Investment Income Tax And Additional Medicare Tax

<p> Although the additional Medicare tax is a separate tax, the IRS considers it to be part of the taxpayer's overall tax liability. So, if the taxpayer's withholdings are not sufficient to cover the entire tax liability, there may be a penalty imposed on the failure to make an estimated tax payment. For that reason, it may benefit a taxpayer who does not increase the amount withheld by the employer to make estimated payments to cover any shortfall.<a href="#_ftn1">¹</a></p><p><hr align="left" size="1" width="33%"></hr></p><p> <a href="#_ftnref1">1</a>. IRS Q&amp;A on the Additional Medicare Tax, available at: <a href="http://www.irs.gov/Businesses/Small-Businesses-&amp;-Self-Employed/Questions-and-Answers-for-the-Additional-Medicare-Tax">http://www.irs.gov/Businesses/Small-Businesses-&amp;-Self-Employed/Questions-and-Answers-for-the-Additional-Medicare-Tax</a> (last accessed September 23, 2025). </p>

<div class="Section1">Yes.&nbsp;The value of any taxable noncash employee fringe benefits is added to an employee&rsquo;s cash wages to determine whether the taxpayer&rsquo;s overall wage income exceeds the applicable threshold (<em><em>see</em></em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="8657">8657</a>). If so, the excess amount will be subject to the additional Medicare tax.<a href="#_ftn1" name="_ftnref1">¹</a> Moreover, similar to the payment of only cash wages, if the combined amount of cash wages and taxable noncash fringe benefits exceeds the mandatory wage withholding amount of $200,000 (<em><em>see</em></em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="8658">8658</a>), the employer must withhold the additional Medicare tax on the excess amount of combined wage income.<a href="#_ftn2" name="_ftnref2">²</a><div class="Section1"><br /> <br /> <em><em>See</em></em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="8887">8887</a> to Q <a href="javascript:void(0)" class="accordion-cross-reference" id="8919">8919</a> for a discussion of the tax treatment of various noncash fringe benefits.<br /> <br /> </div><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp; IRS FAQ, <em>Questions and Answers for the Additional Medicare&nbsp;Tax</em>, available at http://www.irs.gov/Businesses/Small-Businesses-&amp;-Self-Employed/Questions-and-Answers-for-the-Additional-Medicare-Tax (last accessed September 23, 2024).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp; IRS FAQ, <em>Questions and Answers for the Additional Medicare&nbsp;Tax</em>, available at http://www.irs.gov/Businesses/Small-Businesses-&amp;-Self-Employed/Questions-and-Answers-for-the-Additional-Medicare-Tax (last accessed September 23, 2024).<br /> <br /> </div></div><br />

<p> The taxpayer's combined wages and self-employment income is subject to the additional Medicare tax. This means the tax is imposed on the excess of the taxpayer's entire amount of earned income over the applicable threshold. The following fact pattern demonstrates the three-step procedure for calculating the tax owed: <br/><blockquote><em>Example</em>: Sam is a single taxpayer with $130,000 in wages and $145,000 in self-employment income, or total earned income of $275,000.&nbsp;The applicable threshold for a single taxpayer is $200,000. Step 1 - Calculate additional Medicare tax on wages in excess of the applicable threshold; As mentioned above, the applicable threshold for a single taxpayer is $200,000. How-ever, since Sam's wages of $130,000 do not exceed the applicable threshold, there is no additional Medicare tax on his wages. Step 2 - Reduce the applicable threshold by the total amount of wages, but not below zero; In this case, the applicable threshold of $200,000 minus Sam's $130,000 of wages equals a reduced threshold of $70,000. Step 3 - Calculate the additional Medicare tax on any self-employment income received in excess of the reduced threshold. In Step 1, $130,000 of the applicable threshold is absorbed by Sam's wages. Then, in Step 2, the applicable threshold minus Sam's wages is reduced to $70,000. Finally, in Step 3, Sam's self-employment income of $145,000 exceeds the reduced threshold of $70,000 by $75,000, the amount of Sam's self-employment income subject to the additional Medicare tax. The actual tax is $675 (0.9% * $75,000). </blockquote></p>

<div class="Section1">Trusts not subject to the net investment income tax include charitable trusts exempt from tax under IRC Section 501<a href="#_ftn1" name="_ftnref1">¹</a> or IRC Section 664<a href="#_ftn2" name="_ftnref2">²</a> (charitable remainder trusts) and trusts that are not classified as "trusts" for federal income tax purposes.<a href="#_ftn3" name="_ftnref3">³</a> Moreover, if all of the remaining interests in a trust are designated for certain qualified purposes, the trust is not subject to the net investment income tax. These qualified purposes described in IRC Section 170(c)(2)(B) include religious, charitable, scientific, literary or educational purposes.<a href="#_ftn4" name="_ftnref4">⁴</a></div><br /> <div class="Section1"><br /> <br /> Finally, grantor trusts such as revocable trusts are not subject to the net investment income tax. This is because the income of a grantor trust is taxed directly to the grantor. As a result, any net investment income generated by the trust is included in the grantor's net investment income – potentially subject to the 3.8 percent tax at the individual level.<a href="#_ftn5" name="_ftnref5">⁵</a><br /> <br /> </div><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.  Treas. Reg. § 1.1411-3(b)(1)(ii).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.  Treas. Reg. § 1.1411-3(b)(1)(iii).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.  Treas. Reg. § 1.1411-3(b)(1)(iv).<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>.  Treas. Reg. § 1.1411-3(b)(1); IRC § 170(c)(2)(B).<br /> <br /> <a href="#_ftnref5" name="_ftn5">5</a>.  Treas. Reg. § 1.1411-3(b)(1)(v).<br /> <br /> </div>

<div class="Section1">There are several possible ways that an employer might fail to withhold the additional Medicare tax an employee is liable to pay. For example, this scenario might occur if each spouse individually earns wages under the mandatory $200,000 withholding amount. Therefore, if one spouse has wages of $100,000 and the other spouse has wages of $199,000, neither spouse's wages are subject to mandatory withholding. However, because the couple's combined wages of $299,000 exceed the $250,000 applicable threshold by $49,000, they must pay the additional Medicare tax on that amount. Thus, on Form 8959, the couple would compute the additional Medicare tax of 0.9 percent on $49,000 – reporting it on line 60 of Form 1040.<a href="#_ftn1" name="_ftnref1">¹</a></div><br /> <div class="Section1"><br /> <br /> On the other hand, an employer obligated to withhold the additional Medicare tax on wages in excess of $200,000 may simply fail to do so. Under those circumstances, the employer remains obligated to pay the tax to the IRS unless and until the employer can prove that it was paid by the employee. However, even if the employee ultimately pays the tax, it does not relieve the employer of its liability for any interest or penalties assessed as a result of its failure to withhold the additional Medicare tax.<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> </div><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.  Treas. Reg. § 31.3102-4(b), Example J.<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.  Treas. Reg. § 31.3102-4(c).<br /> <br /> </div>

<div class="Section1">The additional Medicare tax is a tax of 0.9 percent that is tacked on to the &ldquo;regular&rdquo; Medicare tax on all wages and self-employment income (collectively referred to as &ldquo;earned income&rdquo;) that exceed applicable threshold amounts. Thus, on earned income in excess of the applicable threshold amount, the total Medicare tax rate is 3.8 percent (the 2.9 percent regular Medicare tax rate plus the 0.9 percent additional Medicare tax rate).<div class="Section1"><br /> <br /> In spite of its name, the tax revenue generated by the additional Medicare tax is not specifically earmarked for the Medicare fund. Similar to the regular Medicare tax, the additional Medicare tax is imposed only on individual taxpayers (<em><em>see</em></em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="8658">8658</a> for a discussion of an employer&rsquo;s obligation to withhold the additional Medicare tax).&nbsp;Thus, entities such as C corporations, trusts and estates are not subject to the tax.<a href="#_ftn1" name="_ftnref1">¹</a><br /> <br /> The applicable thresholds for the additional Medicare tax (not adjusted for inflation) are the sum of the taxpayer&rsquo;s earned income (wages and/or self-employment income) in excess of the following amounts:<br /> <blockquote>(1)&nbsp; $250,000 for married taxpayers filing jointly;<br /> <br /> (2)&nbsp; $125,000 for married taxpayers filing separate returns; and<br /> <br /> (3)&nbsp; $200,000 for single taxpayers and heads of households.<a href="#_ftn2" name="_ftnref2">²</a></blockquote><br /> <br /> <hr><br /> <br /> <strong>Planning Point:</strong>&nbsp;The tax base of the additional Medicare tax and the net investment income are mutually exclusive.&nbsp;To this point, the additional Medicare surtax is imposed on earned income whereas the net investment income tax is imposed on investment income.&nbsp;This means that a taxpayer cannot be subject to both additional taxes on the same income.<a href="#_ftn3" name="_ftnref3">³</a> If income could be included in both tax bases, it will be included in the Medicare tax base.<br /> <br /> <hr><br /> <br /> </div><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp; IRC &sect;&nbsp;3101(b)(2).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp; IRC &sect;&nbsp;3101(b)(2).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.&nbsp; IRS FAQ, <em>Questions and Answers for the Additional Medicare&nbsp;Tax</em>, available at http://www.irs.gov/Businesses/Small-Businesses-&amp;-Self-Employed/Questions-and-Answers-for-the-Additional-Medicare-Tax (last accessed September 23, 2024).<br /> <br /> </div></div><br />

<div class="Section1">No. Pursuant to IRC Section 3102(a), once an employee's wages exceed $200,000 (the mandatory wage withholding amount), the employer must withhold 0.9 percent of the excess amount even if the employee does not actually owe any additional Medicare tax. So for wages in excess of $200,000, the employer must withhold the additional Medicare tax even if those wages combined with his or her spouse's wages do <em>not</em> exceed the applicable threshold for a married couple filing jointly ($250,000).<a href="#_ftn1" name="_ftnref1">¹</a> To the extent the amount withheld exceeds the employee's liability, the employee's remedy is to apply it as a payment against other tax he or she may owe or receive a refund for the excessive withholding.</div><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.  IRS FAQ, <em>Questions and Answers for the Additional Medicare Tax</em>, available at http://www.irs.gov/Businesses/Small-Businesses-&amp;-Self-Employed/Questions-and-Answers-for-the-Additional-Medicare-Tax (last accessed September 23, 2024); Treas. Reg. § 31.3102-4(a).<br /> <br /> </div>

<p> Certain trusts and estates may be subject to the 3.8 percent net investment income tax. Basically, the tax is imposed on any net investment income that remains in the estate or the trust and, thus, is not distributed to beneficiaries, otherwise referred to as "undistributed net investment income." Unlike individual taxpayers, the threshold amount is the amount at which the highest regular income tax bracket begins. Additionally, unlike the applicable threshold amount for individuals, the applicable threshold is adjusted for inflation.<a href="#_ftn1">¹</a> </p><p>For example, in 2025, the amount at which the highest income tax bracket begins with adjusted gross income in excess of $15,650.<a href="#_ftn2">²</a> In 2026, the highest income tax bracket will begin with adjusted gross income in excess of $16,000. As this amount is relatively low, many estates and trusts should expect to be subject to the tax.</p><p> The following examples are used to demonstrate the computation of the net investment income tax for a trust. </p><blockquote><em>Example</em>: In 2025, the Dinosaur trust has AGI of $16,000 and undistributed net investment income of $6,000. The net investment income tax is imposed on trusts and estates on the lesser of: 1) Undistributed Net Investment Income, $6,000; or 2) The excess of (i) AGI of $16,000, over (ii) $15,650, the amount at which the highest regular tax bracket begins, or $350. </blockquote><br/> <br/><blockquote><em>Example</em>: In 2025, the Dinosaur trust has AGI of $25,000 and undistributed net investment income of $6,000. The net investment income tax is imposed on trusts and estates on the lesser of: 1) Undistributed Net Investment Income, $6,000; or 2) The excess of (i) AGI of $25,000, over (ii) $15,650, the amount at which the highest regular tax bracket begins, or $9,350. </blockquote><p>Even though there is $6,000 of undistributed net investment income, because the lesser of the two amounts is $350, only that amount is subject to the 3.8&nbsp;percent net investment income tax.</p><blockquote><em>Example</em>: In 2024, the Dinosaur trust has AGI of $25,000 and undistributed net investment income of $6,000. The net investment income tax is imposed on trusts and estates on the lesser of: 1) Undistributed Net Investment Income, $6,000; or 2) The excess of (i) AGI of $25,000, over (ii) $15,650, the amount at which the highest regular tax bracket begins, or $9,350. </blockquote><br/> Because the lesser of the two amounts is the undistributed net investment income of $6,000, the entire amount of undistributed net investment income is subject to the 3.8 percent net investment income tax. </p><p><hr align="left" size="1" width="33%"></hr></p><p> <a href="#_ftnref1">1</a>. IRC § 1411(a)(2)(B)(ii). </p><p> <a href="#_ftnref2">2</a>. Rev. Proc. 2024-40. </p>

<div class="Section1">No, a taxpayer cannot make such a request. However, the taxpayer may modify Form W-4 to request that his or her employer withhold additional income tax. Even though the additional amount withheld is technically regular income tax (not additional Medicare tax), it is nonetheless credited as a payment to be applied to all Form 1040 tax liability owing including the additional Medicare tax.<a href="#_ftn1" name="_ftnref1">¹</a></div><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.  IRS Q&amp;A on the Additional Medicare Tax, available at: http://www.irs.gov/Businesses/Small-Businesses-&amp;-Self-Employed/Questions-and-Answers-for-the-Additional-Medicare-Tax (last accessed September 23, 2024).<br /> <br /> </div>

<div class="Section1">As discussed in Q <a href="javascript:void(0)" class="accordion-cross-reference" id="8648">8648</a>, whether a trade or business activity from which the taxpayer derives income is passive depends on the taxpayer&rsquo;s level of participation in the activity in question. In the case of a trust that owns interests in a pass-through entity, such as an S corporation or partnership, it is the trustee&rsquo;s participation in the business activities that is generally relevant in determining whether the investment is active or passive with respect to the trust.<div class="Section1"><br /> <br /> In a 2013 technical advice memorandum, the IRS expressed a restrictive view of what participation in a business activity by a trustee is attributable to the trust. In that memorandum, the IRS declared that a trustee&rsquo;s participation in a business in which the trust owned interests was <em>not</em> material even though the trustee was also the president of the company through which the business activity was conducted.<a href="#_ftn1" name="_ftnref1">¹</a>&nbsp;The IRS reached this conclusion based on its view that the trustee&rsquo;s participation in the company as an <em>employee</em> was separate from his role as trustee; and, thus, it was not attributable to the trust. Further, although the IRS did count the trustee&rsquo;s time spent serving as <em>trustee</em> in dealing with the company&rsquo;s business, it determined that the trustee&rsquo;s activities were nonetheless not &ldquo;regular, continuous and substantial&rdquo; within the meaning of IRC Section&nbsp;469 (governing passive activities generally).<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> Although the technical advice memorandum did not address the issue of whether the trust income was net investment income, it reflects the IRS view that the participation of a trustee as an employee or officer of an entity is not attributed to his or her role as the trustee. Based on such a restrictive view of the role of the trustee, it may be virtually impossible for any trust to materially participate in a business activity.<br /> <br /> However, the&nbsp;Tax Court has since rejected the IRS&rsquo; restrictive position.<a href="#_ftn3" name="_ftnref3">³</a> In that case, a trust owned rental real estate properties and engaged in other real estate activities.&nbsp;Three of the five trustees worked full-time in the trust&rsquo;s wholly owned rental real estate LLC.&nbsp;The issue was whether the personal services of the trustees as employees of the LLC would be attributable to the trust.<br /> <br /> Pursuant to IRC Section&nbsp;469(c)(2), all rental activities are passive. In order to rebut that characterization, IRC Section&nbsp;469(c)(7)(B) requires the taxpayer to meet the following two tests: (1) more than one-half of the personal services performed in the trades or businesses by the taxpayer during the taxable year is performed in real property trades or businesses in which the taxpayer materially participates; and, (2) the taxpayer performs more than 750 hours of services during the year in real property trades or businesses in which the taxpayer materially participates.<br /> <br /> Consistent with the technical advice memorandum, the IRS argued that the personal services performed by the trustees as employees of the LLC were not attributable to the trust.&nbsp;The&nbsp;Tax Court, however, rejected the IRS&rsquo; view as being too narrow and held that the participation of the trustees as employees were attributable to the trust. So, because the activities of those trustees/employees met the two IRC Section&nbsp;469(b)(7)(B) tests, the trust was deemed to have materially participated in the rental real estate activities, and, for that reason, they were non-passive activities.<br /> <br /> <hr><br /> <br /> <strong>Planning Point:</strong> Although the&nbsp;Tax Court case also did not involve net investment income, based on the holding, the non-passive rental income would have most likely been excluded from net investment income. Additionally, the&nbsp;Tax Court case is significant because it was a regular opinion reviewed by the entire&nbsp;Tax Court bench rather than a&nbsp;Tax Court Memorandum decision that carries less authoritative weight. In any event, IRS has not yet indicated whether it will follow the decision or continue to apply the restrictive view of the technical advice memorandum. Because a low applicable threshold subjects many trusts to the net investment income tax (<em><em>see</em></em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="8654">8654</a>), trustees should pay attention to how the IRS will deal with this issue as it relates to treating rental real estate activities of a trust as passive or non-passive.<br /> <br /> <hr><br /> <br /> </div><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp; TAM 201317010.<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp; IRC &sect;&nbsp;469(h)(1).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.&nbsp; <em>Frank Aragona&nbsp;Trust et al. v. Commissioner</em>, 142&nbsp;TC 165 (Mar.&nbsp;27, 2014).<br /> <br /> </div></div><br />