Health Care Reform Raises Rates and Reduces Exemptions

Effective for 2013, new rules have increased taxes or reduced exemptions on higher earning taxpayers, making effective year-end tax planning even more important.

Under the Affordable Care Act there is a higher payroll tax and surtax on unearned income of higher-income individuals. Under the American Taxpayer Relief Act of 2012 higher tax rates apply to ordinary income, capital gains and dividends, while at the same time limitations are imposed on the use of the personal exemption and itemized deductions.

For tax years beginning after Dec. 31, 2012, the following new rules apply:

• Increased payroll tax.  A new 0.9% hospital insurance tax (FICA payroll tax) applies to wages received in excess of $250,000 for joint returns; $125,000 for married filing separate; and $200,000 for all other taxpayers. The additional 0.9% tax also applies to self-employment income that meets or exceeds the above thresholds.
• Surtax on unearned income. An unearned income Medicare contribution tax is imposed on individuals, estates, and trusts. For an individual, the tax is 3.8% of the lesser of (1) net investment income or (2) the excess of modified adjusted gross income over $250,000 for a joint return or surviving spouse, $125,000 for married filing separate, and $200,000 for all others.
• Higher individual income tax rates. The income tax rates for most individuals stay the same as in 2012. However, a new 39.6% rate applies for 2013 income above $450,000 for joint filers and surviving spouses; $425,000 for heads of household; $400,000 for single filers; and $225,000 for married filing separately.
• Increased capital gain and dividend tax rates. The top 2013 tax rate for capital gains and dividends rises to 20% for taxpayers with incomes exceeding $450,000 for joint filers and surviving spouses; $425,000 for heads of household; $400,000 for single filers; and $225,000 for married filing separately.
• Personal exemption phase out. There is a personal exemption phase out  for 2013 with a beginning threshold of $300,000 for joint filers and surviving spouses; $275,000 for heads of household; $250,000 for single filers; and $150,000 for married filing separately. Under the phase out, the total amount of exemptions that can be claimed by a taxpayer is reduced by 2% for each $2,500 (or portion thereof) by which the taxpayer's adjusted gross income exceeds the above threshold.
• Limited itemized deductions for high earners. There is a limit on itemized deductions for 2013 for earners with a threshold of $300,000 for joint filers and surviving spouses; $275,000 for heads of household; $250,000 for single filers; and $150,000 for married filing separately. Thus, the itemized deductions of taxpayers subject to this limitation will be reduced by 3% of the amount by which their adjusted gross income exceeds the threshold amount. The reduction will not exceed 80% of otherwise allowable itemized deductions..

Year-end tax planning may be especially productive this year because timely action by the taxpayer could secure significant tax breaks.

What do you think?

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Coal in the Stocking: Proposed Regulations for Two New Taxes

Coal in the Stocking: Proposed Regulations for Two New Taxes

After enjoying Thanksgiving and a bountiful feast with my family and friends, I wondered how Congress and the White House would approach the issue of the looming fiscal cliff. Thus far, they have lived up to my expectations. It will be interesting to see how their game plays out over the upcoming weeks.

Recently, we learned more about two new taxes related to the Health Care and Education Reconciliation Act (HCERA) and the Patient Protection and Affordable Care Act (PPACA). The Department of the Treasury and the IRS gave us an early holiday gift by releasing proposed regulations related to the Net Investment Income Tax and Additional Medicare Tax. Since many tax practitioners are busy in December with year-end tax planning, the release of the proposed regulations is timely. The comment period ends on March 5, 2013, for both sets of rules.

Net Investment Income Tax

The new Net Investment Income Tax (NIIT) goes into effect starting in 2013. The Health Care and Education Reconciliation Act of 2010 added new Section 1411 to the Internal Revenue Code (IRC) and is effective for taxable years beginning after December 31, 2012. The 3.8 percent NIIT applies to individuals, estates, and trusts that have certain investment income above certain statutory threshold amounts.

Individuals will owe the tax if they have net investment income and also have modified adjusted gross income over the following amounts:

Filing Status	Threshold Amount
Married filing jointly	$250,000
Married filing separately	$125,000
Single	$200,000
Head of household (with qualifying person)	$200,000
Qualifying widow(er) with dependent child	$250,000

Note: These thresholds are not indexed for inflation.

Here is a list of what is generally included in net investment income:

·         Interest

·         Dividends

·         Capital Gains

o   Capital gains from sales of stocks, bonds, and mutual funds

o   Capital gain distributions from mutual funds

o   Gain from the sale of investment real estate (including gain from sale of a second home that is not a primary residence)

·         Rental and royalty income

·         Non-qualified annuities

·         Income from businesses involved in the trading of financial instruments or commodities

·         Businesses that are passive activities to the taxpayer (within the meaning of IRC Sec. 469)

The tax does not apply to any amount of gain from the sale of a personal residence that is excluded from gross income for regular income tax purposes.

The IRS indicated that the tax will be reported on and paid with Forms 1040 and 1041.

Estates and trusts are subject to the tax if they have (1) undistributed net investment income and (2) adjusted gross income over the dollar amount at which the highest tax bracket for an estate or trust begins in the taxable year. For tax year 2012, this threshold is $11,650. There are special computations rules for certain unique types of trust. In addition, there are some trusts that are not subject to the Net Investment Income tax.

Taxpayers who anticipate that they will exceed the thresholds listed above might accelerate net investment income to 2012 or take some gains in 2012 rather than facing the Net Investment Income Tax of 3.8 percent and the possibility of additional taxes if certain Bush-era tax cuts are not extended through 2013.

Additional Medicare Tax

The IRS also released its proposed rules regarding the Additional Medicare Tax. The tax applies to an individual’s wages, Railroad Retirement Tax Act compensation, and self-employment income that exceeds a threshold amount based on the individual's filing status. The rate of Additional Medicare Tax is 0.9 percent.

An individual is liable for the Additional Medicare Tax if the individual's wages, compensation, or self-employment income (together with that of his or her spouse if filing a joint return) exceed the threshold amount for the individual's filing status:

Filing Status	Threshold Amount
Married filing jointly	$250,000
Married filing separately	$125,000
Single	$200,000
Head of household (with qualifying person)	$200,000
Qualifying widow(er) with dependent child	$250,000

Taxable wages not paid in cash, such as noncash fringe benefits, are subject to the Additional Medicare Tax, if, in combination with other wages, they exceed the individual's applicable threshold. Tips are subject to the tax also.

The imputed cost of group-term life insurance coverage in excess of $50,000 is subject to social security and Medicare taxes, and to the extent that, in combination with other wages, it exceeds $200,000, it is also subject to Additional Medicare Tax withholding.

An employer is responsible for withholding Additional Medicare Tax from the wages or compensation paid to an employee in excess of $200,000 per calendar year. This is done without regard to the individual's filing status or wages paid by another employer. An individual may owe more than the amount withheld by the employer, depending on the individual's filing status, wages, compensation, and self-employment income. If this is the case, the individual should make estimated tax payments and/or request additional tax withholding using Form W-4, Employee's Withholding Allowance Certificate.

Individuals who are liable for the Additional Medicare Tax will calculate the Additional Medicare Tax liability on their individual income tax returns (Form 1040). They will also report the Additional Medicare Tax withheld by their employers on their Form 1040.

Note: An individual might have two jobs where his or her wages are below the $200,000 threshold at each job. However, the sum of those wages may exceed the threshold at which Additional Medicare Tax is owed. If any employee anticipates such a situation, he or she can make estimated tax payments and/or request additional income tax withholding using Form W-4.

Employers will be relieved to learn that there is no employer match for the Additional Medicare Tax. However, an employer that does not meet its withholding, deposit, reporting, and payment responsibilities for the Additional Medicare Tax may be subject to all applicable penalties.

Note: Taxpayers can be subject to the Net Investment Income Tax and Additional Medicare Tax but not on the same type of income.

While most of the attention during the past two weeks has been focused on the end of the Bush-era tax cuts and the fiscal cliff, this week's release of proposed regulations for taxes relating to the health care laws reminds us that we already have some concrete tax increases in place for 2013.

Road to Somewhere: Tax Changes in the Senate-Passed MAP-21 Transportation Bill

When I filled my gas tank the other day, regular was still below $4 per gallon. The difference between the price I paid and $4 seems to have diminished faster than I would have preferred. Anyone who has watched the price of gasoline increase over the past year can understand why the business standard mileage rate increased from 51 cents per mile for travel during the first half of 2011 to 55.5 cents per mile for travel in the second half of 2011. As of January 1, 2012, the standard mileage rate is 55.5 cents per mile. If the price of gas continues to increase, the standard mileage rate will probably increase again.

The federal excise tax on gasoline is currently 18.4 cents per gallon, and there are 15 days left before current transportation funding and the authority to collect the federal gas tax that supports that funding expires. Congress is now paying close attention to the March 31 deadline.

The Senate voted on March 14 to pass an 18-month transportation bill, known as S. 1813, the "Moving Ahead for Progress in the 21st Century Act" or MAP-21. (MAP-21 sounds more like a food additive, a genome, or a distant star than the name of a bill.) Although the legislation primarily overhauls a number of federal highway-related programs, the bill does contain some important tax changes.

Here are some of the tax changes contained in the Senate-passed transportation bill. This is not a complete list.

Parity for employer-provided mass transit and parking benefits. For 2011, there was parity for exclusion from income for employer-provided mass transit and parking benefits. The exclusion was $230 per month for each of these breaks. However under current law, for 2012, the exclusion is $240 for qualified parking (due to an inflation adjustment) but only $125 for employer-provided transit and van-pooling benefits. Under the bill, effective for months after December 31, 2011, the 2012 exclusion amount for employer-provided transit and van-pooling benefits would be increased from $125 to $240.

Funding break for employers maintaining pension plans. As a result of the current, low interest rate climate, pension plan contributions have been very high, and there is concern in Congress that this will lead to more company layoffs or pension plan freezes. Under the bill, plan liabilities would continue to be determined based upon corporate bond segment rates, which are based on the average interest rates over the preceding two years. However, for plan years beginning in calendar year 2012, for purposes of the minimum funding rules, the segment rates would be adjusted up or down, as necessary, to an amount equal to either 90% or 110% of the 25-year historic average of interest rates, whichever is closest. In today's low-rate environment, the immediate effect of this change would be to raise interest rates for funding purposes and thereby lower the minimum required pension contribution. For plan years beginning in calendar year 2013, the interest rate "corridor" would expand in 5% increments each year until it reaches 30% above and 30% below the 25-year historic average of interest rates.

AMT relief for private activity bonds. Tax-exempt interest on private activity bonds issued after the enactment date and before January 1, 2013, would not be an item of tax preference for purposes of the alternative minimum tax (AMT). Additionally, tax-exempt interest on private activity bonds issued after the enactment date and before January 1, 2013, would not be included in the corporate adjusted current earnings (ACE) adjustment.

Longer write-offs for leased highway property. States may contract with a private entity to lease an existing highway or build a new one, and then operate the highway for a number of years. Although these transactions generally are structured as a lease (plus grant of a franchise permitting the private entity to collect tolls), the private entity is treated as the owner because it has the burdens and benefits of ownership. Under provisions of the bill, for leases entered into after the enactment date, the highway property would have to be depreciated over 45 years (instead of 15), and the cost of granting the franchise to collect tolls would have to be amortized over a period that is not less than the term of the applicable lease (instead of 15 years under Code Sec. 197).

Revocation or denial of passport of individuals owing more than $50,000 in back taxes. Effective on January 1, 2013, the bill would authorize the government to deny the application for a new passport or renewal of an existing passport when the individual has more than $50,000 (indexed for inflation) of "seriously delinquent tax debt." A seriously delinquent tax debt does not include a debt that is being paid in a timely manner under an agreement with the IRS or if the collection of the debt is on hold because of a collection due process hearing. The government also could revoke a passport upon reentry into the U.S. for such individuals.

In addition, the provisions of this bill allow the IRS to impose a levy of up to 100% (up from the current law's 15%) against Medicare service providers with tax delinquencies.

The bill now goes to the House of Representatives. It remains to be seen if all of the tax provisions in the Senate bill will be present in the final legislation. While the transportation bill works its way through the House, do not be surprised if the price of regular gas soon exceeds $4 per gallon. Once that threshold is exceeded, Congress may have some political incentives to add other provisions to this bill.