By Pilar Puerto, Esq., LL.M

As of January 1, 2013, section 1411 imposes a 3.8{c91082aefe0e580fe546c40af534787b48cfd474f8c9ab8dac50bf49a7a1c43a} Medicare Tax on Net Investment Income.  Prior to section 1411, Medicare Tax was imposed on only earned income, like wages. With section 1411, Medicare Tax is imposed on passive income as well. Further, income from a trade or business (e.g., a dental practice) is Net Investment Income if the business activity is a passive activity with respect to the taxpayer under I.R.C. § 469.  For C corporations, Medicare Tax is imposed on dividends regardless of the shareholder’s participation. But, with respect to flow through entities (i.e., partnerships and S corporations), the taxpayer’s participation matters.

Many dental practices currently operate as flow through entities. Thus, a dentist’s participation matters in determining whether or not certain dental practice income is Net Investment Income. In particular, when a dentist owns multiple dental practices but has an associate run these dental practices, the dentist’s income from these dental practices may qualify as Net Investment Income.  In our next newsletters, we will explore how a dentist’s activity in each dental practice may qualify as active income, what planning opportunities are available with respect to avoiding the Section 1411 Medicare Tax, and what steps a dentist should take to ensure that her position passes muster should she ever be audited by the IRS.