New 3.8% Federal Surtax on Estates, Trusts and Individuals

Tuesday, February 19th, 2013

Section 1402 of the Health Care and Education Reconciliation Act of 2010 amended the Internal Revenue Code by inserting Chapter 2A – “Unearned Income Medicare Contribution”. This new chapter introduces a 3.8% surtax on individuals and estates and trusts. It is important for individuals and practitioners to understand its potential impact and to plan accordingly.

Section 1411(a)(2) of Chapter 2A applies to estates and trusts and imposes a 3.8% surtax on the lesser of the undistributed net investment income for the taxable year or the excess of the adjusted gross income for the taxable year over the dollar amount at which the highest bracket in section 1(e) begins for that year. In other words, for 2013, the surtax will only apply to an estate or trust with an adjusted gross income exceeding approximately $12,000, and the 3.8% rate will apply to the lesser of the undistributed net investment income for 2013, defined as income from interest, dividends, annuities, royalties, rents, etc., or the excess of the adjusted gross income for 2013 over approximately $12,000.

The new 3.8% surtax will also apply to individuals, but only at much higher income thresholds. White the surtax will affect estates and trusts with adjusted gross incomes exceeding approximately $12,000, it will only apply to married couples with adjusted gross incomes exceeding $250,000 and unmarried individuals with adjusted gross incomes exceeding $200,000. In order to take advantage of the differences between the tax regimes, personal representatives and trustees should carefully consider making distributions from estates and trusts.