NEW YORK (
) -- The Patient Protection and Affordable Care Act (PPACA) became law back in March 2010. Various provisions of the law go into effect over the next several years. The Supreme Court during 2012 decided not to strike down the law so it largely moves forward as written with a few exceptions. The PPACA includes two new taxes which become effective in 2013. It is critical for those defined as high earners to understand how these new taxes work and the strategies available to minimize their impact.
The first new tax is an incremental 0.9% Medicare tax on wages above $250,000 (married filing joint) and $200,000 (single). A married couple with $500,000 in wages in 2013 will owe an incremental $2,250 in taxes or simply $250,000 x.9%. This new tax is applied to gross wages and is before deductions for items like 401(k) contributions and healthcare premiums. It should be noted the tax also applies to self employment income earned by sole proprietors and partnerships as well.
This first tax will be hard to avoid as it is simply a function of wages or self employment income. The only way to avoid it is to structure compensation to stay below the $250,000 or $200,000 level.
The second new tax related to Obamacare is the "unearned income" tax. Married couples filing jointly with modified adjusted gross income (MAGI) above $250,000 are subject to this new tax. For single individuals this tax kicks in for MAGI above $200,000. So how does this second tax work? A married couple will pay the lower of 3.8% of:
1) excess MAGI above $250k or 2) unearned income.
For example, a married couple with a MAGI of $280,000 and unearned income of $15,000 would owe $570. The calculation works as follows:
Excess MAGI $30,000 x 3.8% = $1,140
Unearned income $15,000 x 3.8% = $250
What is considered unearned income? Unearned income is very broad and includes: taxable interest, dividends, net capital gains, annuities, rents (non-trade/business), and royalties. Luckily, tax planning does exist for this second tax.
The first strategy is to use tax exempt municipals since muni interest is not considered unearned income. A second possible strategy is to use what is known in the financial planning industry as "asset location," strategically dividing assets between taxable and tax-deferred accounts (401k, IRA, Roth IRA) in a way that maximizes after-tax returns. For example, placing an asset class like taxable corporate bonds inside a tax deferred account is more tax efficient. Likewise, a small cap stock fund that pays no dividend makes sense in a taxable account. The goal of asset location is to reduce unearned income where possible. Remember, the lower the unearned income the lower the tax bite!
One other potential planning opportunity involves Roth conversions. While IRA required minimum distributions are not considered unearned income they are considered part of MAGI. Roth IRA distributions are not considered unearned income or MAGI.
I would caution each strategy needs to be evaluated to a person's circumstances. Also, it is important to remember taxes are but one part of the overall situation and the tax tail should not wag the dog. Plan now for these 2013 taxes it might just save you some money!
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--By Michael Maye
Michael Maye is the founder and president of MJM Financial Advisors (www.mjmfinadv.com), a registered investment advisory firm in Berkeley Heights, N.J. He is a member of the National Association of Personal Financial Advisors (NAPFA) and has been a speaker covering tax topics at NAPFA's national and regional conferences. Maye has also been a frequent contributor to the Star Ledger of New Jersey's "Biz Brain" and "Get With the Plan" articles. In addition to NAPFA, he is a member of Financial Planning Association, American Institute of Certified Public Accountants, New Jersey State Society of CPAs and the Estate Planning Council of Northern New Jersey.
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