What Is a Surtax and How Does This Additional Tax Work?

A surtax is an additional tax applied on top of an existing tax liability. It functions as an extra layer of taxation, separate from standard income tax calculations. This type of tax is not an increase in a regular tax rate but is a distinct tax calculated separately. Governments often implement a surtax to generate funds for a specific purpose or initiative. The structure of a surtax means it affects taxpayers who already have a tax liability.

The Surtax Calculation Method

The first component in calculating a surtax is the tax base, which defines the type of income or value the tax applies to. This could be a narrow category, such as investment income, or a broader measure like a taxpayer’s total adjusted gross income.

Another component is the threshold, a specific income level that triggers the tax. A surtax is often only applied to the portion of income that exceeds this predetermined amount. For example, if a surtax applies to income over $200,000, an individual with $250,000 of applicable income would only have the surtax calculated on $50,000.

The final component is the surtax rate itself, which is the percentage applied to the income that exceeds the threshold. To illustrate, consider a hypothetical 5% surtax on all income over $1 million. A person with $1.2 million in income would first determine their excess income is $200,000. The 5% surtax rate would then be applied to this excess, resulting in an additional tax of $10,000, completely separate from their regular income tax liability.

Surtaxes on Individuals

An example of a surtax for individuals in the United States is the Net Investment Income Tax (NIIT). This 3.8% surtax applies to the lesser of a taxpayer’s net investment income or the amount by which their modified adjusted gross income (MAGI) exceeds certain thresholds. These income thresholds are set by filing status: $250,000 for married filing jointly, $125,000 for married filing separately, and $200,000 for single or head of household filers.

The tax base for the NIIT is “net investment income.” This category includes income from sources such as interest, dividends, capital gains, and rental or royalty income. It also encompasses income from businesses involved in trading financial instruments or commodities. It does not include wages, self-employment income, Social Security benefits, or distributions from most retirement plans.

Taxpayers calculate the liability using Form 8960, Net Investment Income Tax. For instance, a single individual with a MAGI of $230,000 and net investment income of $50,000 would face the NIIT. Their MAGI exceeds the $200,000 threshold by $30,000. The 3.8% surtax is applied to the lesser of the $50,000 in investment income or the $30,000 excess MAGI, resulting in an additional tax of $1,140.

Surtaxes on Corporations

Historically, surtaxes were a feature of the U.S. corporate tax system, which used a graduated rate structure. For high-income corporations, the system included a “bubble rate,” which functioned as a surtax to phase out the benefits of the lower tax brackets for the most profitable companies.

This surtax mechanism created a higher marginal rate for corporate income within a specific range. Once a corporation’s taxable income surpassed a high-level threshold, the benefit of having its initial income taxed at lower rates was recaptured, resulting in very large corporations paying a flat tax rate on all their income.

The Tax Cuts and Jobs Act of 2017 (TCJA) overhauled the corporate tax code, eliminating the graduated rate structure. It instituted a single, flat corporate tax rate of 21% for all C corporations, which removed the bubble rate and the associated corporate surtax system.