Obamacare Taxes The Patient Protection and Affordable Care Act, also known as “Obamacare”, introduces several important income tax changes. For individuals, this means new types of taxes on certain types of income. These new taxes include new “surtaxes” on what is called “net investment income”. What you pay depends in part on how much you make.
New Surtax on “Net Investment Income”
Net investment income is a complex formula that is comprised, in summary, of certain types of “unearned” income (non-wage income, or income from self-employment) including interest, dividends, royalties, rental income, gross income from “passive” business activities, and “net gain” from certain sales of capital assets. These types of “passive” income desirable in that it they reflect that your money is working for you, rather than the other way around. Capital gains in particular have historically been subject to lower tax rates than ordinary income. People who build and then sell their businesses often realize capital gain, as do some stock and property investors.
The Obamacare net investment income surtax reduces some though not all of these advantages by assessing an additional 3.8% surtax on “net investment income”. With this surtax, long-term capital gains and qualified dividends may be taxed at up to 23.8% (20% + 3.8%), while non-qualified dividends, interest and rental income can be taxed at up to 43.4% (39.6% + 3.8%). A single filer earning $100,000 in wages and $25,000 worth of investment income wouldn’t pay additional tax since that person’s total income doesn’t exceed the $200,000 threshold. A single filer with $100,000 in ordinary wages and $125,000 in investment income, in contrast, would pay extra tax since his combined income ($225,000) is $25,000 over that threshold. The tax is assessed on that excess ($25,000), which yields $950 in additional tax ($25,000 x 3.8%).
Notice that the law considers the amount over the threshold to be “all” net investment income. The taxpayer doesn’t have the option to allocate his wage income to the amount that is over. Another example: A married couple with $240,000 in ordinary wages and $60,000 in investment income would end up at $50,000 over the threshold. Their bill would be $1,900 ($50,000 x 3.8%). A married couple with all passive income making $260,000 ($10,000 over the threshold) would end up paying $380.00 (3.8% x $10,000). The upside is that (fortunately) the surtax is assessed only on that part of your income that exceeds the threshold, rather than all of your investment income.
Medical Expense Deductions
A somewhat counterintuitive part of Obamacare is the change in how much you can deduct of your medical expenses. Whereas before you could deduct these expenses to the extent they exceeded 7.5% of your adjusted gross income (AGI), the “deductible” is now 10% of AGI. Adjusted gross income is an individual’s gross income from all sources less specific deductions. These deductions include either the yearly standard deduction, or, where there are sufficient “goodies” to claim, itemized deductions. Taxpayers with large medical expenses who itemize in this way can deduct high medical expenses, but only those amounts that exceed the “deductible”. Say, for example, an individual has $100,000 in AGI. Ten percent of this amount is $10,000. Let’s say this person’s health insurance was cancelled and he got into an accident before he could get new coverage. He incurs $30,000 worth of medical bills, which he pays. He can deduct as an itemized expense the amount that exceeds his “deductible”, here $20,000 ($30,000 in bills – $10,000 (the 10% of AGI) = $20,000 deduction). Prior to Obamacare he would have been able to deduct $22,500 (that is, $30,000 in medical bills – $7,500 (7.5% of AGI)).
Increases in Medicare Taxes
Individuals making more than $200,000 ($250,000 for married couples) have to pay a 0.9% Medicare tax on all earnings above this amount. For example, a single filer who makes $300,000 ($100,000 over the threshold) must pay an additional $900.00 in taxes under Obamacare ($100,000 * .009).
Lowered Contribution Limits on Flexible Spending AccountsObamacare lowers the amount you can contribute to your Flexible Spending Account (FSA) from previous years to $2,500, to be indexed for inflation beginning tax year 2014.
Obamacare taxes introduce new tax issues into your personal and business tax planning. Sophisticated tax advice can mean the difference between saving on taxes and making critical mistakes in your calculations and tax liabilities.
Contact me today for a free consultation.