Questio: Form 8960 Net Investment Income Tax Income as related to Large Roth Conv.

[MrLoco]

Here is the scenario:

Wife and I are both retired and We are contemplating a larger than usual Roth Conversion this year as I will apply for MEdicare in 2024 and don't want to be hit with the MEdicare IRRMA surcharges for my 2022 MAGI going forward.
That is one issue.

The second issue is the 3.8% Medicare surcharge on a MAGI of +$250,000 (joint return) using IRS FORM 8960 - NIIT...Net Investment Income Tax.

As an example: Wife and I MAGI for 2021 as follows:

Pensions: $50,000
Dividends: $50,000
Roth Conversion: $200,000
TOTAL: $300,000

So with a MAGI of $300,000 we are over the threshold and would be subject to the MEdicare 3.8% surtax.
My question is: IS the 3.8% applied only to the Dividend Income of $50,000 OR is it also applied to the Roth COnversion amount of $200,000?
Are Roth Conversions included in this calculation?

HAving this tax apply only to the dividend income results in a surtax of $1,900 which I can accept but having it also apply to the $200,000 Roth Conv. results in a 3.8% surtax on $250,000 which comes to $9,500.
Obviously a big difference which may lead us to do a smaller Roth Conv.

Any help is appreciated.

 

[RunningBum]

Pretty certain it's just the part of AGI over $250K ($200K singles) that gets hit with the 3.8% NIIT. Run it through any tax program to verify. Do a $150K conversion, then $151K, and you should see a tax increase of $38, not whatever 3.8% of $251K is.

 

[Out-to-Lunch]

I definitely agree with RB's suggestion to use a tax calculator on a dry run (although I believe he meant $250 and $251k).

But you can get some qualitative insight here:

From: https://www.irs.gov/newsroom/questions-and-answers-on-the-net-investment-income-tax

8. What is included in Net Investment Income?

In general, investment income includes, but is not limited to: interest, dividends, capital gains, rental and royalty income, non-qualified annuities, income from businesses involved in trading of financial instruments or commodities and businesses that are passive activities to the taxpayer (within the meaning of section 469). To calculate your Net Investment Income, your investment income is reduced by certain expenses properly allocable to the income (see #13 below).

9. What are some common types of income that are not Net Investment Income?

Wages, unemployment compensation; operating income from a nonpassive business, Social Security Benefits, alimony, tax-exempt interest, self-employment income, Alaska Permanent Fund Dividends (see Rev. Rul. 90-56, 1990-2 CB 102) and distributions from certain Qualified Plans (those described in sections 401(a), 403(a), 403(b), 408, 408A or 457(b)). (Emphasis added.)

 

[RunningBum]

OP has $50K pension and $50K dividends, so $150/151K of conversions puts them right at $250/251K. They could also just run it as $250/251K conversions.

Actually I'm not sure whether pension is included or not.

 

[Gumby]

The distribution from your traditional IRA (which is what funds the Roth conversion) increases your MAGI for purposes of determining whether you trigger the NIIT, but is not considered investment income to which the NIIT is applies. So, as you suspected, you'll pay 3.8% on only the $50k dividend income.

This site has more detail and examples: https://ultimateestateplanner.com/2013/11/01/year-end-roth-conversion-planning/

OP has $50K pension and $50K dividends, so $150/151K of conversions puts them right at $250/251K. They could also just run it as $250/251K conversions.

Actually I'm not sure whether pension is included or not.

Pensions are also part of MAGI for purposes of triggering the tax, but are not Net Investment Income to which the tax applies.

 

[MrLoco]

Thank you to all.

It seems the Roth Conversion itself while increasing MAGI is not included in the calculation of the NIIT which is what I suspected.