Home Taxes Why Do People Care About the New Health Care Surtax?

Why Do People Care About the New Health Care Surtax?

by My Journey to Millions

You literally can’t open a financial website or check out a financial magazine without hearing about the New Health Care Surtax and I don’t know why  It isn’t that a new tax of this magnitude isn’t important it is that just the majority of the people, call it 95%ish, will never encounter the new tax yet it is everywhere.

What is the New Health Care Surtax?

To partially pay for ObamaCare there was a new tax introduced, put simply by BNA-Bloomberg,

Beginning in 2013, individual taxpayers making over $200,000 annually ($250,000 for married individuals who are filing jointly) will be subject to increased Medicare tax rates (2.35%, up from 1.45%) and an “unearned income” healthcare surtax of 3.8% on all interest, dividend, capital gain, and passive business income.

Put a bit more complicated by the WSJ,

Determining whether you will be subject to the tax is no easy matter.

“The confusion lies in the fact that it’s not a yes or a no,” says Melissa Labant, director of tax for the American Institute of Certified Public Accountants. “It’s a sometimes or a maybe.”

“We’re waiting for guidance from the IRS on a lot of specific issues,” she adds. “We don’t have all of the answers yet.”

If I had to guess planning for this new tax is going to complicated albeit very interesting for financial planners, accountants and lawyers.  For example, tax deferred insurance based investments would not be included in investment income and thus would become even more popular.

Similarly, avoiding family attribution rules and business succession planning will get a lot of attention as it will be even more important to keep a divesting business owner under that threshold.  Just off the top of my head lets say you have someone selling a business for $X.  Couldn’t one just create a demand note and then demand the exact amount that will keep him or her under that tax.  By setting it up that (and I know it would be a little bit more complicated than I am making it – i.e. a buyer would probably want a chance to reduce principal) you could get “net to family” 4% more during the seller’s life with a balloon note payable at death.    Not an insignificant amount.

One could even argue that small business owners can alter their compensation schedule to include more taxable income and less investment income.  It would also push those same owners to actually utilize tax deferred retirement accounts more aggressively as it would lower their MAGI.

With all this interesting new planning ideas why don’t I understand the attention? Because it will affect virtually no one.

The New Health Care Surtax Is Likely not to Affect You

Let us go directly to the IRS data which is problematic for two reasons. One it is from 2009 and two, it provides Adjusted Gross Income and not Modified Adjusted Gross Income which is what the tax is based on.  For an example of why that makes a difference:

Here is a quick formula to determine if the the 3.8% surtax will apply:

    1. MAGI less than or equal to the threshold amount = no tax
    2. MAGI greater than the threshold amount = Tax is 3.8% of the lesser of investment income; or MAGI threshold amount

Note that the surtax liability is determined on income BEFORE any tax deductions (page 2 of Form 1040) are considered. As a consequence, a client with lots of deductions could be in the lowest tax bracket and yet have investment income that is subject to the surtax!

I am sure someone a lot smarter than I could mine the data from the IRS to figure out the number but let us take a simplistic look at just AGI:

Adjusted Gross Income 2009 IRS data

* The footnote [2] indicates less than a .05%

You may have to click to see it clearer but if you are not in the top 3% of earners for the country this is not a tax you need to worry about.  Even if we were to triple that number due to the fact we are dealing with Modified Adjusted Gross Income…we are only at 9% of the Country.

My Theory as to Why I think People Care About the New Health Care Surtax

Almost everyone wants to be rich and have a high income, if they say otherwise they are lying to you and themselves, and just don’t want to do what it takes to get there.  I know that statement sounds negative but it is not.  Could I make more? Maybe, but time with my Son is just so damn important to me.

Proof of that that statement is that people are consistently defending policies that are only affecting the top 3 to 9% of the Country.  If you even mention the death tax people go completely nuts, but again that only affects 1 to 3% of the Country!

Let me be clear I am not a fan of Obamacare as it is written today and being implemented over the next couple year, but I just don’t understand why some of the financial media is jumping on it like most of their readers are in the top one-tenth of the country.

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PK 10/03/2012 - 11:32 am

1) The same defense could be made of the original Alternative Minimum Tax (but it only affects 154 households!)
2) I agree; the Cadillac Plan tax is much more likely to affect people immediately than this tax.
3) The sum of taxes and fees are going to (ahem, likely have already) increase the costs of certain plans, so even if the Cadillac is indexed to inflation + population, it will probably capture more and more folks yearly. I don’t see medical inflation growing slower than regular inflation – maybe I’ll be proven wrong.

Evan 10/12/2012 - 1:45 pm

1) I think the AMT only gets attention because for some reason Congress can’t get their freaking act together and fix it once and for all (i.e. set it to inflate). If it just existed I think it would get less press.

2 & 3) All great points and there is no way you are going to be proven wrong. AND THAT IS MY MAIN PROBLEM WITH OBAMACARE it does NOTHING in terms of prices/costs/expenses. I am not saying it should, but without a focus on that then the problem just doesn’t go away.

Jamie 10/03/2012 - 5:58 pm

I guess that most finance news sources talk about it because people who make more money to get hit by the surtax probably read financial news. It is a really small surtax, though. I think it is worth it.

Evan 10/12/2012 - 1:46 pm

Finance news only there for those that are in the top few percentage points? I would have to guess that anyone making $250-300K+ does not read money magazine.

The BoBo 10/04/2012 - 10:19 pm

While this particular tax may not hit the majority of us – there are certainly others in the bill that do:

Medicine Cabinet Tax ($5 bil/Jan 2011): Americans no longer able to use health savings account (HSA), flexible spending account (FSA), or health reimbursement (HRA) pre-tax dollars to purchase non-prescription, over-the-counter medicines (except insulin). Bill: PPACA; Page: 1,957-1,959.

HSA Withdrawal Tax Hike ($1.4 bil/Jan 2011): Increases additional tax on non-medical early withdrawals from an HSA from 10 to 20 percent, disadvantaging them relative to IRAs and other tax-advantaged accounts, which remain at 10 percent. Bill: PPACA; Page: 1,959.

Tax on Medical Device Manufacturers ($20 bil/Jan 2013): Medical device manufacturers employ 360,000 people in 6000 plants across the country. This law imposes a new 2.3% excise tax. Exempts items retailing for <$100. This will increase the costs to consumers. Bill: PPACA; Page: 1,980-1,986

Raise "Haircut" for Medical Itemized Deduction from 7.5% to 10% of AGI ($15.2 bil/Jan 2013): Currently, those facing high medical expenses are allowed a deduction for medical expenses to the extent that those expenses exceed 7.5 percent of adjusted gross income (AGI). The new provision imposes a threshold of 10 percent of AGI. Waived for 65+ taxpayers in 2013-2016 only. Bill: PPACA; Page: 1,994-1,995

Flexible Spending Account Cap – aka “Special Needs Kids Tax” ($13 bil/Jan 2013): Imposes cap on FSAs of $2500 (now unlimited). Indexed to inflation after 2013. There is one group of FSA owners for whom this new cap will be particularly cruel and onerous: parents of special needs children. There are thousands of families with special needs children in the United States, and many of them use FSAs to pay for special needs education. Tuition rates at one leading school that teaches special needs children in Washington, D.C. (National Child Research Center) can easily exceed $14,000 per year. Under tax rules, FSA dollars can be used to pay for this type of special needs education. Bill: PPACA; Page: 2,388-2,389

Elimination of tax deduction for employer-provided retirement Rx drug coverage in coordination with Medicare Part D ($4.5 bil/Jan 2013) Bill: PPACA; Page: 1,994

So – while I may not really care about the surtax (I wish I had to worry about it) – the one's I mentioned above certainly do affect me – and I'm sure if it affects me – there are hundreds of thousands of others out there just like me that it will hit.

Aaron 10/06/2012 - 6:36 pm

The problem with complaints about FSA caps hurting people with special needs children is FSA isn’t a universally available program, and the limit was set by your employer. It can’t be said that FSA was unlimited.

I’m impacted by the FSA cap because my current employer’s cap is $5000, and they can change that anytime they want. However, my previous employer had a cap of $2400, so this limit wouldn’t have done diddly to me. People with special needs can’t really count of FSA because of that because their employer may not offer it, could end it, or reduce their limit anyway.

On top of that, you only save what you would have paid in income tax on the money you contributed to FSA. If your income puts you into a high tax bracket, you save a lot, but someone with more limited income, and therefore may not pay much of anything in income taxes anyway, barely benefits.

Then on top of all that the use it or lose rules, etc. which prevent you from saving money when medical costs surge on you, which is often when you need it most. My wife just had two hospital stays, totaling $1500 of out of pocket expenses. FSA could have really helped me there, but I wasn’t clairvoyant to know that was gonna happen.

On top of all that, for people with severe medical costs, the federal gov’t already allows you to claim a deduction if your costs exceed a percentage of your income. Granted, it’s exceptionally difficult to reach that amount, but it’s there nonetheless for people who unexpectedly get devastated by medical costs due to medical emergencies.

On top of that, there are provisions to allow for you gain coverage through medicare programs when you contract conditions that require higher medical care costs. For example, my wife recently had to begin dialysis, so she now qualifies for Medicare Part B, which will cover out of pockets our primary insurance won’t. That assistance can help with people who have special needs children, albeit not all of them.

I take advantage of FSA, but it’s not a good program to reduce medical care costs for society overall. Therefore, IMO, damage to FSA is perfectly acceptable if there are other more effective ways to save everyone money on health care.

What would help everyone is if costs were going to be controlled, which is one of the points of Obamacare. There’s a whole other debate about if that’s actually going to happen. I personally think they gutted too much of the provisions that actually would have brought down costs significantly to compromise with hysterical political opposition to the bill.

My biggest gripe about Obamacare isn’t the bill. There should have been a rational, open-minded debate about it, which could have helped improve the bill. Instead, there was a knee-jerk reactionary response to it based on political ideology that slammed the bill because it didn’t fit a particular ideology, and valid criticisms got drowned out. The discussions I had with people about the bill centered almost 95% around striking down ridiculous claims about what wasn’t in the bill than its actual weaknesses, and that continues to this day with talks of Death Panels and the like.

P.S. Please don’t take this as support for Obamacare. I’ve had to defend Obamacare far more than anyone should who isn’t even sure if they support it or not. I’m merely criticizing the system that was in place before it. Count me in the group who definitely thinks significant reform is/was necessary. I just don’t know if Obamacare was the right reform.

Abigail 10/14/2012 - 1:40 pm

Interesting stuff.

When people get upset about extra taxes, I try to remind them that we already pay taxes for other people’s medical problems.

For example, my uninsured husband had two very sudden asthma attacks this year. Turns out they were exacerbated by pneumonia, which we had thought were head colds.

The $9,000 ER bills (just the room and care, not doctors or ambulance, by the way) were heavily discounted given our financial situation. So we’ll pay around $1,750.

If he had some form of insurance, the hospital would have gotten at least $4,500 — probably closer to $7,000.

So hospitals have to rely on government grants. In other words, taxpayers are already paying for sick people.

What I get tired of is people who are against Obamacare have rarely been serious ill. They truly don’t understand how random disease can be — and they certain don’t understand how expensive it can be.

At 19, I was overweight but otherwise a pretty healthy 19 year old. No surgeries, never broken a bone, never even been to ER. Then I got a stomach bug and, within a week, was in the ICU on life support. And spent the next three months in a hospital. Plus another two months of physical therapy.

One of my doctor’s bills from one of the three hospitals was $70,000. That’s not including the cost of the room, drugs, physical therapy, occupational therapy or respiratory care.

Will most people get a rare neurological disease? No. But my point is that you can’t predict. And if you gamble and lose… well, you really lose. And so do the taxpayers when you can’t pay your hundreds of thousands of dollars in bill.


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