Veterinarians: Are you ready for the Medicare surtax?

Enacted as part of the Health Care Act of 2010 and scheduled to take effect in 2013, the Medicare Surtax is a new 3.8 percent tax on investment income of higher-income taxpayers. By planning carefully now, you can prepare for, and potentially reduce, its impact.

For individuals, the 3.8 percent Medicare Surtax is imposed on "net investment income" for those who exceed a certain threshold. The threshold amount for a married couple filing jointly or a surviving spouse is $250,000. A married taxpayer filing separately has a threshold of $125,000, while the threshold for a single taxpayer is $200,000. If your modified adjusted gross income is below your applicable threshold, the 3.8 percent surtax would not apply to you.

Investment income for purposes of the tax includes the total sum of:

✔ interest

✔ dividends

✔ capital gains

✔ annuities

✔ rents (unless you're a real estate professional)

✔ royalties

✔ passive activity income (such as a partnership interest in which you do not materially participate)

✔ income from a trade or business of trading in financial instruments or commodities (like a hedge fund)

✔ oil and gas production payments.

Deductions that count toward investment income—such as depreciation or operating expenses for a rental activity—can reduce the gross income. The IRS will hopefully clarify the types of deductions that may be claimed.

Other types of income will not be considered investment income for purposes of the surtax. Examples include:

✗ income from a trade or business in which you actively participate

✗ gains from the sale of assets used in a trade or business in which you actively participate

✗ distributions from qualified retirement plans and qualified annuities

✗ IRA distributions

✗ income taken into account in determining your self-employment income.

While taxable retirement plan and IRA distributions are not considered investment income, they would increase your modified adjusted gross income and could trigger the surtax. Likewise, gains from the sale of a partnership interest or S corporation stock will only be considered investment income if the seller's business sold all of its nonbusiness property for fair market value and if the entire gain from the sale of the business interest would increase modified adjusted gross income.

Here are a few examples of the surtax at work:

1. Dr. Jones is single, has a salary of $140,000, and annual interest income of $35,000. He would not be subject to the Medicare Surtax, because his modified adjusted gross income ($175,000) does not exceed his $200,000 threshold.

2. Dr. Small and his wife, Jane, are married and file jointly. They have combined salaries of $350,000 and net investment income of $50,000. Their surtax would be $1,900, because the 3.8 percent surtax is applied on their net investment income ($50,000).

Luckily, planning for the surtax now can help reduce its impact down the road. You could:

> Increase your retirement plan contributions. These contributions reduce your modified adjusted gross income in the current year, and the distributions in the future will not be considered investment income.

> Adjust the rent paid between the practice and the practice owner. Excess rent may be subject to a tax not paid before, and it may be time to determine that a fair market value is being paid and nothing more since it may be subject to this new tax.

> Invest in tax-exempt assets

> Make Roth IRA conversions in 2012

> Invest in life insurance policies.

This tax impacts anyone who meets the threshold or owns his or her own practice building, because net rent is subject to the tax and most veterinarians who own their facilities pay rent to themselves. Many who are selling their practice will go over the threshold and may think that the gain from the sale of their practice will be subject to this tax. The bottom line is they won't; the sale of goodwill is a business asset. Those who are "C" corporations and sell their stock will not be as lucky and will be subject to the new tax. Just another good reason why veterinary practices should not be organized as "C" corporations.

Since using any planning technique could have significant consequences, make sure to discuss your specific situation with your tax and financial advisors before making any changes.

Gary Glassman, CPA, a Veterinary Economics Editorial Advisory Board member, is a partner with Burzenski & Co. PC in East Haven, Conn.