By Susan Tompor, Detroit Free Press –
The Supreme Court’s decision to uphold the health care overhaul could seal the deal on a special tax on higher-income households that’s likely to take effect in 2013.
Under the new tax, taxpayers could be subject to an additional 3.8 percent tax called a Medicare contribution tax if they sell a second home, a vacation home, stock or other investments next year.
The new tax was part of the landmark health care reform bill that Congress passed in 2010.
As with many taxes, we’re not talking about something that’s terribly easy to understand. It can be tough to figure out who pays the 3.8 percent tax and who does not — as well as what type of investment income is taxed at 3.8 percent.
Generally, “if your income is below $250,000 as a married couple, you don’t have to worry about this,” said Tim Steffen, director of financial planning at Robert W. Baird, an investment banking firm based in Milwaukee.
The tax — an extra 0.9 percent on gross income from wages and self-employment and 3.8 percent on gross income from investment — will be imposed on taxpayers earning more than $200,000 as single filers or $250,000 for joint-filers.
But the tax could apply to others who don’t necessarily have a big paycheck. It could apply to those who have a very large gain from selling investments in a given tax year.
One tax trigger is if your modified adjusted gross income exceeds $200,000 if single or $250,000 for joint-filers. (Or the threshold is $125,000 if married filing a separate return.)
Say a single taxpayer who typically has an adjusted gross income of $80,000 but in a given year has a $400,000 net gain from the sale of a vacation home.
The 3.8 percent tax rate would apply to $280,000 in this example. That’s because the additional 3.8 percent tax applies only to the amount of your adjusted gross income that exceeds the $200,000 threshold for singles and the $250,000 for joint-filers.
In this example, the tax owed would be $10,640.
The new tax received a little bit of buzz, but many are not aware of the change ahead.
Steffen said he would not advise investors to rush out and sell their investments today simply to avoid this tax. He noted that people can overreact to changes in tax rules.
But Steffen said in his opinion, higher-income people should prepare for the tax to take effect next year, as the health care overhaul moves forward.
“It’s pretty hard to repeal something like this,” Steffen said.
Mark Luscombe, CCH principal tax analyst, said that depending on how the fall elections come out, there may be an effort by Republicans to repeal the law in 2013, and they might try to repeal the 3.8 percent Medicare tax retroactively back to the beginning of 2013.
Clint Stretch, a tax expert and a former tax policy leader for a major accounting firm, noted that the new tax accounted for nearly half the non-mandate revenue raised in the Patient Protection and Affordable Care Act at an estimated $35 billion to $40 billion a year by the end of the decade.
The debate in Congress could get sticky, as there’s also the upcoming expiration of the Bush tax cuts on the table.
While the odds favor an extension of the Bush tax cuts at year-end, Stretch said, he does not think they favor repealing or delaying this new tax. The debate will be complicated by the fact that this tax is used to support Medicare, he said.
And there’s likely to be misinformation on the tax change. One rumor began surfacing via email about a year ago stating that the new 3.8 percent tax would apply to all home sales in 2013 and after — which is not the case.
Interest on tax-exempt bonds, veterans’ benefits and the excluded gain from the sale of a principal residence that are excluded from gross income are not considered net investment income for purposes of the additional tax.
The 3.8 percent tax does not apply to money taken out of a qualified retirement plan or IRA, either.
The tax would apply to non-business related net income from interest, dividends, annuities, royalties and rents and capital gains, as well as income from a business that is considered a passive activity or a business that trades financial instruments or commodities.
The tax could hit some taxpayers hard especially if they have large gains from sales of several investments.
Some wealthier people are not aware of the tax, but others are and some are offended by it, Stretch said. “It’s not like having a lot of capital gains makes you sick when you retire and go on Medicare.”
