Taxes may rise modestly for average Americans and more sharply for wealthier citizens as a result of the Patient Protection and Affordable Care Act, also known as Obamacare. While the Supreme Court's landmark decision upholding the law extending health insurance in the U.S. did not clarify political questions about the cost of health care and expansion of benefits, the tax consequences are clear, albeit largely inconsequential for the majority of citizens.
If you have a lot of medical expenses [the Patient Protection and Affordable Care Act] will affect your tax situation, or if you have an income of $200,000 or more, Melissa Labant, director for tax advocacy and professional standards for the American Institute of CPAs, said Tuesday.
Taxes may rise for Americans due to four distinct changes brought about by the Patient Protection and Affordable Care Act: new limits on flexible spending accounts and health savings accounts, an increased threshold for deductible medical expenses, an increased Medicare tax on wages, and an increased Medicare tax on passive investments, according to Labant. But there are specific actions that can be taken to limit exposure to the new taxes.
Flexible Spending Accounts and Medical Savings Accounts
Flexible Spending Accounts and Medical Savings Accounts allow individuals to set aside pre-tax income to be used solely to pay medical expenses. Setting aside money in a Flexible Spending Account or Medical Savings Account reduces the amount of taxable income reported by an individual, although the fund expires annually.
In the past, there was no limit on the amount of money individuals could place into Flexible Spending Accounts or Medical Savings Accounts, but under the Patient Protection and Affordable Care Act, the accounts will be limited to a maximum of $2,500 beginning in 2013, according to Labant. Similarly, there are now restrictions on what the accounts can be used for. In the past, funds stored in the accounts could be used for any medical-related expense, but under a 2011 provision of the law, they can only be used for items requiring a prescription rather than over-the-counter medical items.
Effectively, by limiting the size of Flexible Spending Accounts and Medical Savings Accounts and disallowing over-the-counter items, the Patient Protection and Affordable Care Act may increase the amount of taxable income individuals must report to the IRS, even though their net income will remain the same. However, the changes will affect only taxpayers who put more than $2,500 in the accounts per year or use them for over-the-counter expenses.
Medicare Income Tax
Under current tax law, employees pay a 1.45 percent Medicare tax. Under the new provisions, though, that tax will increase by 0.9 percent for individuals with adjusted gross incomes above $200,000, according to Labant.
According to data from the 2010 Census, only the top 1 percent of Americans make $200,000 or more in a year, meaning the other 99 percent will be unaffected by the increased Medicare income tax.
Medicare Passive Investments Tax
More significant than the Medicare income tax hike is a 3.8 percent increase in Medicare taxes on income from passive investments which will come into effect in 2013. The tax hike will only affect individuals with an annual modified gross income of over $250,000 for couples or $200,000 for individuals. Likewise, the Medicare tax increase only affects what are known as passive investments, i.e. investments not held for business purposes, something which can sometimes be hard to differentiate, according to Labant.
A Way Out?
There is not technically any way out. The new taxes will apply whether or not you purchase insurance. Moreover, being uninsured will now carry a tax penalty of the larger of $95 or 1 percent of income above the threshold that requires the individual (or couple) to file an income tax return, according to Forbes. Individuals with household income around $96,000 or less will have tax credits available to help cover the cost of insurance.
While there are no guaranteed ways to avoid having your taxes rise in 2013 when the full effects of the Patient Protection and Affordable Care Act are felt if you have an income of at least $200,000 or you have large medical expenses, there are certain types of investments that insulated from the tax hikes, according to Labant. Retirement income is not subject to the 3.8 percent Medicare tax increase. Additionally, certain types of assets like municipal bonds are not subject to the Medicare tax increase, and some people may want to diversify away from stocks to improve their tax situation. Likewise, if you sell your primary residence, the original value of the house, subtracted from the resale value, may not be affected by the tax.
For employers, there is a small business tax credit for businesses that provide insurance for their employees. The tax credit, which went into effect in 2010, applies to businesses with fewer than 25 employees, according to Labant.
However, the single most important thing to do if you believe you are in a category that will be hit by the new taxes is to consult with an accountant, according to Labant.
Meet with a CPA now. You shouldn't wait until 2013 to do this - the time to prepare is now.