicable Yes

Example # 2

Entity Type Grantor Trust
Marital Status Married - Filing Jointly
Modified Adjusted Gross Income $5,000,000
Net Investment Income $1,250,000

Threshold Amount $0
Excess Income $5,000,000
Surcharge Taxable Amount $1,250,000
Surchage Percentage 3.8%
Surcharge Tax $47,500
Is Surcharge Applicable Yes

Planning Strategies to Reduce Clients' Exposure

(1) Investing in tax-deferred annuities.
(2) Purchasing permanent life insurance because cash value accumulation is tax-deferred.
(3) Maximizing contributions to qualified retirement plans, such as profit sharing or defined benefit plans.
(4) Deferring income through non-qualified deferred compensation plans.

This new tax can be a rude awakening for the unwary. Distributions from qualified plans or Roth IRA conversions can increase MAGI, triggering the tax. CPAs should give careful to the factors that determine modified adjusted gross income and net investment income. There are many planning opportunities that may fit your client’s situation and still help them to minimize or avoid the surtax.

Chad L. Reyes
Cliff C. Keeling

Chad L. Reyes is President and CEO, and Cliff C. Keeling is senior vice president, at Wealth and Legacy Group, a boutique life insurance firm which has a deep focus in the pension, risk management and wealth transfer space. WLG predominantly focuses on a collaborative basis with CPA firms, trust and estate law firms and wealth management firms who serve the HNW and UHNW. WLG’s team has over 50 years of combined experience working with families of wealth and the trusted advisors who serve these families. The firm routinely delivers CPE for CPAs They can be reached at 646-402-6300 or and

The foregoing information is not intended to be tax, legal or investment advice and is provided for general educational purposes only. Neither Wealth and Legacy Group nor its subsidiaries, agents or employees provide tax, legal or investment advice. You should consult with your tax, legal or investment advisor regarding your individual situation.

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