In December 2012, the Internal Revenue Service issued proposed regulations to expand upon the Patient Protection and Affordable Care Act of 2010 ("Health Care Act"). One of the provisions of the Health Care Act is Code Section 1411, Unearned Income Medicare Contribution Tax. The result of the new law and proposed regulations may have an effect on veterinary practice owners, as they may have an additional tax liability, depending on their income.
Effective Jan. 1, 2013, certain individuals, trusts, and estates will be required to pay a 3.8% Medicare tax on their share of net investment income. Net investment income includes interest, dividends, royalties, annuities, capital gains, rents, and passive trade or business activities.
The additional Medicare tax will be imposed on individuals, trusts and estates with modified adjusted gross income in excess of the following income amounts:
- Married Filing Joint or Surviving Spouse - $250,000
- Married Filing Separate - $125,000
- Single and Head of Household - $200,000
- Trusts and Estates - $11,950 - projected for 2013
The tax will be calculated on the lessor of the net investment income or total modified adjusted gross income in excess of the threshold amounts listed above.
How will the proposed regulations specifically apply to veterinary practice owners?
If an individual owner has modified adjusted gross income (income from all sources) in excess of the limits listed above, then his/her net investment income will be subject to the 3.8% Medicare tax. As per the proposed regulations, investment income will include rental property owned personally by a DVM and rented to a veterinary practice in which the DVM materially participates.
According to Treasury Regulation 1.469-2(f) (6), properties in these scenarios are treated as "self-rentals" and the associated net income has been classified as non-passive for income tax purposes. Notwithstanding these PAL re-characterization rules, the proposed regulations treat "self-rental" income that is not earned in the ordinary course of a real estate trade or business as passive income for this purpose. Unless there is revised guidance received from the IRS, it is expected that most of these arrangements will be subject to the 3.8% Unearned Income Medicare Tax.
The Unearned Medicare Income Tax has not only created a new tax to learn and understand, but also new planning opportunities. Katz, Sapper & Miller's Veterinary Services Group is committed to increasing "after tax" profitability for owners. Please contact Terry O'Neil for further information regarding opportunities to mitigate the burden the 3.8% Medicare tax may place on your personal profitability.
If you currently own the hospital building in a separate entity that leases the facility to the veterinary hospital operations company, we suggest you review the taxable income that is generated from its operations and your personal tax situation to determine if you will be subject to this new tax.
Additionally, we suggest you review the lease terms to determine that fair market rent is being charged and an arm's length lease agreement is in place.
We are awaiting the final regulations and will keep you informed as we learn more.