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Don't Forget the New Medicare Taxes
Effective Jan. 1, 2013, two new Medicare taxes may affect the farmer's overall tax liability, too. These Medicare taxes are not attributable to ATRA but came into effect for 2013 as a result of the Affordable Care Act, which passed into law in March 2010. Generally, these two new taxes may affect farmers with modified adjusted gross income over the threshold amount of $200,000 ($250,000 for farmers filing jointly). Briefly, these two new Medicare taxes can be summarized as follows:
- An additional 3.8% tax on "net investment income" for farmers over the threshold amount1
- An additional 0.9% on earned income in excess of the threshold amount2
Under proposed IRS regulations, if the sale of farmland is considered to be a disposition of property held in a trade or business in which the farmer meets the "material participation" requirement3, capital gain resulting from the sale is not considered "net investment income" and will not be subject to the 3.8% Medicare tax. However, if the sale of farmland is considered to be the sale of property from a passive activity in which the farmer does not meet the material participation requirement, the 3.8% Medicare tax will apply to the amount of the resulting net capital gain in excess of the farmer's threshold amount.
Moreover, the additional 0.9% Medicare tax will apply on the farmer's net farming income that falls above the threshold.
Example (Use the same facts as previous example): The farmland that Brett sold was not land that Brett actively farmed but was land that he held for investment purposes. Brett does not meet the "material participation" requirement and the sale is considered to be the sale of property from a passive activity. Brett will have additional tax liability as a result of the 3.8% Medicare tax on net investment income on the $800,000 of net long-term capital gain. Under the rules for the new 3.8% Medicare tax on net investment income, the entire $800,000 of capital gain is subject to the tax. His additional tax liability on the sale is $30,400 (3.8% × $800,000).
Moreover, Brett's net farming income in the amount of $600,000 shown on Schedule F is in excess of the $200,000 threshold. Brett will owe additional Medicare tax on his adjusted self-employment income in excess of the $200,000 threshold. The amount of Brett's self-employment income subject to the new Medicare tax is calculated as follows.
Note: The amount of self-employment income subject to self-employment tax is 92.35% of self-employment income. Multiplying self-employment income by a factor of 0.9235, as shown in the table, makes this adjustment. See publication 225, Farmer's Tax Guide, and Schedule SE, Self-Employment Tax, for further details on this adjustment.
The additional amount of Medicare tax on self-employment income that Brett owes is $3,167 (0.9% × $354,100).
Note: Further information on the new Medicare taxes and how they apply to farming income and sales may be found at "Farms and the New 2013 Medicare Tax Increases." The article also discusses the material participation requirement.
ATRA consists of many changes that may increase a farmer's tax liability for 2013 onward. Higher-income farmers are primarily affected. In addition, the new rules may increase tax liability on farming activity income as well as the farmer's tax liability on capital gains. The two new Medicare taxes (one that applies to earned income and one that applies to investment income, such as capital gains) may further increase the farmers tax liability in addition to those increases attributable to ATRA. Farmers should consult their tax advisor on the best strategies to minimize the impact of these new tax rules that become effective in 2013.
1The IRS has issued proposed regulations regarding the 3.8% Medicare tax on net investment income. See REG-130507-11, Federal Register Vol. 77, No. 234 (Dec. 5, 2012).
2 The IRS has issued proposed regulations regarding the 0.9% Medicare tax on net investment income. See REG-130074-11, 2012-52 IRB 790 (Dec. 27, 2012).
3 See IRC §469 and Treas. Reg. §1.469-5T and Prop. Reg. §1.1411-5.