The passage of landmark legislation always prompts our clients to wonder, “How will this affect me?” When it comes to the Patient Protection and Affordable Care Act, that initial reaction was delayed by the Supreme Court’s review of its legality. In the aftermath of the decision of the Supreme Court, many questions have surfaced regarding its direct impact on Americans. There are some benefits to be realized, such as:
- Medical insurance availability for people with ‘pre-existing’ conditions
- Extending parental medical coverage to adult children up to age 26
- Encouraging employers to preserve medical benefits for employees who retire between ages 55 and 65 before they qualify for Medicare.
- Reducing the Part D ‘donut hole’ or coverage gap with 50 percent discounts on Medicare drugs
- Eliminating lifetime limits on insurance coverage
- Disease and illness prevention
The costs attached to these benefits are the additional 0.9 percent add-on to payroll Medicare tax on earned income, and the new 3.8 percent tax on net investment income or modified adjusted gross income (MAGI) above the thresholds, which will apply to higher-income taxpayers ($200,000 for individual filers and $250,000 married/joint filers) beginning in 2013. Some caveats to note:
- Net investment income includes things like dividends, interest, royalties, rent and capital gains. Tax-exempt interest (like municipal bond income) and veteran’s benefits are excluded.
- Income generated within the confines of retirement accounts (401(k), 403(b) and certain 457 plans), tax sheltered annuities and IRA accounts (both Roth and Traditional) are excluded. However, as distributions from these accounts occur, the amount distributed will continue to count toward modified adjusted gross income (MAGI).
Let’s look at an example: Scott and Brenda file jointly and have $267,000 in MAGI. Of that, $28,000 of income arrives as dividends, interest and capital gains. The couple will pay (the new) 3.8 percent tax on $17,000 (The calculations: their MAGI less the threshold of $250,000), which is less than the $28,000 in investment income. So, based on the new 3.8 tax, Scott and Brenda will owe additional tax of $646 above what they would have owed absent the additional tax increase.
Alternately, Scott and Brenda have $600,000 in MAGI (all earned income) and $28,000 of investment income. In this scenario, they will pay 3.8 percent tax on $28,000, which is less than the $350,000 income over threshold. Their additional tax due is $1,064. The couple would have more financial impact from the .9 percent payroll tax on earned income ($600,000-$250,000 threshold = $350,000), an additional tax of $3,150, and a total increase of $4,214
These new taxes, combined with the possibility of the expiration of many other ‘Bush-era’ tax cuts, make it prudent to consider ways of accelerating or otherwise recognizing income before 2012 year-end. It obviously depends on each individual’s circumstances, but possible strategies might include:
- A Roth IRA conversion or Roth 401(k) contributions made prior to year-end
- Recognizing capital gains before year-end
- Electing to have year-end bonuses paid in 2012
- Pushing equipment purchases and other business-related expenses into 2013
Medical insurance premiums will likely continue to escalate as they have for a number of years. Perhaps more competition and more people participating will help contain increases in premiums, but there will also be increased consumption of health care services. It remains to be seen how this all plays out, but long-term planning will continue to be a worthwhile defense against upcoming changes.
