Now that the Supreme Court has ruled that the Patient Protection and Affordable Care Act (PPACA, aka ObamaCare) is constitutional, it is time to understand the PPACA’s aspects that everyone agrees really are a tax. Interestingly, the acknowledged taxes in ObamaCare are much larger than are currently expected to be collected under the individual mandate “tax” (although this article on employer-provided healthcare discusses the unintended consequences that might change this).
There are a dizzying number of new taxes in the PPACA. The largest of these taxes will directly affect all affluent persons and are detailed below. Those taxes on the affluent are:
A new investment tax, which is estimated to raise $123 billion over the next ten years.
A payroll surtax on earned income, which is estimated to raise $87 billion over the next ten years.
The new investment tax affects the investment income of most joint filers with adjusted gross income (AGI) of more than $250,000 ($200,000 for single filers). AGI is the number at the bottom of the front page of Form 1040. It includes all taxable income, including wages, interest, dividends, capital gains, retirement income, partnerships, and small businesses. It is before subtractions for itemized deductions (such as mortgage interest and charitable gifts), or personal exemptions.
Starting on January 1, 2013, a 3.8% tax is assessed against investment income when AGI is above the $250,000/$200,000 thresholds. Since all income determines the application of the threshold, the investment tax can apply from the first dollar of investment earnings, even if investment income is itself way below the threshold.
Absent contrary guidance from the IRS, the investment tax applies to interest, dividends, rents, royalties, all (both short- and long-term) capital gains, partnership income in which the taxpayer does not materially participate, and the taxable portion of annuity payments. Importantly, capital gains include all taxable gains from sales of real estate, including a personal residence. The $500,000 exclusion for a personal residence ($250,000 for single filers) still applies.
The application of the investment tax to personal residences is particularly controversial, and has been the subject of widely-reported incorrect comments. An example is therefore in order. Assume a couple bought a residence long ago for $100,000. In a year when they have $100,000 of other income, they sell the home for $1,050,000. After subtracting the $100,000 cost of the home and the $500,000 exclusion, they have investment income of $450,000. Together with the $100,000 of other income, the total of $550,000 is $300,000 over the $250,000 AGI limit. Triggered by the sale of their residence, they owe 3.8% of the $300,000, or $11,400 of additional taxes.
The investment tax does not cover payouts from a regular or Roth IRAs, a 401(k) plan, or a defined benefit (pension), Social Security income, municipal-bond interest, veterans’ benefits, or business income on which you are paying self-employment tax (such as a Subchapter S, a Schedule C, or a partnership).
If you are subject to the investment tax, the above rules provide the following tax minimization ideas that you should consider:
Maximize income at 2012’s lower rates, and push deductions into 2013. For investments that are likely to have a relatively short holding period, one should purposefully harvest gains in 2012, even if this means immediately re-purchasing the same investment.
Municipal-bond income is more valuable than before. Tax-exempt interest does not increase one’s AGI, and is also not subject to the investment tax.
Those looking to sell companies should attempt to close the transaction in 2012, and then not elect installment tax treatment.
Because 401(k)s are exempt, increase 401(k) contributions.
Because Roth IRAs and Roth 401(k)s are not taxable when withdrawn, Roth withdrawals will not increase one’s AGI. Conversion of regular IRAs or 401(k)s to a Roth account will decrease the amounts that will otherwise be subject to the investment tax.
Waiting on the above suggestions may be advantageous because it is possible that Congress and the President might do something responsible in the lame duck session after the elections. However, some items (like accelerating the sale closing of a business or residence) will need to be initiated much earlier.
Payroll Tax on Earned Income
The second major PPACA tax on the affluent is a payroll surtax. This changes what has previously been a flat tax, and adds a progressive component. The Medicare payroll tax increases by 0.9% (from 1.45% to 2.35%) on wages and self-employment income above $250,000 ($200,000 if a single filer). Unlike Social Security taxes, the Medicare tax is uncapped. The new levy has no deductible component for self-employed taxpayers.
Currently, the Medicare tax on salary and/or self-employment income is 2.9%. If you’re an employee, 1.45% is withheld from your paychecks, and the other 1.45% is paid by your employer, but those who are self-employed pay the entire 2.9%. If you are self employed, the new Medicare tax will be 3.8% once the additional .9% rate is included. In other words, both the investment tax (covering passive income) and the Medicare payroll tax (covering earned income) will be 3.8% for the affluent.
Taxes also Increase because of Bush-era Expirations
These PPACA tax increases come in the backdrop of the expiration of the so-called Bush tax cuts at the end of 2012. As noted already, it is possible that some of the tax increases that will otherwise occur might be addressed after the elections. Assuming no further changes in the tax laws, the following table compares current federal income tax rates that will occur, starting on January 1, 2013. The 2013 rates for investment and capital gains include the new 3.8% investment tax, but exclude the Social Security Tax, and all state income taxes:
|Income Level/Type||Federal Income Tax Rates|
|2012||2013 with no changes||Obama proposal|
|Over $388,350 rate||35%||39.6%||39.6%|
|$217,450 to 388,350 rate||33%||36%||36%|
|Top investment income rate||15%||43.4%||43.40%|
|Top capital gains rate||15%||23.8%||30%|
President Obama’s proposed tax plan would not alter the 2013 taxes to be paid for the two affluent groups shown above. President Obama would increase capital gains rate for the affluent to 30%, even higher than will occur if no further tax changes occur.
Other PPACA Taxes
There are a large number of taxes that do not discriminate on the affluent. Some (but not all) of PPACA’s other large taxes are listed below. Those purchasing or using these products (read, practically everyone) will at least indirectly pay for these additional taxes:
A new tax on health insurers that is estimated to raise $60 billion over the next ten years;
A new tax on pharmaceutical companies that is estimated to raise $20 billion over the next ten years;
A 2.3 percent medical device tax, calculated on the gross selling price of all medical devices – This is estimated to raise $19 billion over the next ten years;
Increasing income taxes on those who are currently able to take a medical deduction (generally, the older and chronically ill) – This is accomplished by raising the threshold before medical expenses become a medical deduction. On Schedule A, the current 7.5% adjusted gross income threshold will become 10% in most circumstances. This is estimated to raise $15 billion over the next ten years;
A new $2,500 annual cap for flexible spending accounts, combined with excluding over-the-counter medicines from these accounts – This is estimated to raise $20 billion over the next ten years;
A new tax on “Cadillac” health plans, which is expected to raise $149 billion over the next ten years. See the end of this article on healthcare coverage for more information.