We now have certainty about what the future holds for the Patient Protection and Affordable Care Act (PPACA). By upholding the PPACA, the Supreme Court kept the wheels moving that will affect all of us for years to come. The new law comes with some very specific tax provisions that you need to understand since you may want to take action in 2012 before some of those new taxes come into play.
8%. Starting January 1, 2013, there will be a new Medicare tax on investment income for individuals with modified adjusted gross income (MAGI) above $200,000, couples with MAGI above $250,000 or trusts with MAGI above $11,200. The tax will be on the investment income that exceeds these thresholds. Investment income is defined as interest, dividends, capital gains, annuity income, rents or Social Security benefits. What is not investment income: wages, pensions, retirement account withdrawals and conversions, and tax-exempt municipal bond interest. Stop and think about this for a minute. If you are married and had $300,000 of income from your job but no assets, you would not pay any additional tax, but if you made only $50,000 in income and then sold a business and incurred $500,000 of capital gains, you would owe an additional 3.8% on the amount over $250,000. This presents planning opportunities.
Strategic Thought #1. If you have been debating about selling an asset that has a lot of appreciation (e.g., real estate, investment, business) you might consider doing it in 2012 versus 2013 and saving some money. Even if Congress doesn’t allow capital gains taxes to rise to 20% as currently scheduled, the 3.8% tax on top of the current 15% capital gains rates (federal) amounts to a 25% increase in taxes paid.
Strategic Thought #2. If you do have high income, you need to look at where that income comes from. Taxable interest will create more problems going forward than tax-exempt interest.
Strategic Thought #3. Roth IRAs are going to become more popular since distributions from them would not trigger the 3.8% tax because those distributions are not added to the calculation of MAGI. Regular IRA distributions, while themselves not subject to the tax, are added to MAGI and could push you over the threshold and make other investment income taxable.
0.9%. Starting January 1, 2013, there will be a new Medicare tax on wages and self-employment income for individuals with modified adjusted gross income above $200,000, couples with MAGI above $250,000 or trusts with MAGI above $11,200. This is different from the 3.8% tax because it applies to wages (which already had a 2.9% Medicare tax, so this brings total Medicare taxes on wages up to 3.8%). The burden of this extra 0.9% falls solely on the taxpayer; it is not shared by the employer (the employer does pay 50% of the 2.9%), yet the employer will have an obligation to collect it.
Strategic Thought. S Corporations might become more popular since business income earned by active owners would not be subject to the 0.9% tax, even if the income exceeded the threshold amounts (passive owners would be subject to the tax). Keep in mind that there still must be a reasonable wage paid to the active owners and this could be subject to the 0.9% tax. (Of course, you should talk to your accountant about before making a decision about starting an S Corporation.)
$2,500. Starting January 1, 2013, contributions to Flexible Spending Accounts (FSAs) are going to be limited to $2,500, down from the current $5,000.
Strategic Thought. A Health Savings Accounts (HSA) should be considered because you can put more money into an HSA ($6,250 for married couples in 2012) than an FSA. You can use the money in an HSA for similar things as FSAs (like a kid’s orthodontics) and you can roll over unused money from year-to-year.
10%. Starting January 1, 2013, the medical expense deduction floor will increase. People with a lot of medical expenses can deduct those costs on their tax return if they exceed 7.5% of their MAGI. But that floor will rise to 10% in 2013 for those under age 65. For those over age 65, the floor will remain at 7.5% through 2016 and rise to 10% in 2017.
Strategic Thought. If you are contemplating elective medical procedures that might qualify for a deduction above the 7.5% floor, consider scheduling them for 2012.I encourage you to meet with your financial planner or accountant sooner rather than later to discuss the planning opportunities you still have in 2012. Keep in mind that the election could change some of these upcoming tax increases, so be thoughtful about what changes you make to your situation. In the end, though, it looks like taxes are going up, and that means retirement incomes will be affected.