With all the discussion about the Health Care laws that are being monitored by the IRS, just what are the tax implications for the 2013 tax year and the 2014 tax filing season? Following are three key changes you should know about the Affordable Care Act (ACA) as it relates to your individual income tax return. There will be additional changes going forward, so specifically, we are looking at tax year 2013.
To start, there is only one tax law change for 2013 that could affect taxpayers in all income groups: the change to deductible medical expenses when a taxpayer is itemizing deductions. Only medical expenses that exceed 10 percent of your adjusted gross income (AGI), often referred to as the "medical expense deduction floor", will be allowed as a deduction. (Taxpayers who are age 65 or older in 2013 still have a medical deduction floor of 7.5 percent.) This change will affect all those who itemize deductions and claim a medical expense deduction. So, if you typically claim this deduction, you're going to want to watch for this change.
The other two changes for 2013 that come from the Affordable Care Act affect "high income" taxpayers. The new tax rules required an additional 0.9 percent Medicare tax be paid when there is an earned income greater than $200,000 for Single, Head of Household or Qualifying Widow taxpayers; $250,000 for Married Filing Jointly taxpayers, and $125,000 for Married Filing Separately taxpayers. This includes wages and self-employment income. The additional taxes will be withheld from your pay if your wages are $200,000 or greater regardless of your filing status. Taxpayers affected by this change may need to adjust their withholding or make estimated tax payments to ensure the additional taxes from this change doesn't trigger a balance due when filing taxes next year. Income tax withholdings can be increased by submitting an updated Form W-4 to the employer.
If you have the additional Medicare taxes withheld and you know you won't be subject to the additional taxes at the end of the year because you have a loss from a small business or your total earnings are less than $250,000 on a joint return, you must wait to file your tax return to receive a refund of any excess tax withheld. Employers generally are not able to refund the taxes. IRS is developing a new Form 8959, Additional Medicare Tax, for 2013 to calculate any additional Medicare tax that may be owed or any excess tax paid. The excess taxes paid will be treated as a refundable credit when reported on the tax return and with any remaining tax being issued as a refund after all federal tax liability reported on the return has been satisfied.
The next change, and perhaps one of the most confusing one for high income taxpayers, is the new 3.8 percent Medicare surtax on Net Investment income. Taxpayers with an income of greater than $250,000 if Married Filing Jointly, $200,000 if Head of Household, Single or a Qualifying Widow and $125,000 if Married Filing Separately will owe the new tax on Net Investment Income (NII). NII includes investment income such as interest, dividends, capital gains, passive income, and rental or royalty income. The tax is assessed on the smaller of the total NII or excess income greater than the income thresholds. Sound confusing? It is. Here's an example.
John is a single taxpayer with an AGI of $225,000, consisting of $180,000 in wages, $15,000 in retirement income and $30,000 in net investment income from interest, dividends and passive income from an S-corp. $25,000 is subject to the surtax which is determined by subtracting the $200,000 threshold amount from the $225,000AGI. When comparing the excess income of $25,000 to the net investment income of $30,000, the excess income is lower, therefore the excess income of $25,000 will be subject to the 3.8 percent Medicare tax
Taxpayers will determine any applicable Medicare tax on the new Form 8960, Net Investment Income Tax--Individuals, Estates and Trusts, when they file their income tax return. Taxpayers whose AGI may exceed the threshold amounts and who have investment income may need to adjust their withholding or make estimated tax payments to ensure the new Medicare tax on investment income doesn't trigger a balance due when filing taxes next year.
The good news for the vast majority of taxpayers is these particular new rules for 2013 will have very little impact. The BAD news is that if you are impacted, you will owe more tax. Further bad news for those impacted is that for some taxpayers, you may owe BOTH new taxes, and even more bad news, may owe taxes at a new HIGHER tax bracket and capital gain tax rate that were introduced in the American Tax Relief Act of 2012. The NEW highest tax bracket for very high income earners that is 39.6 percent and a new 20 percent capital gain tax rate applies to the same very high income taxpayers. So possibly a quadruple whammy tax increase if you are a very high earner with net investment income. Finally if you had medical expenses, you could find yourself with a potential tax increase due to the decrease in medical expense deduction from the increase in the medical deduction floor. But as I said, that scenario will only be for a limited population of taxpayers, but it certainly will be a bad April 15th for them. So, if you're affected, or even just think you're affected, talk to your tax professional to make sure you plan accordingly.