Excerpt from: Fleming and Curti (click for full article)
You may have heard about a potentially significant new tax liability for special needs trusts. With adoption of the Patient Protection and Affordable Care Act (what is often referred to as “Obamacare”) Congress created a new tax intended for high earners to contribute to Medicare. A fairly complicated formula attempts to capture investment income (as distinct from income from employment) and impose a tax.
Enter the doctrine of unintended consequences — or at least we hope this
consequence was unintended. Because of the definition of income subject to the
tax, it is possible that some special needs trusts will end up paying a
significantly higher tax. Here’s how it works:
The new tax is imposed on “net investment income.” That is defined as
dividends, capital gains, interest, rents, royalties — pretty much income other
than wages. It was intended to cover relatively higher-income individuals, so
it will kick in only for the highest tax brackets for each category of
taxpayer. That means, for instance, that a married couple will owe the 3.8%
Medicare tax only if their total income (including that investment income)
exceeds $250,000.
But here’s the problem: the highest tax bracket for trusts kicks in at a much,
much lower figure — $11,950 in 2013. So a special needs trust subject to income
taxation will pay an extra 3.8% on any investment income in excess of that
amount.
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