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The following is a brief overview of the key tax changes affecting individuals that will become effective in 2013 as a result of the Patient Protection and Affordable Care Act of 2010, as amended by the Health Care and Educational Reconciliation Act of 2010 (the “legislation”).
Higher Medicare taxes on high-income taxpayers. High-income taxpayers will be subject to a tax increase on wages.
The Medicare payroll tax is the primary source of financing for Medicare's hospital insurance trust fund, which pays hospital bills for beneficiaries, who are 65 and older or disabled. Under current law, wages are subject to a 2.9% Medicare payroll tax. Workers and employers pay 1.45% each. Self-employed individuals pay both halves of the tax (but are allowed to deduct half of this amount for income tax purposes). Unlike the payroll tax for Social Security, which applies to earnings up to an annual ceiling ($110,000 for 2012), the Medicare tax is levied on all of a worker's wages without limit. Under the provisions of the legislation, which take effect in 2013, most taxpayers will continue to pay the 1.45% Medicare hospital insurance tax, but single individuals earning (i.e., combined wages) more than $200,0000 and married couples (filing jointly) earning more than $250,000 will be taxed at an additional 0.9% (2.35% in total) on the excess over those base amounts. Self-employed persons will pay 3.8% on earnings over the threshold.
Additional tax on unearned income. Beginning in 2013, an additional tax will be applied to investment income. The additional tax for individuals is 3.8% of the lesser of (1) net investment income or (2) the excess of modified Adjusted Gross Income (AGI) over the threshold amount. The threshold amount is $250,000 for a joint return or surviving spouse, $125,000 for a married individual filing separately, and $200,000 in any other case. Net investment income is interest, dividends, royalties, rents, gross income from a trade or business involving passive activities, and net gain from disposition of property (other than property held in a trade or business). Net investment income does not include distributions from qualified retirement plans, including pensions and certain retirement accounts. For example, income from individual retirement accounts (IRAs), IRC section 401(a) money purchase plans, IRC sections 401(k), 403(b) and 457(b) plans would be exempt.
For an estate or trust, the surtax is 3.8% of the lesser of (1) undistributed net investment income or (2) the excess of AGI over the dollar amount at which the highest income tax bracket applicable to an estate or trust begins.
Floor on medical expenses deduction raised from 7.5% of AGI to 10%. Under current law, taxpayers can take an itemized deduction for unreimbursed medical expenses for regular income tax purposes only to the extent that those expenses exceed 7.5% of the taxpayer's AGI. The legislation raises the floor for itemized medical expense deductions from 7.5% of AGI to 10%, effective for tax years beginning after December 31, 2012. The AGI floor for individuals age 65 and older (and their spouses) will remain unchanged at 7.5% through 2016.
Limit health flexible spending arrangements (FSAs) to $2,500. An FSA is a tax-advantaged financial account that can be set up through a cafeteria plan of an employer. An FSA allows an employee to set aside a portion of his or her earnings to pay for qualified expenses as established in the cafeteria plan, most commonly for medical expenses, but often for dependent care or other expenses. Under the healthcare legislation, however, allowable contributions to health FSAs will be capped at $2,500 annually, effective for tax years beginning after December 31, 2012. The dollar amount will be indexed for inflation after 2013.
Dependent coverage in employer health plans remains applicable in 2013. The legislation extended the general exclusion for reimbursements for medical care expenses under an employer-provided accident or health plan to any child of an employee who has not attained age 27 as of the end of the tax year. This change is also intended to apply to the exclusion for employer-provided coverage under an accident or health plan for injuries or sickness for such a child. Also, self-employed individuals are permitted to take a deduction for the health insurance costs of any child of the taxpayer who has not attained age 27 as of the end of the tax year.
We hope this information is helpful. If you would like more details about these provisions or any other aspect of the legislation, please do not hesitate to call us.
Internal Revenue Service--Circular 230 Disclosure:
Pursuant to Treasury regulations, any tax advice contained herein (including attachments) was written to support the promotion or marketing of the matter(s) or transaction(s), thus, the taxpayer should seek advice based on the taxpayer's particular circumstances from an independent tax advisor. This communication is not written, and cannot be used by the taxpayer, for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.
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