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2013 Federal Income Tax Return “Regrouping” Election Can Permanently Reduce Exposure to the New 3.8 percent Medicare Surtax

February 18, 2014 Business & Tax Blog Medicare Tax

2013 is the first year of the 3.8 percent Medicare Surtax, which was enacted as a part of the law popularly known as “Obamacare.” Taxpayers have a one-time opportunity to make an election on their 2013 federal income tax returns to permanently reduce exposure to the new surtax. Before filing an income tax return this year, it is important to understand and potentially avoid the surtax.

The surtax applies to interest, dividends, capital gains, rental and royalty income, certain annuities, and income from certain passive business and investment activities. It potentially applies to persons with modified adjusted gross income over $200,000 for individual filers and $250,000 for married joint filers.

The planning opportunity relates to income from “passive” business activities. The IRS determines whether an activity is passive derivatively by reference to the pre-existing Internal Revenue Code Section 469 passive loss rules. The activity is not passive if the taxpayer meets hourly participation thresholds. Grouping activities under the new rules makes it easier for taxpayers to meet the material participation hourly thresholds to avoid classification as a passive activity. If separate activities do not individually satisfy the participation thresholds, the aggregated activities may qualify. However, once a taxpayer elects to group activities under Section 469, he or she usually must retain the grouping for all future years.

Special rules apply to real estate professionals and persons engaging in leasing and farming activities. These individuals may have planning opportunities not available to others.

The clock is ticking on taxpayers’ limited window to make the regrouping election. The election must be made on a taxpayer’s income tax return for the first tax year beginning after December 31, 2012. Taxpayers that have exposure to the new surtax in 2013 should plan now to ensure that the election is properly and timely made on 2013 returns.

For more information concerning 3.8 percent Medicare Surtax planning, as well as planning to avoid related taxes:

Medicare Surtax Planning for Real Estate Investors and Developers

E. John Wagner, II