The tax impact of the Affordable Care Act

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Checking Up on the Affordable Care Act

By Rande Spiegelman

SOURCE: SCHWAB

 With all the commentary and debate surrounding the Patient Protection and Affordable Care Act, or “Obamacare,” it can be difficult to figure out what to expect as an individual. The effects of the new law will vary from person to person and state to state, but as investors, we should pay particular attention to five key tax changes.

 

1. Increased Medicare tax for high earners: Last year saw an increase of 0.9% in the Medicare tax levied on earned income of more than $200,000 for single filers and $250,000 for married couples filing jointly. High earners are now paying a new marginal Medicare tax of 2.35%.

For example, a single filer who earns $300,000—$100,000 over the single filer threshold—has to pay $900 more in Medicare taxes (0.9% of $100,000).1 A married couple earning the same amount only pays $450 in extra tax because they earned $50,000 more than their $250,000 threshold (0.9% of $50,000).

 

If you fit either description, you might not have noticed the change in your pay until late last year. Employers are only required to begin the additional withholding when your Medicare wages exceed $200,000, regardless of your filing status.

Importantly, if you file jointly and your wages were below $250,000 in 2013, you can claim a credit for the excess withholding on your tax return.

2. Surtax on unearned income: The Affordable Care Act will add a surtax of 3.8% on net investment income for single filers earning more than $200,000 ($250,000 for married filers). Net investment income includes interest, dividends, royalties, rental income, gross income from a trade or business involving passive activities, and net gain from disposition of property other than that held in a trade or business.

With the new surtax, long-term capital gains and qualified dividends can be taxed at a top rate of 23.8% (20% + 3.8%), while non-qualified dividends, interest and rental income can be taxed at a top ordinary rate of 43.4% (39.6%+3.8%).

A single filer earning $100,000 in ordinary wages and $25,000 in investment income wouldn’t pay any extra taxes because that person’s income doesn’t exceed the $200,000 threshold. But if a single filer with $100,000 in ordinary wages had $125,000 in investment income, $25,000 would be taxed at the 3.8% rate, meaning a $950 tax bill.

 

A married couple with $240,000 in ordinary wages and $60,000 in investment income would find themselves $50,000 over the threshold and would have to pay 3.8%, or $1,900, in extra taxes. And a married retired couple with no ordinary wages and $260,000 in net investment income would have to pay $380 in extra taxes (3.8% of $10,000).

3. Modified threshold for claiming medical expense deductions: The new healthcare reform increases the adjusted gross income (AGI) threshold for claiming an itemized deduction for medical expenses from 7.5% to 10%. However, the 7.5% threshold will continue to apply through 2016 for individuals 65 and older and their spouses.

4. A new $2,500 limit on health care flexible spending account contributions: The Affordable Care Act lowers the contribution level from the previous year to $2,500 for health care flexible spending accounts. This lower limit could potentially increase an individual’s tax liability, if they were setting aside more than $2,500. The dollar amount will be inflation-indexed after 2013.

Note that both the additional Medicare tax on wages and the surtax on net investment income are subject to estimated tax penalties if you fail to pay withholding or quarterly payments, so plan accordingly.

5. Penalty for failing to have insurance: The penalty for the uninsured starts at $95, or 1% of taxable income in 2014, whichever is greater. In 2016, it will increase to the greater of $695 or 2.5% of taxable income. Unlike income levels subject to increased Medicare taxes, which are not indexed for inflation, the penalty for failure to insure will be adjusted for inflation. Subsidies will be made available to those who can’t afford insurance.

Rande Spiegelman, CPA, CFP®, is Vice President of Financial Planning at the Schwab Center for Financial Research.

1. All other taxes still apply regardless of amount or filing status.