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  • Health Care Reform's Tax Implications

    by Mitchell Freedman

    Health Care Reform's Tax Implications Splash image

    The recently passed health care reform bill levies new taxes that are intended to help offset the cost of expanded access to care.

    Taxpayers who have significant unearned income and those who have significant income from various sources can very well be looking at—aside from income tax changes—an additional 4.7% of tax. That’s a hefty bite.

    The most significant impacts I have seen at this point are for married couples whose modified adjusted gross income MAGI exceeds $250,000 and individuals whose incomes exceed $200,000. Taxpayers above these thresholds will pay a higher tax on dividends and interest and other types of income that are not wage income. The capital gains tax will be higher as well. As a result, I think this will impact individuals who have significant portfolios.

    Before providing detail on the new taxes, I want to state that there still remains a high amount of uncertainty about how the law is going to impact final tax regulations. Even though the bill was debated for a long time, it was rushed through. As a result, the government is going to revisit a number of issues related to the legislation, and it is difficult to predict what kinds of changes are going to be incorporated into the tax regulations.

    New Unearned Income Tax

    Starting on January 1, 2013, married couples whose incomes are above $250,000 will be assessed an additional 3.8% federal tax. The threshold for married couples filing separately would be $125,000 per person. Unmarried individuals filing as single or head of household will face a threshold of $200,000. To reiterate, this is a new, additional tax. The 3.8% levy will be on the lesser of the individual’s MAGI above those threshold amounts or their unearned income.

    For example, assume a married couple had $300,000 worth of MAGI, $75,000 of which was unearned income consisting of dividends and interest. The couple calculates how much of their MAGI is above the $250,000 threshold, which is $50,000. Therefore, only $50,000 would be subject to the 3.8% tax because it is a ‘lesser of’ calculation. (The $50,000 of MAGI is less than the passive income of $75,000.)

    Since this is a separate and complete tax, my understanding at this point is that the new tax will have no impact whatsoever on the alternative minimum tax (AMT), although we will have to wait to see how the IRS forms are prepared. My suspicion is that the tax will be over and above the AMT that a taxpayer might find themselves owing.

    Irrevocable trusts are subject to the new tax above the threshold amounts. (Living trusts are separate because they do not file their own returns; instead the creators file those returns as individuals.)

    Rental income is also subject to the additional 3.8% tax. The actual amount subject to the tax would be net rentals, which is rentals reduced by any business expenses.

    An Additional Tax

    There will be another new tax levied as of January 1, 2013. This tax is 0.9% on salaries and wages that exceed $250,000 for married couples filing jointly, $125,000 for married individuals filing separately, and $200,000 for unmarried individuals. This is an additional tax, over and above the 3.8%, and it is strictly based upon amounts of salary that you have. This is going to be an additional Medicare tax in a sense, but it will not be assessed on the employer. Rather, it will only be assessed on and withheld from the employee.

    Unlike Social Security, where there is a certain income limit at which one stops being taxed, Medicare taxes continue to be taxed on earned wages, regardless of the income level. The new law says that the extra Medicare tax is going to be assessed on couples whose wages exceed $250,000 and individuals who earn over $200,000. To be perfectly clear, this is on top of paying extra Medicare premiums for those already covered by Medicare because these high wage earners are getting paid more money too.

    Retirees and Deferred Accounts

    Distributions from deferred accounts—whether they are pensions, traditional IRAs, or defined-contribution plans—do not enter into the calculation for the 0.9% tax because it is only assessed on earned income. I did read that in the calculation of modified adjusted gross income (MAGI) the amounts distributed from deferred accounts were not included.

    The distributions from deferred accounts—whether they are pensions, traditional IRAs, defined-contribution plans or 401(k)s—do not enter into the calculation for 3.8% tax either, which is based on modified adjusted gross income. As a result, required minimum distributions (RMDs) will not push a taxpayer above the threshold for the additional tax.

    There is nothing else that I came across that I thought might be earth-shattering in particular to retired investors or those approaching retirement. However, the one thing that could hit taxpayers big is realizing capital gains, because they would be included in the calculation of unearned income. The thresholds factor in dividends, annuity income, royalties, and rents gained from disposition of property. These would all be considered a type of passive income that would be subject to the new taxes.

    IRS Regulations Forthcoming?

    It is not uncommon in complicated areas of the tax law for the Internal Revenue Service to issue regulations as to how the laws are applied. In highly complex areas, sometimes it can be years before the IRS actually comes out with definitive regulations on application.

    There have been times when the IRS issued regulations that are temporary for four, five or six years until they finalize them, and even then sometimes the final regulations are different from the temporary regulations. There are a lot of gray areas in the tax law and a lot of uncertainties, and sometimes taxpayers just have to make informed decisions as to how to proceed and evaluate their risk tolerance to certain treatments in the event that the treatment is not exactly as the IRS says it should be.

    In other words, with complex issues questions always come up that were never anticipated by the drafters of the legislation. What we typically see are “technical corrections” to tax laws. When something not intended results, the language is changed so that application of the law is as Congress intended it.

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    In this case, we are dealing with the fact that the President has stated and Congress has indicated an intent to revise the law. So there’s a lot of uncertainty.

    Impact on Portfolio Decisions

    When the Bush tax cuts were enacted several years ago, the dividend tax came down to 15% and the tax on long-term capital gains was reduced to 15%. These cuts prompted a lot of investors to more readily realize their capital gains because the tax bite for doing so was not so onerous. They also started buying dividend-paying stocks and moved out of such things as certificates of deposit or bonds where the interest was taxable at their highest incremental tax rate. So I would suspect that informed elders and informed retirees are not going to just sit and take the bite. They are going to reposition their portfolios in such a way as to minimize their tax burden.

    For example, as I understand the tax law at this point in time, municipal bond interest will not be subject to the higher tax rates. Therefore, we are likely to see individuals moving from dividend-paying stocks and from other interest-bearing types of investments into municipal bonds because they will not—at least at the current time with the current legislation—be impacted by the higher tax rate.

    Tax Legislation in Question

    Outside of the health care reform bill, investors also have to contend with the expiration of the Bush tax cuts. If there are not any changes to the tax laws, beginning in 2011 we will go to back to the old laws from the start of last decade.

    Due to the inherent unpredictability of Congress, I have found that it is very difficult to do tax planning ahead more than a couple of years.

    Tax laws change because so much of taxation deals with issues having to do with social problems and other non-economic reasons. Therefore, I would caution against making irrevocable decisions purely on the tax issues because taxpayers could find that two years later there’s a new administration, things change and all of the sudden there is an entirely different tax environment.

    I always caution people to think about taxes when making decisions, but not to let taxes be the tail that wags the dog. Rushing to realize capital gains might not be the right thing. Though I’ve illustrated some issues related to the health care bill, these issues are not cast in stone. Tax issues are always evolving over time.

    Health Care Reform's New Taxes

    The health care reform law will enact two new taxes on January 1, 2013:

    • An additional 3.8% tax: Assessed on couples with modified adjusted gross incomes above $250,000 and unmarried individuals with incomes above $200,000. The 3.8% levy will be the lesser of the individual’s modified adjusted gross income above the threshold amounts and their unearned income.
    • An additional 0.9% tax: Assessed on couples with wages above $250,000 and unmarried individuals with salaries above $200,000. This will be on top of the 3.8% tax and it is strictly based upon the amounts of salary that you have.

    Distributions From Deferred Accounts Are Exempt

    Distributions from deferred accounts—whether they are pensions, traditional IRAs, or defined-contribution plans—do not enter into the calculations for either the new 3.8% tax or the new 0.9% tax.

    Mitchell Freedman , CPA/PFS, AIF, is the founder and president of Mitchell Freedman Accountancy Corporation, specializing in business management and financial counseling for performing and creative artists and individuals with complex and unique financial needs. He is also the founder and president of MFAC Financial Advisors, Inc., a registered investment advisory firm.


    Ron from TX posted over 4 years ago:

    Well the Dems have done it again. Rob the well off who have worked, saved, and invested wisely. I this doesn't get people off the a-- and to the polls in November they deserve all they get. You can be sure that the people reaping the benefits will be at the polls to get Obama re-elected so he can give them more.

    Pete from NJ posted over 4 years ago:

    How ironic that snake oil salesmen Obama for a year claims that his legislation is not a tax and VOILA, it is upheld by a conservative and very bright Justice because it is a tax. I fear that Obama may have just doomed our economy to a second recession.

    Gary from TX posted over 4 years ago:

    I recall a year of so ago reading about congress eyeballing taxes on Muni bonds. If the European contagion drags us down again, it will come up again. They want it all... never cut back.

    Fear and loathing in the US of A!

    Jay from AZ posted over 4 years ago:

    It's about time the Bush tax cuts for the wealthy are repealed once and for all. The 4.8% combined Medicare tax on the wealthy is only fair. I welcome it.

    James from NJ posted over 4 years ago:

    Thank you Mitchell Freeman for helping us understand about all this tax legislation. Your article is clear and concise, unlike what we hear from the politicans and the media (just a bunch a "Talking heads").

    It is obvious the politicians and media are doing their best to control the outcomes and manipulate us for thier own self interests. For politicans - their obsession to get re-elected and continue to feed at the trough. For media - throw fuel on the fire and hype the news to keep us glued to the tv set, to boost their ratings and sell more advertising, generate revenue. Just compare the quality of the debates on FOX, MSNBC vs CSPAN. Thanks again Mitchell!

    Don from FL posted over 4 years ago:

    Excellent info....keep us posted on the roll out. It is sad that Obama and his senate had to lie to the American people to pass this collosal document/law. Can we ever trust this current gang in Washington?

    Bruce from MI posted over 4 years ago:

    Mr Freedman fails to mention that the important tax hike that will be levied against all of the free riders who get free care on our dime. This is some 55 billion dollars a year in health care costs that those of us who pay for health care pay in higher premiums. Sorry free riders.

    Dick from TX posted over 4 years ago:

    If we want the benefits we have to pay the price!
    In a democracy, the majority rules (except the US Senate). The additional taxes are a pittance in comparison with the benefits to our fellow citizens who are in need.

    Emile from CT posted over 4 years ago:

    Thanks for a clear, concise and timely tax update. The current recovery, hindered by lack of demand-business is saving, consumers lack funds-requires gov, all levels, spend including resuming fed funds to states . To keep deficit to minimum, tax increases on wealthy (who don't spend/invest all funds) required. This was learned in the thirties and, as the saying goes, ignorance leads to a repittion ( The cost of the health plan would be covered by eliminating only a third of Romney's proposed tax reductions-which reductions would only aggrevate the recession/depression/deficit) Tax rates were much higher for decades, prosperous decades.

    Booker from MD posted over 4 years ago:

    I really do appreciate your thorough ,concise update. There is so much uncertainty and the unknown creates a tremendous amount of stress. Keep the analysis coming!

    Eugene from TN posted over 4 years ago:

    This Law, that was passed by hook or crook, by lies (using 6 yrs of cost against 10 yrs of revenue) so it could get a positive CBO "score," and by the legislative slight of hand of "reconciliation" that even Robert Byrd (D-WVa) said should NEVER be used to pass "major" laws will eventually bring the United States to it's financial and healthcare knees.

    It pains me to say this since I have grandchildren but we will be Greece in 30 years! We will be broke but still have people rioting in the streets because someone else is still supposed to pay their bills for them.

    As on of the anchors on CNBC said - "Health care but will become a right but no one will be able to get in to see a doctor."

    If it weren't so sad for the country it would be a joke the way Pelosi-Obama-Reid pulled this thing off on the American people.

    Jim from WI posted over 4 years ago:

    A lot of this garbage could be easily fixed with one simple change - if you don't pay taxes, you don't vote to decide how tax revenues are distributed.

    Fred from PA posted over 4 years ago:

    I have worked since is was 13 years old and saved and invested throughout the years even during difficult times.
    Now the government is looking to strip the savings of the "boomer" generation to support their enormous social agenda.
    I cannot help but believe the politicians have been keeping an eye on the growing baby boomer accounts in IRA's and 401K's and trying to figure out how to best take control of these funds.

    Marni from MO posted over 4 years ago:

    What the banks didn't gamble away the The government taketh. The message being sent to the small investor is not positive.

    Mary j. Hubbard from FL posted over 4 years ago:


    Dave the Brit from MI posted over 4 years ago:

    There is nothing in this bill that deals with the high cost of medical care - just distributing the high cost of many to a few. The history of governments trying to control costs is strewn with unintended consequences - like lower quality, higher costs and debt, higher taxes, declining supply of good practitioners, lower standards to allow less qualified employees into system, longer wait times, bloated bureaucracies, less incentive to try new technologies, widespread corruption and a huge voting block that depends on government. After spending $trillions and sacrificing millions of lives to fight Communism/Socialism for 100 years, I am astonished that you Americans seem to now be embracing these discredited forms of coercive control. The rest of the sensible world thinks you have all fallen asleep (or gone mad). Wake up and save yourselves so that you can continue being the world's beacon of liberty.

    Anthony Harris from CA posted over 4 years ago:

    Thank you Mr. Freedman for your clear and concise review of the changes in taxes as a result of the Affordable Care Act.

    This was not an article on politics or medical public policy.

    I appreciate that the AAII is here to help individual investors like me with clear and nonpartisan financial guidance.

    I further appreciate the validity of the partisan political opinions of many of those above. As a decorated military veteran, I pledged my life and honor to protect our freedom of speech. However, I'm sorry that you have polluted THIS investment forum with your partisan politics. I suggest you call into your political talk shows and Fox News as a more productive forum for sharing those views.

    Norm from U.S. posted over 4 years ago:

    I'm old, so this really won't affect me that much, but I really fear the consequences to my children and my grandchildren for the cost of paying for those who will not pay their own way.

    We work all our lives saving all we can and the government takes it to pay the way for those who will not pay their own way in this life.

    This is socialism at its worse.

    Charles Clark from IL posted over 4 years ago:

    Thankyou for a very concise summary of a very complicated piece of legislation.

    I note lots of comments about the fairness of these higher taxes, and I think Eugene from Tennessee makes a very poignant comment as regards tax fairness. It may be proper for those who make more to pay more, but it is absolutely wrong that any citizen (with the possible exception of those serving in the armed forces) pays nothing. Even the very poor who live on welfare should have to pay a nominal tax, because then there is a common shared sacrifice. Citizens who only receive will never be concerned with the need for limited government because their is no cost to them in the expansion of government. If the very poor paid a nominal tax amount and then they were at risk of having that nominal amount increased in order to provide a new social benefit, they might begin to reconsider whether the new benefit was indeed necessary.

    J Cleland from MI posted over 4 years ago:

    Before this law I was well on my way to turning over my entire nest egg to my health insurer and a few pharmaceuticals if I managed to make it to full life expectancy. The gov't will nevr take as much as those guys would have.

    Victor from CO posted over 4 years ago:

    Never underestimate the power of an advertised free lunch supposedly paid for by somebody else's borrowed money. The free lunch may not be well-prepared, though, but it's "free."

    Dr. Richard Corcoran from CA posted over 4 years ago:

    Gee, when did the slim of Fox news eek over to AAII. Is AAII going to advise intelligent individual investors, or is this organization full of the bigoted, self absorbed, propaganda pushing ilk of the pathologically lying crowd at Fox? I hope AAII has some open minded, kind, well intentioned people, and far better politically informed people than the folks above, or its time for me to boycott this group.

    Dr. Richard A Corcoran

    Gordon Gillesby from MN posted over 4 years ago:

    First, thank you Mr. Freedman for your wonderfully intelligent and apolitical analysis. I would wish more of this sort of real information was easier to access.

    As to the bulk of the comments posted, while I agree that the Law of Unintended Consequences is the biggest thing to be feared, I must confess a general loathing for much of what has been said. Assuming I understood Richard Cocoran correctly, I have to agree that these attitudes seem highly ignorant, arrogant and bigoted.

    None of us made our money alone. We ALL stand on the shoulders of giants . . . If society is to be just, it needs to recognize that there are those who cannot help themselves and that it is no fault of their own.

    I have no objection to reasoned discussion and making attempts to limit fraud -- so long as the poor are not made the 'straw-man' argument justifying abuses for which they have continually been victims rather than perpetrators. I welcome attempt to end corrupt at ALL levels of society including the government and the corporations which enslave people in order to build the extreme wealth of a relative few.

    I have no problem paying reasonable taxes for services which have helped me build our wealth over the last generation. I do not see the reason that people cannot share some of what benefits they have gained with those who have been denied those same benefits and opportunities.

    Norman Nicholas from FL posted over 4 years ago:

    I find your article very informative. Keep us posted.

    Vern Andrews from CA posted over 4 years ago:

    I want to thank Mr. Freedman for his understandable analysis of the Health Care Bill that our Congress failed to read while they passes it into law. I think we should make a great effort to eliminate these Congressmen that passed this law and replace them in November with more responsible Congressmen and Congresswomen. I also think that the current bill will significantly increase costs because someone will have to pay for all the free stuff and that means you and me. This bill should be repealed and replaced with a bill that includes the good features of the current Tax bill and that ideas to reduce health care costs be included by allowing insurance to be procured across state lines and other means to make health care more affordable to all.

    David Thompson from CA posted over 4 years ago:

    I tend to think that most of those making comments have not had any health problems to be concerned about. They will, however, get older and need to seek finance for the health care issues they will encounter. Although the new health care law is far from perfect, I expect changes to be made to more closely align it with the needs of all.

    Dick Baskin from TX posted over 4 years ago:

    I grew up in the 40's and 50's before most families had private or employer sponsored insurance. My family paid for their health care from their savings. By today standards we would have been considered part of the working poor. I was 28 before I was covered by health insurance. I paid for the birth of my children and other health care costs from my savings.

    I truly believe that individuals should be responsible for the majority of their health care expenses and insurance should be for catastrophic illnesses. If individuals would take responsibility for their health care cost, we would not need the health care act or these new taxes.

    Richard Berg from CO posted over 4 years ago:

    Thank you Mr. Freedman for your article on the taxes in the Afordable Care Act. You did leave out one change to the tax code that will have an added tax on some people who have high medical expenses. The amount that you can deduct for medical related expenses has been changed from 7 1/2% of adjusted gross income to 10%. As a retired person with a wife that requires more than average medical costs, I see my tax liability going up $200 to $300 on our moderate income.

    I am upset with those who posted comments that there is anything political about telling the truth about a new law. This is the first real information on the tax consequences of this new law.

    Philip Bashook from IL posted over 4 years ago:

    I agree fully with Gordon Gillesby. As a retiree who is working part time and not making $250K, but living off social security, medicare and my pension plus saving my investments for when I can work I think it is time the rich, meaning those making over $250,000 per year, pay their fair share. Seems like whenever these same people are asked to support the common good they use the excuse that they did it alone. Did they not use the federal highways to get from town to town and certainly the same is true for those who supplied them with goods and services? If received food and supplies flown in who paid for and manages the airports before the goods were shipped via truck or car for purchase? What about the water systems and sewer systems they use that our taxes support for the common good. What about the health care facilities they use that get tax exemptions? And the emergency rooms they expect to be available when they need them, supported by tax dollars? I guess if they don't want to pay taxes to help others they should move from this society and not use our public facilities or services. If I recall there was someone like them who refused to pay the fire service tax and when his house was burning down he decided he now wanted to up for the service. Too late, He is the sort I am speaking. The fireman let his house burn down, and deservedly so. So those who don't believe they live in an community dependent on each other, get with the program in our society and pay your fair share like the rest of us who play by the rules.

    Stephen Levinson from CA posted over 4 years ago:

    I guess when the upper 1% of income pay 39% of income taxes, the 1% are not paying their fair share and are not playing by the rules. So what percent of income should "the rich" (i.e. those with income above $250K) pay to be fair and to play by the rules? I guess the answer is 4.7%. That number will stand until some enlightened individuals decide that we should raise taxes by another 4.7%, and another, and another. Soon, there will be no more rich people. I guess that's the goal.

    Victor Bradford from CO posted over 4 years ago:

    Thanks for the article, and for helping explain a complicated issue.

    Regardless of the proposed or existing medical delivery system, we can be grateful that so many health care practitioners are trying to care for patients. Perhaps, too, we should ask ourselves, "what can we do to make things better," and not just, "how can I (or someone else) get the proper share of what's available."

    Larry Seekman from MI posted over 4 years ago:

    Richard Berg from Colorado should read "Atlas Shrugged". Perhaps that would help him understand? But then again, perhaps not.

    George Alexander from GA posted over 4 years ago:

    What exactly is a fair tax? What exactly is my fair share? What determines one's fair share? If I provided jobs for 20 people making $50,000 a year, what portion of my profit should I pay? Perhaps I should buy them all houses and pay for their kid's education as well and pay my "fair" share of taxes. One day guys like me will stop providing good jobs for people like Mr. Berg. At that point he can become a ward of the state.

    Peter Yogman from UT posted over 4 years ago:

    How many months do we work for the government, state and federal, before we begin to work for ourselves. Is working for the government through June before I work for myself "fair"? This word is way overused and abused. I agree with Mr. Alexander.

    Second point. Why does our government borrow its own currency from private sources. We exist in a private debt money system. It was no accident that the income tax and the Federal Reserve Act were passed at about the same time. We can create our own money without the debt attached. The key is creating too much or too little leading to inflation or deflation. But we have given this Constitutional right up to private interests who charge us for our own currency and get us all at each other's throats.

    Sam Ramani from CA posted over 4 years ago:

    About time we stopped being selfish and think about the unfortunate people who are hurting.They are about 40 million of them with children who do not have healthcare and who will drain the hospitals and other services for which we will have to pay more. So I don't mind paying a few bucks more to get all these unfortunate people insured so that they do not drain the healthcare services which will cost us more in the long run. It is really a shame on the richest country in the world and we cannot even give the basic need of healthcare for the unfortunate poeple who are hurting.

    Edw Prather from CA posted over 4 years ago:

    Thanks for some clarity on these taxes, however I heard that the Medicare Part B deduction from SS will initially double then in a later year triple. Is this a fact?

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