Ask the experts: 2013 Medicare tax leads to confusion

Questions about the new Medicare tax and about buying retirement credits are this week's "Ask the Experts" topics.

The answers are from Greg Burke, a Sacramento CPA and IRS tax expert. To see more of his advice – or that of our other local experts on investing, personal finances and wills/trusts, go to: www.sacbee.com/ personalfinanceblog.

I've heard that if you sell your home in 2013, you must pay a 3.8 percent Medicare tax on the sale. This concerns me because I am putting my home on the market next year. Is this true or just another urban legend?

There is a great deal of misunderstanding regarding the new Medicare tax on unearned income, at least with respect to the sale of a principal residence.

Here's how it works: The 3.8 percent Medicare tax becomes effective for 2013. It applies to the lesser of two amounts: "net investment income" or the excess of your "modified adjusted gross income" over certain threshold amounts. Those threshold amounts are: $250,000 for married taxpayers filing jointly; $200,000 for singles/heads of household; $125,000 for married taxpayers filing separate returns.

"Net investment income" includes capital gains. The sale of your principal residence may create capital gain income, but only to the extent that it exceeds certain IRS "Section 121" exclusion amounts.

You may be able to claim the exclusion if the home you sell in 2013 was your principal residence for at least three of the last five years, and you haven't claimed the exclusion on the sale of any other residence in the last two years.

The exclusion is the lesser amount of: the gain from the home's sale or $500,000 if you are filing a joint return ($250,000 if filing single/head of household).

Bottom line: Unless the gain from selling your principal residence exceeds the $250,000/ $500,000 exclusion and your modified adjusted gross income is over the applicable threshold amount, the gain probably will not be subject to the 3.8 percent Medicare tax.

After five years, I am eligible to purchase "air time" retirement credits for my school district job. The option expires Jan. 1. It's pretty expensive, about $6,000 per year purchased. What is the penalty if I cashed in my Roth IRA – about $10,000 – as a down payment on the air time? Most of my IRA is original principal, not earnings. Do you pay a penalty if all the funds are your own?

If you take an early withdrawal from a Roth IRA, a 10 percent penalty tax applies to the portion that is includable as income.

Assuming that contributions to your Roth IRA were made directly (not a rollover from a regular IRA), only the portion of the withdrawal that represents earnings on your contributions would be subject to the 10 percent tax.

For example, you contribute $1,000 in 2009. It earns an additional $50, so your withdrawal is $1,050. Only $50 would be income subject to the 10 percent tax.

An early withdrawal from a Roth IRA is one within five years of the first taxable year for which a contribution was made and before you reach age 59 1/2, with certain exceptions.

The situation is slightly more complicated if the distribution is from a "qualified rollover contribution" from an IRA to a Roth IRA within the previous five years. In that case, all of the $1,050 withdrawal in 2012 may be subject to the 10 percent tax.

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