By: Elaine E. Bedel, CFP®
With over 2,000 pages, it will take time to determine the full impact of the Patient Protection and Affordable Care Act on consumers. While there are desirable healthcare reforms in the new legislation, it will come at a potentially high price for some taxpayers. In our example, the impact is a 15% increase in income taxes.
On March 23, 2010, President Obama signed the controversial healthcare bill into law. The intent of the legislation is to ensure that everyone has medical insurance and that it is affordable. The estimated cost of the healthcare package is $940 billion over ten years.
Where will the dollars come from to pay for the provisions of this bill? While both businesses and individuals will feel a direct impact, let’s look specifically at the new taxes that will be imposed on individuals over the next three years.
Income Taxes set to Increase in 2011
Even without the additional taxes included in the healthcare mandate, 2011 will see the sunset of the Bush tax cuts enacted in 2001. Unless extended, which no one expects will happen, both the ordinary income tax and capital gain rates will increase. Under current law, the individual tax rates range from 10% to 35%. Next year the lowest rate will be 15% and the highest will increase to 39.6%. The long-term capital gain rates will increase from 15% to 20% (from 0% to 10% for low AGI). Also, qualified dividends will no longer be taxed at the capital gain rate, but rather as ordinary income subject to an individual’s highest marginal tax rate.
Medicare Payroll Tax Increase
Currently, everyone pays a Medicare payroll tax of 1.45% on all earned income. Beginning in 2013, this tax will be increased by .9% to 2.35% on earned income over $200,000 for individuals and $250,000 for married filing joint. This means that for every $1,000 over the limit, an additional $9 of Medicare payroll tax will be collected.
New Medicare Contribution Tax
Also beginning in 2013, a new Medicare contribution tax of 3.5% will be imposed on investment income, which includes interest, dividends, capital gain, and other passive income. This is in addition to the ordinary income or capital gain tax that investment income is already subject to.
The new tax will only be imposed on individuals with adjusted gross income above $200,000 ($250,000 for joint filers). Assuming the Bush tax cut is not extended as discussed above, this means that investment income subject to ordinary income tax rates will be taxed at 43.1% for those in the highest bracket (39.6% plus 3.5%) and the long-term capital gain rate in 2013 will be 23.5% (20% plus 3.5%).
Impact of Tax Increase
Let’s assume a married couple has adjusted gross income of $340,000, consisting of $300,000 of earned income; interest from investments of $10,000; qualified dividends of $5,000; and $25,000 of long-term capital gain. For comparison purposes, we will simply calculate the income tax based on 2010 tax rates and the anticipated rates in 2013 without consideration of personal exemptions, deductions, credits, etc.
Using the 2010 tax rates:
· Earned income of $300,000 = $76,781
· Interest of $10,000 at the marginal rate of 33% = $3,300
· Qualified dividends of $5,000 at 15% = $750
· Long-term capital gain of $25,000 at 15% = $3,750
· Total Federal Tax = $84,581
· Tax as a percent of AGI of $340,000 = 24.9%
Using the anticipated 2013 tax rates on the same income:
· Earned income of $300,000 = $84,580
· Interest of $10,000 at the marginal rate of 36% = $3,600
· Qualified dividends of $5,000 at the marginal tax rate of 36% = $1,800
· Long-term capital gain of $25,000 at 20% = $5,000
· Additional Medicare payroll tax of .9% on earned income over $250,000 or $50,000 = $450
· New Medicare contribution tax of 3.5% on investment income of $40,000 = $1,400
· Total Federal Tax = $96,830
· Tax as a percent of AGI of $340,000 = 28.5%
The increased tax on the $340,000 of income is $12,249 or 14.5%.
Summary
The combination of the expiration of the 2001 Bush tax cuts and the new taxes included in the Obama healthcare bill will have a major impact on taxpayers with incomes above the threshold amounts. In our example, the increased tax is more than $1,000 per month. The result will be a reduction in consumer spending, less saving for the future, or a combination of both. Effected individuals should discuss with their financial advisor the impact this will have on their future financial security and make adjustments as appropriate in their long-range planning.
