Your tax return for this year will determine your Medicare premiums in two years, if you’ll be a Medicare participant then.
Since 2007, as income rises Medicare Part B premiums rise. More people will pay the higher premiums each year under the Affordable Health Care Act of 2010. Through 2010, the incomes at which the higher premiums were imposed were indexed for inflation. Now, the triggering income levels are frozen for several years. The higher premiums are labeled a surtax.
The IRS receives your 2010 tax return in 2011 and transmits the modified adjusted gross income (MAGI) to Social Security. Social Security processes the information and sometime around mid-November 2011 tells you the monthly Medicare premium you’ll pay in 2012. If you filed a 2010 tax return late or not at all, your previous most recent return will be used to compute the premiums.
It can make sense to reduce MAGI when it is near one of the breakpoints for higher Part B premiums. MAGI is the adjusted gross income on your tax return (the last line on the first page of Form 1040) increased by tax-exempt interest, EE savings bond interest used for education expenses, and excluded foreign earned income. Itemized deductions on Schedule A, such as mortgage interest and charitable contributions, don’t reduce MAGI.
Capital gains, annuity income, IRA distributions, and dividends all are included in MAGI.
For 2010, the standard monthly Part B premium is $96.40 for those whose premiums are withheld from Social Security and $110.50 for all others. The 2011 amounts will be announced soon.
The surtax begins for single taxpayers with MAGI of $85,000 and married couples filing jointly with MAGI of $170,000. Premiums rise on a sliding scale as income rises, until beneficiaries with the highest MAGI pay 80% of the per capita estimated cost of Part B. See the table nearby for the breakpoints and premiums for 2010. The 2011 premiums should be announced soon.
A few strategies can help you reduce or eliminate the Medicare surtax.
– Limit withdrawals from retirement plans and annuities to only the amounts needed for spending and required by law or contract. Avoid selling assets that would increase capital gains in taxable accounts, except to the extent you need the cash to meet your spending needs.
Naturally you don’t want to avoid selling assets that should be sold under your portfolio strategy just to avoid the Medicare surtax. But when considering a sale, keep in mind that higher Medicare premiums could be part of the cost of selling.
– You can shelter capital gains and up to $3,000 of other income by selling capital assets with losses.
– You may be able to generate deductible losses from business activities. You have to run the activity like a real business, not a hobby, to meet the IRS’s rules for deducting losses. But losses from businesses can be deducted against other income and reduce your MAGI. The losses are deducted directly on your tax return when they are generated through a sole proprietorship or a pass through entity such as a partnership, limited liability company, or S corporation.
||If Your Modified Adjusted Gross Income Is:
||$85,000 or less
||$170,000 or less
||$85,001 – $107,000
||$170,001 – $214,000
||$107,001 – $160,000
||$214,001 – $320,000
||$160,001 – $213,000
||$320,001 – $462,000
Your ability to avoid the surtax does not end when the tax return is filed. You may be able to reduce the surtax through an appeal when you show that since the tax return was filed your financial situation changed for the worse.
A change in marital status is the most common reason for an appeal. The change could be marriage, divorce, or widowhood. You’ll need to prove both the change in marital status and that in resulted in a lower MAGI.
Other changes that are likely to lead to successful appeals and premium reductions are retirement, not working for other reasons, and a reduction in working hours by you or your spouse. The changes can be voluntary or involuntary as long as they result in lower income in the current year than was reported on your return two years earlier.
What if you had a one-time increase in your income in 2010, such as a large capital gain, distribution from a retirement account, or even conversion of a traditional IRA to a Roth IRA? These won’t result in a successful appeal. Since each is a one-time event, it will increase Part B premiums for only one year. A tax benefit of converting to a Roth may be that it reduces or eliminates your surtax for all future years.
If you file an amended tax return after the IRS sent its data to Social Security, you can appeal using the amended tax return data.
Details of how to appeal the higher premium are in the letter announcing the premium.
November 2010 RW.