Affordable Care Act: Part II

By now, you have probably heard the news regarding the Supreme Court ruling on June 28, 2012, which upheld the Affordable Care Act that allows Congress to impose a tax on individuals who do not have proper health insurance coverage.

However, there are several other provisions included in the Act that are important to note. Two such provisions, which will go into effect on January 1, 2013, have many investors and high-wage earners apprehensive as to what the impact of the 3.8% surtax on investment income and the 0.9% Medicare Hospital Insurance (HI) tax will be on them.

Important Note: Before discussing how these additional taxes are calculated, we must point out that even though both of these tax increases are for Medicare, neither of these taxes are withheld or paid in by one’s employer. If you are subject to either or both of these taxes, the tax will be computed on your individual income tax return as an additional tax liability for the year. Therefore, if you think you may be subject to these additional taxes, please consult your tax advisor at The Marston Group, PLC to correctly estimate your tax liability in accordance with these new provisions.

The threshold amounts for these two new taxes are:

Modified Adjusted Gross Income (MAGI): $250,000 for a joint return, $125,000
  for married filing separately, and $200,000 for all others.
Wages: $250,000 for a joint return, $125,000 for married filing separately, and
  $200,000 for all others.

Currently, these threshold amounts are not scheduled to be indexed for inflation.

Unearned Income Medicare Contribution Tax of 3.8%:

This new 3.8% Medicare surtax is imposed on individuals, estates, and trusts. The tax is generally levied on income from interest, dividends, annuities, royalties, rents, and capital gains. The 3.8% tax is computed on the lesser of: (1) net investment income, or (2) the excess of modified adjusted gross income (MAGI) over the threshold amount. For this purpose, modified adjusted gross income does not include items such as interest on tax-exempt bonds, veterans’ benefits, and excluded gain from the sale of a principal residence.

Example: A single taxpayer has net investment income of $100,000 and MAGI of $300,000. (Keep in mind, the income threshold for a taxpayer filing as single is $200,000). Therefore, the taxpayer’s MAGI exceeds the threshold amount by $100,000. In this case, the taxpayer would pay the 3.8% surtax on the entire $100,000 of net investment income, resulting in additional tax of $3,800.

Additional Hospital Insurance Tax of 0.9% for High Wage Earners:

Under current law, most people are familiar with the two components of the FICA (Federal Insurance Contributions Act) taxes, commonly referred to as “Social Security taxes,” which are withheld from an employee’s paycheck, matched by the employer, and submitted to the federal government.

The two components of the FICA tax are: (1) OASDI (Old Age, Survivors and Disability Insurance) tax of 4.2% or 6.2% on an annually adjusted “wage base” (the current wage base for 2012 is $110,100), and (2) Medicare Hospital Insurance (HI) tax of 1.45% on all wages, regardless of the wage amount.

The Self-Employment Contributions Act (SECA) likewise imposes the two taxes (OASDI and HI) on self-employed individuals. However, with the self-employment tax, the taxpayer is allowed to deduct one-half of the total self-employment tax as an above-the-line deduction on the tax return, thus reducing the taxpayer’s adjusted gross income. This deduction essentially allows the self-employed person to deduct the employer equivalent portion of the tax.

The new HI tax of 0.9% does not qualify for the deduction of one-half of the self-employment tax. Therefore, this 0.9% is a flat tax on the amount of wages over the threshold amount.

Note: Taxpayers who have both high wages and investment income may be hit with both taxes.

Example: A single taxpayer has net investment income of $100,000, wages of $300,000 and MAGI of $375,000. In addition to paying the 3.8% surtax of $3,800 (see previous example), the taxpayer will also pay an additional HI 0.9% tax of $900, as computed on the wages in excess of the $200,000 threshold ($100,000 x .09).

Assume that the taxpayer in the above example had identical tax returns (and marginal tax rates) for 2012 and 2013. In 2013, he will pay an additional $4,700 in taxes over his 2012 tax liability. Therefore, for certain taxpayers, these additional taxes may be quite significant.

Your tax advisors at The Marston Group, PLC are ready to talk about your individual situation and any planning opportunities that may exist to help mitigate the impact of these new taxes.