Tax Implications from the Health Care Legislation

As we begin to talk about tax tips and news, we will spend some time addressing the fluidity of the current tax environment, and the importance of keeping on top of changes that affect planning.  One of the big recent developments was the Supreme Court’s ruling upholding the constitutionality of the Patient Protection and Affordable Care Act.  While the main thrust of the act was health care reform, it included a number of provisions that impact the tax code, both for individuals and businesses.  This week we will highlight some of the provisions that will affect individuals.  “How do these changes affect me?” you might ask.  Following are three of the major tax changes that will influence the most people.

Medical Deduction Threshold

Generally speaking, medical expenses are available for itemized deductions to the extent that they exceed 7.5% of adjusted gross income.  Starting in 2013, this threshold increases to 10% for individuals 64 and younger.  Individuals 65 and older will continue to use the 7.5% threshold until 2017. This means fewer people will be able to use the deduction, and the overall deduction will be lower across the board.

Additional Medicare Tax- Earned Income

Starting in 2013, an additional 0.9% surtax will apply to earned income (W-2 and self-employment income) in excess of $250,000 for married couples and $200,000 for individuals.  Unlike the social security cap on earned income, this amount is applied per couple on a married return, not per individual.  The tax thresholds also feature a significant marriage penalty.  An unmarried couple filing two separate returns could have earnings of $400,000 between them before the tax kicks in, while a married couple begins to pay at $250,000.

Additional Medicare Tax- Unearned Income

Starting in 2013, an additional 3.8% surtax will apply to unearned income in excess of $250,000 for married couples and $200,000 for individuals.  While still awaiting formal guidance from IRS as to the exact parameters of income included, we expect it to include at least the following:

  • Interest
  • Dividends
  • Rents and royalties
  • Gross income from passive businesses
  • Sale of property including stocks and real estate

There’s an important misconception we’ve heard surrounding this tax, claiming that the tax will apply to home sales and encouraging people thinking of selling to sell in 2012 instead of 2013.  While this is true for rental and investment property, it doesn’t apply to a primary residence that qualifies for the gain on sale exclusion.  If you’ve lived in the house for two out of the last five years, up to $250,000 ($500,000 for married couples) of gain can be excluded.  Assuming you can use this exclusion then the gain will not be added to taxable income and will not be subject to the surtax.

The above tax increases present some interesting planning situations.  For taxpayers that may be affected by the new taxes, some counterintuitive strategies may be called for.  It may make sense to accelerate income into 2012, and defer deductions until 2013.  As always, individual situations may vary.  But if you think you might be impacted by these changes, don’t wait to talk to your tax advisor to devise a strategy to best mitigate these changes.