Back in 2010, President Barack Obama signed the Patient Protection and Affordable Care Act and its companion Health Care and Education Reconciliation Act of 2010. Together, these two acts, better known by Republicans and Democrats alike as “Obamacare,” represent the biggest change in health care finance since Medicare was created in 1965. They also include some of the most significant tax changes in a generation.
Investment Income
The new Medicare tax might not seem like a big deal, especially if your income is not high enough to be affected. Hey, it’s just 3.8 percent, right? How bad can that be? Well, leaving aside the fact that a new tax still hurts, this is the first time investment income has ever been subject to Medicare tax. Many commentators fear it’s just the proverbial camel’s nose “under the tent” for even higher taxes. After all, it’s a lot easier for legislators to go from 3.8 percent to 5.8 percent than it is to go from zero to 3.8 percent. So, we’ll be paying lots of attention to this provision.
Your first line of defense is choosing investments that don’t generate taxable income. If you’re investing for income, for example, bank account interest and most bond interest is fully taxable. That means they are subject to regular tax plus the new Medicare tax. Municipal bonds, however, are free from federal and most state tax income. So, shifting fixed-income portions of your overall portfolio will help defeat the Medicare tax.
Deductions
On the health care side, beginning in 2013, the new law limits health insurance company deductions for executive compensation to $500,000 per person, as opposed to the regular $1 million for other businesses. It doesn’t stop insurance companies from paying their top executives more than half a million, however; instead it just stops them from deducting anything over that amount on their own tax returns.
There’s still much to learn about Obamacare. The employer mandate has been postponed until 2015. So we’ll all have to keep our eyes open and our wits about us as events unfold.
New Requirements Implemented Over Time
Provisions of the Affordable Care Act and the Health Care and Education Reconciliation Act of 2010 are being implemented over time. The changes in past years are listed below.
2010
- Small businesses with up to 25 employees earning $50,000 per year or less qualified for a new tax credit of up to 35 percent of the cost to provide health benefits to their employees.
- Insurance companies could no longer deny coverage to children for pre-existing conditions. They cannot set lifetime limits on plan coverage, and they have to let children stay on their parents’ plans through the age of 26.
- Medicare Part D recipients who entered the so-called “donut hole” will get rebates and discounts on prescription drug coverage. (The “donut hole” is a gap in prescription coverage where the government pays nothing and beneficiaries pay the full cost of drugs themselves.)
2013
- Beginning in 2013, medical and dental expenses were deductible only if they exceeded 10 percent of adjusted gross income (AGI), up from the previous 7.5 percent rate. However, if you or your spouse is 65 or older, the floor will remain at 7.5 percent until 2016. Unless, of course, you’re 65 and subject to Alternative Minimum Tax, in which case the rate has already increased to 10 percent.
- If you participate in a health care flexible spending account at work, your contributions will be capped at $2,500 per year, with no contributions for over-the-counter medications.
- If your earned income is above $200,000, or $250,000 if you file jointly, you’ll pay an extra 0.9 percent Medicare tax on any additional earned income. Given the new marginal tax rates in the 2013 “fiscal cliff” legislation, that extra Medicare tax charge could help push your actual marginal rate well above 40 percent.
- Finally, you’ll pay an Unearned Income Medicare Contribution of 3.8 percent on investment income if your adjusted gross income is above those same thresholds. Investment income is defined as interest, dividends, capital gains, rents, royalties and annuities.
Pam Burns, a partner at ProActive Tax & Accounting, is licensed as a Certified Public Accountant in the State of Florida and an Enrolled Agent governed by the Internal Revenue Service. She has a Masters Degree in Taxation from Florida Atlantic University and a second Masters Degree in Accounting with Forensic studies. Pam is a Forensic CPA (FCPA), a Certified Tax Coach and a Certified Valuation Analyst. She has been in private practice for 23 years.