We’ve all heard about the Affordable Care Act—otherwise known as Obamacare—for years at this point.
Passed as a law in 2010, some of the changes are finally starting to take effect, some are yet to come—and there are a lot of questions about both.
Whether you’re a fan, a critic or just uncertain about what Obamacare will mean for you, you should be aware that one sweep of changes took effect at the beginning of 2013, and it will start to impact your taxes.
We spoke to Thomas Nice, CPA, a partner in the national tax office at CohnReznick who’s done extensive research on the impact of Obamacare, as well as Samantha Vient, a LearnVest Planning Services certified financial planner, for the inside scoop.
From increased tax rates to changes in healthcare deductions, we break down what you need to know.
1. Medicare Tax Increase for High Earners
As of the new year, high earners face a 0.9% increase in payroll taxes (officially, the Medicare hospital tax). Anyone making a gross income of $200,000 or more will have that extra chunk taken directly from their paychecks.
This tax also applies to couples who jointly make $250,000 or more. Nice points out: “If a married couple filing jointly was making $150,000 a person [for a total of $300,000], an employer wouldn’t withhold the extra tax from payroll because they wouldn’t know the spouse’s income or that the couple was going to be over the threshold.” So, if the 0.9% wasn’t already withheld through payroll, that couple would have to pay the extra chunk at tax time.
How will this affect you? Those whose incomes put them above the threshold will pay this tax on the difference. So if you’re an individual who makes $225,000 a year, you’ll pay the extra 0.9% tax on only $25,000 of your earnings.
Vient notes that this extra tax could have a bigger impact on people living in expensive cities, where higher salaries don’t get you as far: “If you live in a place like NYC or San Francisco, that’s where you’ll feel the extra squeeze.”
2. Increased Taxes on Investment Income
For the tax year 2013 (which we’ll pay for in April 2014), high earners face an additional 3.8% tax on investment income. This applies to people making above $200,000 individually or $250,000 as a married couple filing jointly, but unlike the payroll tax we mentioned above, this tax is based on modified adjusted gross income (AGI).
To recap, the 0.9% payroll tax is based on how much you make in total, whereas this investment tax looks at how much you make after adjusting for state taxes and additional deductions you take. Effectively, this means that the income threshold for this tax is a bit higher than for the other tax hike.
How will this affect you? If you make above the previously mentioned threshold, you’ll have to pay 3.8% of whichever is less: 1) your investment income or 2) the amount that your modified AGI exceeds the threshold. Vient says that this tax won’t hit retirement accounts, just taxable brokerage accounts, while Nice notes that for the purposes of this tax, “investment income” includes money you make passively, such as from rental properties.
If you’re a high earner with investment income, “you’re potentially looking at a hit from two places,” Vient says—an increased payroll tax, plus an increased investment tax. You may be subject to both taxes, but they’re not on the same type of income, since one comes out of payroll from work, and one is on investments.
3. Changes to Who Can Deduct Medical Expenses on Taxes
Previously, in order to qualify to deduct your medical expenses on your taxes, these expenses had to cost you at least 7.5% of your adjusted gross income. That threshold has now risen to 10%. Admittedly, 7.5% is already pretty high, Vient points out, “so the average American won’t reach that threshold, and this won’t affect most healthy people.”
But if you have an extraordinary medical expense, decreasing what you can deduct by 2.5% will certainly have an impact. For example, previously, if your income was $100,000, you’d have to spend more than $7,500 on medical bills to qualify. Now you’d have to spend more than $10,000.
How will this affect you? Vient points out that this new rule could make a bigger difference for poorer populations than wealthier ones. “If both a rich and a poor person have $5,000 in expenses, the poor person used to be able to deduct more of that,” Vient says. Meanwhile, “the rich person could never have deducted that amount because $5,000 would have been below the threshold, so there’s no change.”
4. Cap on Flexible Spending Accounts (FSAs)
At present, there’s no legal limit on how much people can contribute to an FSA (although many plans impose their own limits). “The whole idea of an FSA,” Nice says, “is that you put pretax money into the account, and get reimbursed. So, at the end of the day, you’ve used pretax dollars for these particular expenses,” which includes medical care and, sometimes, such dependent expenses as daycare.
Starting in 2013, only the first $2,500 in one of those accounts will be free from tax. Nice notes that some plans might still allow you to deposit more than that into your FSA, but “if you have expenses beyond $2,500, and you get reimbursed, the IRS rule is that you have to receive those excess reimbursements on your W-2 as taxable income.” Because that would require the company to deal with W-2s, most companies will probably reduce their contribution limit to $2,500 to make things simpler.
How will this affect you? On the ground, Vient says, this is unlikely to affect many people because many plan limits were already around $2,500. So unless you are used to contributing—and using—significantly more than $2,500 in FSA funds per year, this change may not have much or any impact on you.
5. Taxes on Medical Devices
As of the end of 2012, manufacturers have to pay a 2.3% excise tax on the sale price of medical devices. This is levied on companies, not patients, and includes equipment ranging from gloves to pacemakers. Things that consumers generally buy for themselves, like contact lenses and hearing aids, aren’t subject to the provision.
How will this affect you? The upshot of this change is still unclear. “Any increase in devices is going to get pushed down eventually to the consumer in increased costs of care,” Vient says. Although this tax doesn’t directly affect consumers, time and history have shown that the industry is very good at trickling additional costs down. “Maybe we’ll see this through insurance companies,” Vient adds. “It could directly affect our rates.”
What You Can Do to Safeguard Your Finances?
First of all, there’s a good chance that these laws won’t affect you at all. You probably don’t need to worry if:
- You earn less than $200,000 a year ($250,000 combined, if you’re married and file jointly)
- You don’t have any extraordinary medical expenses that take up a huge percentage of your income
- You don’t normally use more than $2,500 from your FSA
If You Do Earn More Than That Threshold …
“If there’s anything you can do to move your AGI below the threshold amounts,” Nice says, “then that could save you 3.8% tax on your income” because of the investment tax. For example, contributing to a 401(k) can reduce your total taxable income because traditional 401(k)s are pre-tax. If you’re near the cusp, reducing your income just a bit can make a difference.
If You Normally Deduct Medical Expenses on Your Taxes …
If you have high medical expenses that you’d normally deduct come tax time, and you are concerned that you won’t be able to make the new threshold, Vient suggests participating in an FSA at work, rather than trying to deduct medical expenses on schedule A when you file. Self-employed? “A high-deductible plan with an HSA will allow you to take advantage of tax deductions for your medical expenses.”
Concerned About the FSA Cap?
Vient says that, if you’re used to using more than $2,500 from your FSA, “it’s time to really think about your emergency fund.” Start by figuring out your out-of-pocket max for your co-insurance. If, for example, your expenses exceed $2,500, and your out-of-pocket max is $4,000, you could pay $1,500 out of pocket for medical expenses. If you weren’t expecting the extra hit, you may not have those extra funds available. But if you do that calculation in advance, then you can set that amount aside in your emergency fund.
What Else Is in Store for the Future?
In 2014, as a result of the Affordable Care Act, we’ll all be required to have health insurance (as long as our income is over a certain level), and if we don’t comply, we’ll be penalized with a fee. Most employers will also have to start providing health insurance for their employees or pay a $2,000-per-employee penalty.
Although the mandate requiring companies to provide insurance is intended to help average Americans, some speculate that it could increase costs for employers, which they’ll pass down by lowering wages.
In the end, Obamacare is still a mystery in many ways—not just because the law is incredibly long and dense, but because it is so far-reaching and wide-ranging that it’ll surely have many unintentional and unforeseen effects.
These might be good, bad or just plain interesting.