More On Tax Planningfrom The Advisor's Professional Library
- Selected Provisions of the American Taxpayer Relief Act of 2012 The experts of Tax Facts have produced this comprehensive analysis of selected provisions of the American Taxpayer Relief Act of 2012 (the Act) to provide the most up-to-date information to our subscribers. This supplement analyzes important changes to the tax code with emphasis on how these developments impact Tax Facts’ major areas of focus: Employee Benefits, Insurance, and Investments.
- Annuities: Variable Annuities Annuities are hot. The tax rules vary with the circumstances. Advisors must be aware of these intricacies when discussing annuities with clients.
Most Americans have, in some form, heard of the “Patient Protection and Affordable Care Act of 2010” and the “Health Care and Education Affordability Reconciliation Act of 2010,” both of which were signed into law in late March, combining to become better known as “Obama Care.”
Since the passage of the two bills, Americans have finally had time to read more than the first few pages. Not only do the bills mandate health insurance coverage for each American in some form, but they have also created an income-specific, legislated benchmark for any American to be considered “rich.” The potential problem is that the depicted-rich thresholds have not been indexed for inflation. Therefore, the possibility of more Americans becoming classified as rich is not out of the question, especially if inflation, wages, salaries and even investment income drastically increase adjusted gross income (AGI) over the next 10 or even 20 years.
Unless the new House majority can secure enough support in the new, evenly divided Senate to overturn the “Obama Care” legislation, the following is a brief breakdown of some possible future tax issues for individual taxpayers:
- Individual health insurance coverage mandate or excise tax penalty
- Itemized deduction for medical expenses reduced for all taxpayers
- Increase in Medicare-related payroll taxes
- New Medicare tax on unearned income
There are many other tax-related provisions which the law covers, and probably some which haven’t even been discovered, in the enormous number of pages outlining the legislation, but for sake of simplicity, I’ve chosen the four changes that could most affect individuals.
Per the “2010 Health Care Reform: Tax Considerations” document published at 360financialliteracy.com, the AICPA’s (the American Institute of Certified Public Accountants’) website, the individual mandate forces Americans to have adequate health care coverage or pay a tax penalty beginning in 2014. Adequate coverage is defined to some extent within the bill; however, it still remains subject to future legislative changes at any time, resulting in possible future tax burdens with little control by taxpayers.
The tax penalty looks to be the greater of: $695 per year with a maximum of three times that ($2,085) per family, or 2.5% of household income over the threshold amount required to file a tax return. Furthermore, the annual household penalty may not exceed either 300% of $695 which is $2,085, or the national average premium for a bronze level plan offered through the new insurance exchange that will be created.
Per a Congressional Budget Office (CBO) letter from January 11, 2010 to Sen. Olympia Snowe, (R-Maine), the bronze level plan for single individuals will be $4,500 - $5,000/year or $12,000 - $12,500/year for a family. The law then, in turn, exempts the penalty for individuals and/or families where $2,085 or the lowest-cost bronze level plan exceeds 8% of household income. So the question becomes: Would a middle-class family with $145,000/year in household income be exempt from paying the bronze level coverage penalty because the $12,000 bronze level plan for a family would be 8.2% of the assumed household income, based on this example?
Further assuming that is correct, and this middle-class family has to pay only the penalty option of $2,085/year, many healthy families may gamble by effectively saving themselves $9,000 to $10,000/year by not having any coverage. Surely my example above isn’t actually an option under Obama Care, is it? If so, it looks like all Americans paying for adequate coverage will be forced to pay higher insurance premiums in years to come. Somebody has to fund the difference in the possible lost premiums if many families choose the route of dropping coverage as assumed above.
Floor for Medical Expenses Deduction
Secondly, per “2010 Health Care Reform: Tax Considerations,” Obama Care changes the itemized deduction floor for medical expenses. It will no longer remain at 7.5% of adjusted gross income, but has been increased to 10% of AGI effective in tax year 2013. The floor for individuals age 65 and older remains at 7.5%, but only until the year 2016. So, anyone 65 and older should start searching for the fountain of youth, or it looks like your tax bill could be on the rise come 2016, as well.
As for the rest of us, we’d better start exercising and eating healthier very soon, because in 2013, we’ll have to spend another 2.5% of our income on medical expenses to even have a chance for a tax deduction on Schedule A. On a side note: the itemized deduction floor for writing off your mortgage interest on Schedule A remains at 0% of AGI. Obviously, Obama Care views purchasing health insurance as a secondary need to purchasing a house, or least that’s the way the tax code explains it. [Editor’s note: This may change if certain provisions in the administration’s Deficit Reduction plan come to pass—mortgage interest deductions are on the block.]
Medicare Payroll Tax
Thirdly, per the “2010 Health Care Reform: Tax Considerations” document, an increase in the Medicare payroll tax will be applied to any single taxpayer making more than $200,000, and any married couple making more than $250,000, effective in the 2013 tax year. It will be an additional 0.9% or a total of 2.35% of earned wages in excess of these income limits for the employee portion. The current Medicare payroll tax is 2.90% per person on all earned wages with no limits, paid equally by the employee and employer.
The Self-employed Would Take a Hit
Therefore, the irony is the current 1.45% employee portion still remains at 1.45% up to the wage limits listed above, and then increases to 2.35% on any excess wages above those limits. For self-employed individuals, who are both the employer and employee, the increased tax will result in a total of 3.80% in Medicare payroll tax on all wages above those limits instead of the current 2.90%. I assume that all self-employed business people finding themselves in this situation come 2013, will probably increase their prices by at least 1.0% to cover the new tax, so this actually becomes a tax not only on the rich, but on all consumers. As such, is Obama Care really only increasing taxes on the rich?
Capital Gains Not Immune
Last but not least, per the “2010 Health Care Reform: Tax Considerations” document, the most ludicrous tax hike is the new Medicare payroll tax that has been extended beyond earned income to unearned income. Beginning in 2013, a new 3.8% tax will be imposed on the net investment income of all taxpayers (including estates and trusts) with an AGI above $250,000 for joint filers and $200,000 for single filers. For estates and trusts, the tax is assessed on the lesser of: undistributed net investment income, or the excess of AGI above the highest-income tax bracket threshold for estates and trusts. Net investment income includes the sum of interest, dividends, royalties, annuities, rents, passive activity income from a trade or business, and even any net gain from the disposition of property (such as capital gains).
As of right now, distributions from tax-deferred retirement accounts (401(k), IRA, etc.) are excluded, but who knows—come tomorrow that could change! Under this provision, any taxpayer selling appreciated property such as timberland and/or farmland had better increase their price, because when the net gain pushes their total AGI past the limits listed above, the sale becomes less profitable immediately. For example: A single taxpayer making $100,000/year sells some land he inherited 10 years ago for a net gain of $250,000. His AGI is $350,000 for that year, and instead of paying only 15% capital gains tax (based on the current capital gains tax law), he will effectively pay 18.8% on all gains exceeding his AGI past $200,000.
The economic lesson I take from this example is that property will become more expensive, forcing all Americans to pay more for any purchase of property, which in my view, is an indirect tax effect we will all face. Again—is Obama Care really only increasing taxes on the rich?
As mentioned in the beginning, a new legislated benchmark has been set for anyone that continues to prosper—whether through hard work, business risk-taking or just the prudence of saving a lot of money over many years.
The problem I see is that the stated benchmark of certain income limits is only the perception of this Obama Care bill and not the true reality. All Americans will feel the effect of the taxes imposed, because at the end of the day, the law of supply and demand will force prices of all consumer goods and services to increase at some level, due to the additional taxing penalties being assessed on those defined as “rich.” The key point that someone’s perception doesn’t account for, is that everyone is a consumer, regardless of household income. So, once successful business owners pass through their cost increases, it will affect every consumer, regardless of social status!