President Obama's Affordable Care Act, which was deemed constitutional Thursday by the Supreme Court, includes some major tax changes that will take effect next year. Here's a refresher course on how sweeping health-care reform will impact individual taxpayers like you.
Right now, the Medicare tax on salary and/or self-employment (SE) income is 2.9%. If you're an employee, 1.45% is withheld from your paychecks, and the other 1.45% is paid by your employer. If you're self-employed, you pay the whole 2.9% yourself.
Starting in 2013, an extra 0.9% Medicare tax will be charged on: (1) salary and/or SE income above $200,000 for an unmarried individual, (2) combined salary and/or SE income above $250,000 for a married joint-filing couple, and (3) salary and/or SE income above $125,000 for those who use married filing separate status. For self-employed individuals, the additional 0.9% Medicare tax hit will come in the form of a higher SE bill.
Medicare Tax on Investment Income
Right now, the maximum federal income tax rate on long-term capital gains and dividends is only 15%. Starting in 2013, the maximum rate on long-term gains is scheduled to go up to 20% and the maximum rate on dividends is scheduled to increase to 39.6% as the so-called Bush tax cuts expire.
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But that's not all. Also starting in 2013, all or part of the net investment income, including long-term capital gains and dividends, collected by higher-income folks can get socked with an additional 3.8% "Medicare contribution tax." Therefore, the maximum federal rate on long-term gains for 2013 and beyond will actually be 23.8% (versus the current 15%) and the maximum rate on dividends will be a whopping 43.4% (versus the current 15%). Yikes!
The additional 3.8% Medicare tax will not apply unless your adjusted gross income (AGI) exceeds: (1) $200,000 if you're unmarried, (2) $250,000 if you're a married joint-filer, or (3) $125,000 if you use married filing separate status.
The additional 3.8% Medicare tax will apply to the lesser of your net investment income or the amount of AGI in excess of the applicable threshold. Net investment income includes interest, dividends, royalties, annuities, rents, income from passive business activities, income from trading in financial instruments or commodities, and gains from assets held for investment like stock and other securities. (Gains from assets held for business purposes are not subject to the extra tax.)
For example, a married joint-filing couple with AGI of $265,000 and $60,000 of net investment income would pay the 3.8% tax on $15,000 (the amount of excess AGI). If the same couple has AGI of $350,000, they would pay the 3.8% tax on $60,000 (the entire amount of their net investment income).
$2,500 Cap on Health-Care FSA Contributions
Right now, there's no tax-law limit on contributions to your employer's healthcare flexible spending account (FSA) plan (although many plan impose their own limits). Amounts you contribute to the FSA plan are subtracted from your taxable salary. Then you can use the funds to reimburse yourself tax-free to cover qualified medical expenses. Good deal! Starting in 2013, however, the maximum annual FSA contribution for each employee will be capped at only $2,500.
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Higher Threshold for Itemized Medical Expense Deductions
Right now, you can claim an itemized deduction for medical expenses paid for you, your spouse, and your dependents, to the extent the expenses exceed 7.5% of AGI. Starting in 2013, the hurdle is raised to 10% of AGI. However, if either you or your spouse is age 65 or older at yearend, the 10%-of-AGI threshold will not take effect until 2017.
That said, the fate of these four ObamaCare-related tax increases may hinge on what the Supreme Court decides next month. So maybe you have more reasons to be interested in that decision than you initially thought. Stay tuned. I'll keep you posted.
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