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The Real Tax Provisions of Health Care Reform
Posted in Tax and Finance

A new show on Bravo? No, it’s just that now that the U.S. Supreme Court has cleared the way for health care reform, it’s time to start thinking about the “real” tax provisions enacted as part of the Patient Protection and Affordable Care Act. Although some of the health care reform tax changes have already taken effect, a number of the more significant changes will become effective in 2013.

Higher Medicare payroll tax 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 percent Medicare payroll tax. Workers and employers pay 1.45 percent each. Self-employed people pay both halves of the tax (but are allowed to deduct half of this amount for income tax purposes). Under the provisions of health care reform effective for 2013, single individuals earning more than $200,000 and married couples earning more than $250,000 will be taxed at an additional 0.9 percent (2.35 percent in total) on their earnings in excess of those base amounts. Self-employed persons will pay 3.8 percent on the excess.

An employer’s obligation to withhold the extra 0.9 percent does not kick in until an employee’s wages exceed $200,000. Joint filers with combined incomes over $250,000 may find themselves in a situation where they owe additional Medicare tax on their tax return. Because the withholding rules do not account for the difference in treatment between individual and joint filers, employers do not have to account for spousal earnings when withholding the additional Medicare tax. This underwitholding can be remedied by filing a new Form W-4 with your employer requesting additional withholding or through quarterly estimated tax payments. Otherwise, joint filers may owe penalties to the Internal Revenue Service for underpayment of estimated tax.

New tax on investment income

Under current law, the Medicare payroll tax only applies to wages. Beginning in 2013, a Medicare tax will, for the first time, be applied to investment income. Although termed a Medicare tax, the revenue from it will not actually go into the Medicare Trust Fund. A new 3.8 percent tax will be imposed on the net investment income of single taxpayers with an adjusted gross income (AGI) above $200,000 and joint filers with an AGI over $250,000. Net investment income consists of 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). The new tax won’t apply to income in tax-deferred retirement accounts, such as 401(k) plans, and it will not apply to municipal bond interest. Also, the new tax will apply only to the lesser of a taxpayer’s net investment income or the amount by which the taxpayer’s AGI exceeds the $200,000/$250,000 threshold.

Increased threshold for itemized medical expense deduction

The threshold for deductible medical expenses is set to increase from 7.5 percent of AGI to 10 percent of AGI beginning in 2013. The effective date of this provision depends on the age of the taxpayer. The increased threshold kicks in for individuals under the age of 65 in 2013. If you or your spouse will be 65 or older by the end of 2013, the increase does not apply until 2017.

New excise tax on sale of medical devices

For sales occurring after Dec. 31, 2012, a tax equal to 2.3 percent of the sale price is imposed on the sale of any taxable medical device by the manufacturer, producer or importer of such device. A taxable medical device is any device defined in section 201(h) of the Federal Food, Drug and Cosmetic Act, which is intended for humans. This new excise tax will not apply to eyeglasses, contact lenses, hearing aids or any other medical device determined by the IRS to be of a type that is usually purchased by the general public at retail for individual use.

Retiree drug plan deduction

Under current law, companies that maintain a qualified retiree prescription drug plan qualify to receive subsidies with respect to certain qualified expenses of the plan, and those subsidies may be ignored when calculating the tax deduction with respect to those expenses. The result is a double benefit for the company: a refund and expense deduction at the same time. Effective for 2013, this double benefit will be eliminated and companies will no longer be able to take a deduction for expenses that are reimbursed through the subsidy program.

If you have questions about how these tax changes may impact you or your business, please contact a member of our Tax and Finance Practice Group.

DISCLOSURE REQUIRED BY CIRCULAR 230. This Disclosure may be required by Circular 230 issued by the Department of Treasury and the Internal Revenue Service. If this article, including any attachments, contains any federal tax advice, such advice is not intended or written by the practitioner to be used, and it may not be used by any taxpayer, for the purpose of avoiding penalties that may be imposed on the taxpayer. Furthermore, any federal tax advice herein (including any attachment hereto) may not be used or referred to in promoting, marketing or recommending a transaction or arrangement to another party. Further information concerning this disclosure, and the reasons for such disclosure, may be obtained upon request from the author of this article. Thank you.

  • Partner

    Ross D. Cohen serves as Co-Leader of the Federal Tax Team and concentrates his practice on federal tax transactional and planning issues of partnerships, joint ventures, limited liability companies and S and C corporations.

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