New rules from the ACA means higher taxes in 2013 for almost everyone

Now that the 2012 presidential election is over, the Affordable Care Act will begin to phase in. Coupled with the expiration of the Bush Era tax cuts, for many individuals, 2013 will certainly begin with a smaller paycheck and higher taxes.

Immediate implications

Beginning in 2013, individuals with earnings greater than $200,000 per year and couples with more than $250,000 will pay an additional 0.9 percent of Medicare tax on wages above those threshold amounts.

For those individuals with income over these thresholds, an additional 3.8 percent tax will be due on capital gains, interest income and dividend income. The $200,000 and $250,000 thresholds do not increase with inflation, allowing more taxpayers to be impacted by the additional tax every year.

Medical Flexible Spending accounts will be limited to $2,500. Most employers had self-imposed limits of $5,000, but there was no government limits.

Taxpayers that have enough medical deductions to benefit from these as an itemized deduction will have to come up with more deductions. Currently any medical expenses in excess of 7.5 percent of adjusted gross income are an eligible deduction. Beginning in 2013, the limit will be raised to 10 percent. For example a family with $100,000 of adjusted gross income will need expenses in excess of $10,000 in order to claim a medical expense deduction.

Unless the House and Senate quickly compromise, individuals will be paying significantly more in federal tax in 2013 than they have in the past 11 years. Long-term capital gain rates are expected to increase from 15 to 20 percent. In addition, the top marginal tax rate will increase from 35 to 39.6 percent. The qualified dividend tax benefit will expire and all dividends and interest will be taxed at the person’s top marginal bracket as high as 39.6 percent. Keep in mind, if your income exceeds the thresholds mentioned earlier ($200,000 for individuals and $250,000 for married couples), the long-term capital gains tax will actually be 23.8 percent and the tax on dividends and interest could be as high as 43.4 percent.

The other hidden tax increase that is not often mentioned are the marginal tax brackets which are due to reset in 2013 to the levels they were in 2001. Accordingly, the 10 percent bracket is eliminated leaving the 15 percent bracket the lowest income tax rate on income up to $27,050 for individuals and $45,200 for married couples with the next bracket beginning at the 27.5 percent level. A taxpayer with taxable income of $100,000 could recognize an increase in federal tax in excess of 20 percent.

In 2013, the AMT tax will affect more taxpayers. Another change will be resetting the recently reduced Social Security tax from the current rate of 4.2 percent to 6 .2 percent, and the phase out of itemized deductions. This reduction in allowable itemized deductions can reduce a taxpayer’s itemized deductions up to 80 percent. Personal exemptions could also potentially be reduced or totally eliminated for high income earners.

Phased-in Implications

Beginning in the year 2018, businesses or insurance companies selling health plans with premiums greater than $10,200 per person or $27,500 per family, not including dental or vision care, will be subject to an excise tax. The excise tax could be as high as 40 percent of the premium that exceeds the limits. That premium may seem high now, but if health insurance continues to increase every year as it has, it won’t be long before the standard policy exceeds those limits and becomes subject to the excise tax. It is certain that the insurance companies will pass this additional tax onto the customer.

Phasing in during 2014, helping to lower the cost of insurance, will be tax credits to make it easier for individuals with income between 100 percent and 400 percent of the poverty level and who are not eligible for affordable insurance coverage.

Also beginning in 2014 is the small business tax credit which will increase for those businesses and nonprofit organizations providing certain levels of affordable health insurance to employees.

What You Can Do

There is no single approach that will work for all taxpayers. It is important to consult with your tax advisors in 2012 to plan ahead. Before the end of 2012, consider taking capital gains to lock in the 15 percent gain this year. Remember if you still like the stock, it can always be immediately repurchased. Consider rolling some of your traditional IRA investments into a Roth IRA. With the tax increase looming, this year could potentially be the lowest rates taxpayer’s will see for many years.

Typically, taxpayers should defer income and accelerate deductions; however, this year’s strategy should be reversed in some cases. Individuals with high medical costs may still want to accelerate medical expenses into 2012 due to the medical deduction threshold poised to increase in 2013.

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