We have reviewed the new health care law for its impact on our clients and other high income families and individuals. While we will discuss the implications of specific provisions with individual clients, our overall observations are as follows:
Affecting individuals and investors:
Starting in 2013, if under age 65, medical expenses can only be deductible to the extent they exceed 10% (up from 7.5% currently) of adjusted gross income (AGI). We are not sure what happens if one spouse is under 65 and the other is over 65! After 2016 there is no age floor, the threshold will be 10% for everyone. With the new health care legislation, planning for a large medical expense takes on an added dimension (age).
Most of the provisions related to additional taxes on high income individuals and investors do not begin until 2013, however, it is not too early to begin to prepare for this new tax world.
There are two separate taxes that are slated as Medicare taxes.
- A Medicare payroll tax. This tax will be levied only on those who have earned income (e.g. wages or self-employment income) and only on amounts that exceed a threshold of $200,000 for single individuals and $250,000 for married couples. The tax is .9% on amounts in excess of the threshold. Example: You are married, combined earned income is $260,000, the tax would be $90 [($260,000-250,000)*.009].
- A Medicare tax on investment income. This is a more complex calculation. You would be subject to this tax if your adjusted gross income exceeds $200,000 for single individuals or $250,000 for married couples. The tax would be the lesser of 3.8% of net unearned income (broadly speaking this is investment-related income -- capital gains, dividends, interest, net rental income, royalty income, etc.) or 3.8% of adjusted gross income (AGI) in excess of the above thresholds. [Note: The law references “modified” adjusted gross income, but for most people this is the same as AGI.] Example: You are single, adjusted gross income is $260,000 and net investment income is $50,000. The tax would be the lesser of $1,900 (50,000 * .038) or $2,280 (260,000-200,000)*.038. In this case the additional tax would be $1,900. Keep in mind, if there is no investment income, there is no tax. And if the AGI threshold is not exceeded, there is no tax. Distributions from pension accounts are not considered investment income or earned income, although they would raise AGI. Estates and trusts are also subject to this tax. If investment income exists in a trust or estate, it appears that the tax will the lesser of 3.8% of undistributed net income or 3.8% of adjusted gross income (AGI) in excess of the then-current dollar amount at which the highest tax bracket begins (we estimate this will be about $12,000 in 2013). Example: There is $20,000 of undistributed income in a trust, AGI is $18,000. The tax would be the lesser of $760 (.038 * $20,000) or $228 ($18000-12000)*.038. In this case the tax would be $228.
The tricky aspect of the second tax (related to net investment income) is that it appears that folks who would not normally be subject to the tax (because in most years they fall under the gross income threshold), may be subject to the tax in a year when there is a special event such as the sale of a residence, the sale of a business, receipt of a severance package, etc. We will be assisting clients in understanding the new law and in minimizing its impact as they consider future financial life events.
It is clear that in an environment where the government is on the hunt for revenue raising opportunities, self-employed individuals, who can control net taxable earned income with aggressive retirement plan contributions, will have an advantage. Another observation is that a year in which a radical change in income occurs, such as at retirement or when minimum required IRA distributions begin, can deliver a big tax surprise. This makes consideration of a Roth Conversion all the more pressing.
There may be further adverse tax changes for high income individuals and families as Congress must act before year-end to prevent the rollback of the Bush tax cuts.
Affecting business owners who provide health insurance to employees:
- There are many provisions in the law that increase costs for health insurance companies (excise tax on "Cadillac" plans starting in 2018, fees starting in 2014, etc.). We anticipate that these costs will be passed on to employers via increased premiums on existing plans.
- Beginning in 2011 businesses will be required to report the value of health insurance benefits on the employee’s W-2.
- The law includes a tax credit for small businesses that provide health insurance to employees. To benefit from the credit, for businesses with fewer than 25 employees, average annual wages must be less than $50,000 and for businesses with fewer than 10 employees, average annual wages must be less than $25,000. Details are not yet available but we would be surprised if this provided a benefit except where there is a small, side-line source of income.
Affecting employees: Starting in 2013 the deduction for health costs in Flexible Spending Plans will be limited to $2,500.
Affecting parents: Children can be covered on their parent's health insurance until their 26th birthday. We believe this will be available at the start of the employer's next insurance plan year.
