Student Question of the Week: 3.8% Medicare Surtax

Student Question from Leslie G
Course:  Fundamentals of Insurance Planning

Student Question:

Hi Dan,

I’m confused on how I would know whether or not to apply the 3.8% Medicare surtax in the following CFP Board released question.  How can I know without knowing their AGI?

Your client’s federal marginal tax rate is 35% and the state marginal rate is 8%.  The client does not itemize deductions on his federal return and is considering investing in a municipal bond issued in his state of the residence which yields 5%.  What is the taxable equivalent yield?

Instructor Response:

Hi Leslie!

Great question here.  This is a perfect example of how the CFP Board will ask you to take certain pieces of information a step further in the analysis.  Your basic question here is if you include the 3.8% Medicare surtax when calculating the taxable equivalent yield.  And the answer is absolutely “Yes”.  How do we know that?  Well, you are correct that we don’t know their AGI, which the surtax is based on.  However, we are told that their marginal federal tax rate is 35%, which means their AGI minimum is $400,000.  This places them well into the threshold for the surtax.  So, do include that in your calculation.

You should arrive at a taxable equivalent yield of 9.39%.

Thanks for the question!

Student Response:

Right! Thanks for that.  I imagine that once I get to the Tax Planning course, this question from the Board would have been more apparent.

Instructor Response:

Absolutely!  That is definitely a tough question at this point, having not yet been exposed to the tax tables.  Goes to show you how the exam will require you to apply different areas of knowledge!