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Affordable Care Act

3.8% Tax on Unearned Income

The Affordable Care Act has created a host of new taxes which start to become effective in 2013. The two issues with the greatest potential impact to most taxpayers are the Medicare taxes on earned and unearned income. I attended a full day seminar on this topic a few weeks ago and have spent time reading the law and the Internal Revenue Service Regulations that attempt to explain its implementation. The law is complex and will create more than a few headaches next spring. 
 

Much of what I have seen in the press has been, at best, misleading, and in many cases plain wrong. My hope here is to give you an outline of the law and allow you to determine if it may impact you.

 

First, who will pay the tax on unearned income? The definition of who the tax applies to uses a concept called “modified adjusted gross income.” For the most part this is the last line on page one of your Form 1040. If your modified adjusted gross income is greater than the following you may be subject to the tax:

  • $250,000 for married filing joint,

  • 200,000 for single or head of household,

  • $125,000 for married filing separately, or

  • Trusts with undistributed net investment income or with adjusted gross income greater than the highest tax bracket threshold ($11,950 for 2013) with net investment income.

     

     

     

     

     

     

     

     

     

The tax applies to unearned income, meaning net investment income. This includes interest, dividends, annuities, and royalties, and rents not derived in the ordinary course of a trade or business. Gross income derived from a trade or business that is a passive activity, or from trading financial instruments or commodities, is also included, as well as certain capital gains. Note that the law also brings into play the passive activity rules, which on their own, are a maze of complicated and vague requirements.

 

Several immediate questions come to mind.

  • Why the inclusion of annuities but not pension payments?

  • What are rents derived in a trade or business?

  • How is net investment income computed?

  • What deductions will apply?

  • How will the passive activity rules be applied to income from a trade or business, or more importantly what records will you need?

     

     

     

     

     

     

     

     

     

If these thresholds don’t apply to you, or your income does not come from the categories described, stop reading and spend the time doing something more enjoyable than worrying about this tax. Maybe a root canal!

 

To over-simplify, if you have overall income in excess of the thresholds, and have net investment income, you may be subject to the tax.
Given the complexity of the law and the uncertainty of the regulations, I strongly suggest that if you meet the basic rules, please give us a call so we can determine your specific potential exposure to the tax. This will apply to the 2013 returns and may require your estimated payments to be modified.

 

0.09% Tax on Earned Income

Just in case wage earners were feeling left out, the act also imposes an additional Medicare tax of 0.09% on wages. This tax does not apply to the employer portion, but must be collected at the employer level. The tax is based upon wages or self- employment income in excess of $250,000 for married filing joint return and $200,000 for all other returns.

 

The first issue is what happens to married couples that each earn wages of, for instance, $175,000? The employer will not be required to withhold since the withholding begins at wages in excess of $200,000, so the tax will be due with the return when filed. Employers are faced with additional withholding requirements even though they are not taxed.

Once again the implications are varied and we suggest you contact us to work with your specific fact pattern.

 

There is some remote possibility that he Affordable Care Act will be delayed or, less likely, repealed. Absent that, this tax is part of the law and needs to be considered for the 2013 tax year. We would be happy to discuss the implications further with you and help you plan for your specific needs.

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