Most of us are familiar with the taxes that fund Medicare—1.45% of our salary is withheld, and a matching amount is contributed by our employer. Those who are self-employed pay the full 2.9%. Those with salaries or self-employment income over the threshold amount ($200,000 for single persons, $250,000 for married persons filing a joint tax return), there is an additional 0.9% Medicare tax that helps fund the Affordable Care Act. But there is more!
Medicare premiums are withheld from Social Security benefits, or are paid directly by those on Medicare who are not receiving Social Security benefits. For those with total incomes above a threshold amount in any one year, the premium will increase for the 2nd following year.
I have a client with a very modest income—he will normally pay $121.80 each month for Medicare. In 2016 he sold some real estate he has owned for several years. As a result of the high income in 2016, his Medicare premium will increase to $389.80 each month, an increase of $268 per month, or $3,216 per year in 2018. It will revert to the basic level in 2019. If both husband and wife are on Medicare in 2018, the increase will apply to each of them.
The increase can occur because the taxpayer is simply earning more each year, but in most situations it is because of a one-time event, as in my client’s situation. This person became my client because he wanted to determine the tax cost of the sale before he spent the proceeds. Had he approached me before making the sale we may have avoided the increase in Medicare premiums and may have even reduced the income tax cost of the sale. In doing any tax planning, however, it is important to put thing into perspective. I would rather see my client pay a little more in tax (and Medicare) than to give up a great deal of value to the marketplace. While this is unlikely with Real Estate, it is very possible some stock investments. What could my client have done?
- Do a like-kind (Section 1031) exchange of one property for another—this could defer the recognition of the gain, and could eliminate it if the client owned the new property at his eventual death.
- He could have made an installment sale of the property, spreading the taxation of the gain over several years as the note was repaid. This could have been a very viable options, providing secure investment returns while reducing his overall taxes and future Medicare premiums.
The answer is to plan—to talk with us before undertaking a major financial transaction.