More On Tax Planningfrom The Advisor's Professional Library
- IRAs: In General Individual Retirement Accounts are highly popular tools for contributing funds that grow on a tax deferred basis. Depending on the type of IRA, the accumulation can be tax free.
- Annuities: Estate Tax The value of certain types of annuities may be included in an estate’s value. Understanding the intricacies of these inclusions is a critically important aspect of estate planning.
As the ink dries on the Supreme Court’s health care ruling, advisors are figuring out how the law will add to their clients’ as well as their own costs. Considering the Patient Protection and Affordable Care Act’s broad reach, one simple thing is true of the PPACA’s potential tax and investment consequences: it’s complicated.
Doctors, for example, can expect individually to be socked with at least 20 new taxes over the next 10 years, according to Jeffery Van Wart, manager for the Houston branch of national broker-dealer and RIA Cantella & Co., which manages nearly $1 billion and serves both physicians and medical groups.
From an investment standpoint, Van Wart said, both doctors and medical groups are staying liquid and in securities such as safer tax-free municipal bonds while they wait to see how the PPACA shakes out over the next few years.
“They’re not willing to take on a lot of risk because so much is so uncertain about how this is going to affect their income both individually and in the industry as a whole,” Van Wart said in a phone interview with AdvisorOne on Thursday. “We’re living in a world of negative uncertainty. The bill is so cumbersome that you have to be a political scientist and legal scholar to understand it all. What we do know is that there are a lot of new taxes because the law has to be paid for, and that’s never a positive for a business.”
Health Law’s Costs May Strike as Bush Tax Cuts Disappear
Van Wart said he has been experiencing a sense of disbelief that the PPACA’s requirements may hit him in the wallet at the same time that the Bush tax cuts fall off the fiscal cliff on Jan. 1. Already, he said, as an independent contractor he pays $1,400 per month in health insurance premiums for his family policy.
People will quickly find ways to undercut the law, Van Wart predicted. As a hypothetical example, he said, if he made $500,000 a year and paid the 1% penalty tax instead of buying insurance, that $5,000 cost would be substantially less than what he pays now for his health policy. “And if something bad happened to me, they couldn’t refuse me, so I’d just go get some insurance then and get coverage,” he said. “So it would be cheaper for me not to have insurance, pay the tax, and then go get insurance [after getting sick] because they’ve got to take me. It’s absurd.”
Van Wart still hopes that the PPACA will be overturned – and he is not alone. Republicans in both houses of Congress have sworn that they will take up a vote to put an end to the health care law, and presidential candidate Mitt Romney has promised to put a repeal into motion if he wins.
At issue for many advisors is the Supreme Court’s 5-4 ruling that the health care law is a tax. Indeed, the historic ruling written by Chief Justice John Roberts says that the PPACA’s mandate for individuals to buy insurance falls under lawmakers’ power to levy taxes. Republicans are now accusing Obama administration officials of forcing the bill through Congress in 2010 while lying that the mandate wasn’t a tax.
“Look, reconciliation is available because the Supreme Court has now declared it a tax,” Republican Senate Minority Leader Mitch McConnell told “Fox News Sunday” on July 1. “They have unearthed the massive deception that was practiced by the president and the Democrats, constantly denying it was a tax.” (Romney, meanwhile, has faced charges that his Massachusetts health care plan also amounts to a tax.)
Democrats, for their part, have declared the June 28 Supreme Court decision a victory. The Democratic Senatorial Campaign Committee raised $2.5 million in the three days following the ruling, according to a Huffington Post report, and the Democratic Congressional Campaign Committee said it had raised another $2.3 million. However, the report also said that the National Republican Senatorial Committee has witnessed a significant uptick in donations because the ruling confirms that the PPACA constitutes a massive tax on small business.
Preparing Clients for Income Taxes as High as 43.4%
Politics aside, one thing is certain: the PPACA gets the majority of its funding through tax increases on the highest earners. Individuals must pay a 3.8% tax on investment income if they earn more than $200,000 annually, and couples likewise must pay the investment income tax if they make more than $250,000. In addition, the act imposes a 0.9% tax increase on wages for people who earn that much.
According to Tim Steffen, director of financial planning at Robert W. Baird & Co., the most obvious repercussion of the court ruling is that some investors may trigger capital gains they were thinking about taking in 2013.
“High earners may accelerate income from stock options or bonuses into this year to avoid the additional 0.9% tax on their wages above the thresholds scheduled for 2013,” said Steffen in a statement, but he cautioned investors not to overreact as months remain before year-end to consider market performance and make investment decisions. The results of the presidential election in November also may change tax policy, he noted.
Gavin Morrissey, director of advanced planning at Commonwealth Financial Network, said in a blog post for AdvisorOne that the PPACA 3.8% surtax coupled with the expiration of current tax rates “could lead to a federal marginal income tax rate of as much as 43.4%” for advisors’ highest-earning clients.
“A few safe havens from the new surtax are available,” Morrissey added. “For example, distributions from IRAs and qualified plans are not subject to it. But investment income is, including interest, dividends, capital gains, nonqualified annuity distributions, rents (if passive income) and royalties.”
What can advisors do to prepare their clients? For those who already contribute the maximum amount to their qualified plans, Morrissey recommends a Roth conversion of IRA balances. “Your clients could pay tax on the converted amount at today's lower marginal rate while building an account from which future distributions would not be included in MAGI,” he said.
Investments in Belly of the Health Care Beast
Or, investors can head straight into the belly of the beast and invest in health care stocks and bonds.
Frank Fantozzi, CEO of Cleveland-based Planned Financial Services, which offers securities through LPL Financial, said on the day of the court ruling that he expected to see market movement in subsectors such as hospitals, medical devices and pharmaceuticals. The overall health care sector is expected to benefit from about 32 million additional insured customers phased in from 2014 to 2019.
“From a business standpoint, when you understand how insurance companies work, theoretically, if you can insure the entire population, then you can get a truer measure of your costs and risks and a lower cost of insurance,” Fantozzi said. “Long term, this all gets baked into the economy, just as past legislations have come to fruition.”
And S&P Capital IQ ETF Analyst Todd Rosenbluth wrote on May 21 that in light of the pending court ruling on health care reform, he believes that the Health Care Select Sector SPDR Fund (XLV) is worthy of scrutiny. XLV is the largest health care ETF in the United States, with more than $4.5 billion in assets.
“Year to date through May 18, XLV was up 4.6%. This was near the 4.3% increase in the Health Care sector of the S&P 500 Index and ahead of 3.0% gain for the S&P 500 Index,” Rosenbluth wrote in “A Bottom-Up Look at a Key Health Care ETF.”
On the day before the Supreme Court ruling, the ETF was up 9% year to date, driven by an improvement in Pharmaceuticals, and as of Friday, it was up 11.02% versus 10.47% for the S&P 500 Index.
Jeff Loo, head of S&P Capital IQ’s health care equity research, said in a phone interview the day before the ruling that the sector was outperforming the broader markets by about 40 basis points year to date.
“Depending on how the Supreme Court decides, I think if they overturn the mandate and keep the rest of the law intact, I would expect some downward pressure on the health care sector,” Loo said. “If the entire law is kept intact, I would expect some appreciation in the health care sector, although modest, because I think some of that is already priced into the marketplace.”
For more about the PPACA and taxes, read William H. Byrnes and Robert Bloink’s Unintended Consequences of the HIT: Eliminating Health Coverage in Small Businesses at AdvisorOne and Alson Martin's blog at Tax Facts Online.