March 5, 2013 : Lindsey Buchholz - The Tax Institute
When Do I Need to Start Caring About the Health Care Changes?
Think you don’t need to deal with the implications of the new health care changes until next year? Think again.
2013 is an important year for health care reform. Not only do several tax provisions kick in for the first time, but the first open enrollment period for state health insurance exchanges begins October 1, 2013.
4 key 2013 tax changes
1. Medical Expenses
Currently, taxpayers may deduct medical expenses if they itemize deductions and medical expenses are more than 7.5% of their adjusted gross income (AGI). Only expenses that are more than this 7.5% “floor” are deductible. Starting in 2013, the floor is raised to 10%.
Example: In 2012 and 2013, Jeff has deductible medical expenses of $5,000 and AGI of $40,000. He itemizes deductions. In 2012, he can deduct $2,000 ($5,000 expense – ($40,000 AGI × 7.5%)). In 2013, Jeff can deduct only $1,000 ($5,000 expense – ($40,000 AGI × 10%)) of the expense.
Note: If the taxpayer or the taxpayer’s spouse is 65 or older, the floor remains at 7.5% through calendar year 2016.
2. Flexible spending arrangements
Contributions are made “pre-tax” to FSAs. For instance, if an employee is in the 15% tax bracket and contributes $1,000 to an FSA, the employee saves $150 ($1,000 × 15%). Put another way, the employee can pay for $1,000 in expenses with only $850 in savings.
Currently, there is no cap on health FSA contributions, although most employers limit the contribution to $5,000. Starting in 2013, the amount of money an employee may contribute to a health FSA will be capped at $2,500. There is no change to dependent care FSAs.
3. Medicare payroll tax
The current Medicare tax on earnings is 1.45% (2.9% for self-employed taxpayers). Starting in 2013, employees earning more than $200,000 ($250,000 for married taxpayers filing jointly) will pay an additional 0.9% Medicare tax, but only on earnings over these amounts.
Employers are responsible for the additional withholding in the pay period in which wages reach $200,000, regardless of filing status. Self-employed taxpayers must pay the additional 0.9% (not 1.8%!) on net self-employment income over the thresholds. The tax is reconciled on the taxpayer’s tax return for the year. That is, any additional Medicare tax owed will be paid with the return and any overpayment of tax will be refunded.
4. Medicare tax on net investment income
Starting in 2013, a 3.8% tax will be imposed on net investment income of higher income individuals. For this purpose, net investment income means the total of dividends, interest, and net capital gains. The new tax applies ONLY to investment income that is taxable, only to the extent their AGI is over $200,000 ($250,000 for joint filers). Thus a taxpayer who sells a residence and is allowed to exclude all of the gain would not pay this tax because the gain is excludable for the 3.8% tax as well. If the taxpayer can’t exclude all of the gain, the tax would apply only to the taxable gain (and only to the extent that AGI is over the threshold).
Example: In 2013, Mandy sells a rental property for $90,000. Her taxable capital gain on the sale is $25,000. Mandy’s AGI for 2013 is $70,000 (including the capital gain). She files using the single filing status. She does not have to pay the 3.8% tax because her AGI is under the $200,000 threshold amount. If Mandy’s AGI had been over $200,000 she would have owed the additional 3.8% tax on some or all of the $25,000 gain from the sale, depending on how far over the threshold her AGI is.
Example: In 2013, Bob and Bonnie sell their principal residence for a gain of $350,000. They are able to exclude all of the gain on the sale. They do not have any other investment income. Bob and Bonnie file a joint return and their AGI is $265,000. Even though their AGI is over the $250,000 threshold amount, they do not have to pay the 3.8% tax because none of the gain on the sale of the residence is taxable and they have no other investment income. If Bob and Bonnie had been able to exclude only part of the gain because they didn’t meet the requirements for full exclusion, they would owe the additional 3.8% tax on some or all of taxable gain.
Health insurance exchanges
With the individual mandate requiring nearly everyone to have health insurance in 2014, a key component of Affordable Care Act is the health insurance exchange — a marketplace where consumers can shop for a health insurance plan. Those who do not have health insurance — and who do not have access to affordable insurance through an employer or qualify for government sponsored insurance (such as Medicare) — will be able to compare prices, coverage, and plan features and choose the plan that is best suited for them.
Exchanges will open in tax year 2013, allowing individuals to purchase health insurance with coverage starting in 2014. The first-open enrollment period starts October 1, 2013 for coverage beginning January 1, 2014.
Those who purchase insurance from an exchange and meet income and other requirements may be eligible for a subsidy providing assistance with the cost of health insurance premiums. Some will instead qualify for another type of government-sponsored insurance called Medicaid; those individual will not purchase insurance through the exchanges and instead will enroll in coverage through the Medicaid program.
With the individual mandate going into effect, even those who do not qualify for a subsidy may want to explore exchange options. For instance, some taxpayers who currently pay for health insurance on their own may find they can get lower-cost insurance from an exchange. There will also be an exchange for small businesses allowing business owners to purchase insurance for themselves and their employees.
Have more questions about the impact of the Affordable Care Act and how it will affect you and your family this year? Head over to The Community to discuss.