By: Sharolyn Hockey
The Patient Privacy and Affordable Care Act (also known as the “ACA” or “Obamacare”) dominated the headlines before and after its rollout. What many Americans still don’t realize is that the ACA included way more in its 2,407 pages than just healthcare mandates. The 2010 law included three key tax law changes that will impact taxpayers in 2013.
Medical Deduction Floor
Only one of these key changes could affect taxpayers regardless of their income level: the change to deductible medical expenses for those who itemize deductions. For taxpayers under the age of 65, only medical expenses that exceed 10% of adjusted gross income will be allowed as a deduction, up from 7.5% in previous years. Taxpayers at least 65 years of age in 2013 still have a medical deduction floor of 7.5%.
Additional Medicare Tax on Earned Income of High-Income Taxpayers
The new tax rules require that taxpayers with earned income greater than $200,000 for Single, Head of Household or Qualifying Widower/Widow, and $250,000 for Married Filing Jointly (or $125,000 for Married Filing Separately), pay an additional 0.9% Medicare tax on wages in excess of the applicable threshold. This includes both wages and self-employment income.
The additional taxes should have been withheld from your pay during the year if your wages were in excess of $200,000, regardless of your filing status. If the additional tax is withheld in error, taxpayers must wait to file their return to receive a refund of any excess tax withheld. The excess taxes paid will be treated as a refundable credit on the return.
Additional Medicare Tax on Net Investment Income of High-Income Taxpayers
The new 3.8% Medicare tax on Net Investment Income (NII) is perhaps the most confusing tax change for high-income taxpayers.
Taxpayers with an income greater than $200,000 for Single, Head of Household or Qualifying Widower/Widow, and $250,000 for Married Filing Jointly (or $125,000 for Married Filing Separately) may owe additional tax on investment income, which includes interest, dividends, capital gains, passive income and rental or royalty income. The tax is assessed on the smaller of the total NII or the excess income greater than the income thresholds.
Good News for Most, Bad News for Some
The good news for the vast majority of taxpayers is that the 2013 tax law changes will have very little impact.
The bad news is that if you are impacted, you will pay more tax. Additionally, the American Taxpayer Relief Act of 2012 introduced a higher tax bracket and capital gains tax rate for 2013. The new highest tax bracket is 39.6% for very high income earners, and a new 20% tax rate for long-term capital gains (LTCG) and qualified dividends applies to the same very high-income taxpayers. Those taxpayers could be facing a hefty tax balance due on April 15th if they’ve failed to plan for the potential quadruple whammy: higher marginal income tax rate combined with higher LTCG and qualified dividends tax rate combined with additional tax on earned and unearned income combined with reduced itemized deduction for medical expenses.
Does Underpayment Necessarily Mean Penalty?
The IRS expects you to pay taxes on income as it is earned throughout the course of the year, and underpayment penalties can be imposed for failure to do so. There are ways to mitigate penalties, if you find yourself underpaid at year-end.
If you’ve paid in at least 100% (or 110%, depending on your income level) of your prior year’s tax liability, then you’ve met the “safe harbor” threshold, and no penalty for underpayment will be imposed, as long as you pay the tax due by the April 15th deadline. Some taxpayers may be able to reduce penalties by annualizing their income, matching their income for tax purposes to the period in which it was actually received. Your tax advisor can provide guidance for your specific tax situation.
Tax Planning Strategies Still Available to Taxpayers
While the end of the 2013 tax year has passed, there’s still time for some taxpayers to take advantage of tax planning strategies. Taxpayers can make 2013 contributions to a Health Savings Account, a Medical Savings Account, or to a traditional or Roth IRA through April 15, 2014. Self-employed taxpayers could make SEP IRA or SIMPLE IRA contributions not just through the April 15th deadline, but until the date their extended return is filed, potentially as late as October 15, 2014.
Taxpayers should bear in mind that such contributions are subject to restrictions and limitations, and they should consult their tax advisor to confirm deductibility before making any contributions.
Countdown to April 15th
Regardless of any delays in the start of tax season (see article on page 12), the filing deadline is set by statute. Taxpayers need to file their federal return (or a request for an extension of time to file) no later than Tuesday, April 15, 2014. The deadline for most tax documents to be post-marked is January 31st (i.e. W-2s, Forms 1099-INT, etc.)
We’ve included a quick reference tax checklist [see pages 13 and 14] to help get taxpayers thinking about the tax documents they should be receiving and what to look for in the coming weeks. Our checklist includes other information taxpayers may need to gather, depending on the past year and their tax situation. BWFA tax clients should have already received their personalized 2013 tax organizers — those who haven’t should contact their BWFA tax team to let us know.