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Tax and Financial News for April, 2010

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Health Care Reform: How will it affect your pocketbook?

President Barack Obama came into office promising an era of change. On March 23 he delivered on one campaign promise by signing into law what is arguably the most sweeping change to the nation’s health care system in U.S. history. To give you some idea of the effort expended in passing the measure – and the sheer enormity of the bill – let’s look at a few facts.

On March 21, the United States House of Representatives passed H.R. 3590, the Patient Protection and Affordable Care Act. This bill, called the Health Care Act, was subsequently amended by H.R. 4872, the Health Care and Education Affordability Reconciliation Act of 2010. The Reconciliation Act was signed into law on March 30.

The Health Care Act is a 906-page document and The Reconciliation Act is a 2,310-page document, according to the Government Printing Office.

This information, along with all the recent press about the acts, will help you understand how massive the new law is and how complicated it will be to
implement. With that in mind, let’s discuss a few of the major tax provisions and their implications in the new law.

Higher Payroll Taxes

As with most government initiatives this size, there has to be some mechanism to pay for the plan. One of those revenue raisers is an increase in Medicare taxes on wage earners. A new 0.9 percent Medicare tax will be levied on taxpayers who file single and earn more than $200,000. The threshold for married couples filing jointly is $250,000. Presently, all taxpayers pay 1.45 percent of their earned income in Medicare taxes, which is matched dollar for dollar by their employer. Self-employed individuals pay the full 2.9 percent. Beginning in 2013, taxpayers will pay an additional 0.9 percent on amounts in excess of these base amounts. The $200,000 and $250,000 thresholds will not be indexed for inflation.

Medicare Taxes on Unearned Income

Currently, individuals pay Medicare taxes only on earned income (wages and self-employment income). Unearned income (dividends, capital gains, etc.) is not subject to Medicare tax. Beginning in 2013, this exception will disappear. For those with adjusted gross incomes in excess of $200,000 for singles and $250,000 for married couples filing jointly, a new 3.8 percent Medicare tax will be levied on net investment income in excess of those threshold amounts.

How this will affect individual taxpayers will depend on the source of their income. For example, if a married couple has $75,000 in wages and $300,000 in capital gains, the new tax would apply to net investment income of $125,000 ($75,000 + $300,000 less $250,000). The overall additional tax would be $4,750 (3.8 percent of $125,000). Let’s take a look at high wage earners. Assume our sample couple earns $300,000 and has $75,000 in capital gains. The increased Medicare tax would equal $3,300 (0.9 percent of earned income over $250,000 plus 3.8 percent of $75,000 net investment income).

Income from tax deferred retirement accounts such as a 401(k) or similar accounts will not be included in income subject to the additional tax. The tax would apply to estates and trusts. The two provisions increasing Medicare taxes are estimated to increase revenue by $210 billion over 10 years.

Deductible Medical Expenses

Presently, medical expenses in excess of 7.5 percent of adjusted gross income can be deducted as an itemized deduction. The new law increases this threshold to 10 percent for tax years after 2012. For individuals older than 65 and their spouses, the new threshold will not take effect until after 2016.

This increase in the nondeductible floor could have unintended consequences to those forced to withdraw funds from their retirement accounts to pay medical bills. Under current law, IRA withdrawals used to pay for deductible medical expenses (i.e. expenses in excess of the 7.5 percent floor), are not charged a 10 percent penalty upon early withdrawal. Increasing the floor to 10 percent will raise the portion of a withdrawal subject to penalty.

For example, assume you are 35 years old and must withdraw $25,000 from your IRA to pay a hospital bill for your child. Assume also that your adjusted gross income is $125,000 and you itemize deductions. Under current law, your itemized deduction would be $15,625 ($25,000 – [7.5 percent of $125,000]). The new law would reduce that deduction by $3,125 to $12,500. Additionally, if your withdrawal is subject to the early withdrawal penalties, you would pay a 10 percent penalty tax on the $3,125.

Since the new law does not take effect until 2013, perhaps Congress will be able to address the higher penalty tax. This change is expected to increase revenue by $15 billion over 10 years.

Individuals Without Coverage

Beginning in 2014, nonexempt U.S. citizens and legal residents will be required to maintain a minimum amount of health coverage. Individuals who fail to do so will be subject to certain penalties beginning in 2016. The penalty will be the greater of 2.5 percent of household income over the minimum income required to file a tax return or a per-person penalty rate. The rate for each adult in the household would be $695 while the rate for uninsured children under 18 years old will be half of the adult rate. The overall penalty cannot exceed 300 percent of the per-adult penalty, or $2,085.

Low Income Tax Credits

Families and individuals with income of up to 400 percent of the federal poverty level ($43,320 for an individual or $88,200 for a family of four) will be eligible for a cost sharing subsidy if they participate in a local health insurance exchange. They cannot be eligible for Medicaid, employer-sponsored insurance or other acceptable insurance.

Every Bill has its Quirks

As a side note, there are a few obscure provisions that were hardly mentioned during the debate. One of those is a tax on indoor tanning services. Beginning July 1, if you use an indoor tanning salon, expect to see your bill increase by 10 percent.

The Health Care and Reconciliation acts are complicated and will take time to sort out. There is no doubt there will be income tax implications for many Americans. Some provisions will take awhile to implement, but now is the time to begin looking at your personal finances to minimize potential negative effects of the changes in health care law.

Have a terrific April.

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