On March 23, 2010, President Obama signed comprehensive health reform, the Patient Protection and Affordable Care Act, into law. It was subsequently deemed constitutional by the Supreme Court and includes some major tax changes that will take effect next year. Here is a refresher course on how sweeping health-care reform will impact individual taxpayers like you.

While the individual mandate tax gets most of the attention, the new law actually contains 20 new or higher taxes on the American people. These taxes are gradually phased in over the years 2010 to 2018.

Some of the items that are already in effect are:

As of July 1, 2010, individuals using indoor tanning salons pay a new 10% excise tax. This has not produced as much revenue as anticipated.

As of January 1, 2011, employees with health savings accounts, flexible spending accounts or health reimbursement accounts are no longer able to use pre-tax funds in these accounts to buy over-the-counter medicines for allergy relief and the like without a doctor’s prescription (there is an exception for insulin).

As of January 1, 2011, taxpayers who withdraw money from health savings accounts for non-medical expenses before age 65 face a 20% penalty, up from 10% before.

On January 2013, five new taxes will come into force:

1. The Medical Device Manufacturing Tax

This 2.3 percent tax on medical device makers will raise the price of (for example) every pacemaker, prosthetic limb, stent, and operating table.  The tax is particularly destructive because it is levied on gross sales and even targets companies who have not turned a profit.

Potential concerns:

These are often small companies with less than 20 employees who pioneer the next generation of life-prolonging devices. In addition to raising the cost of health care, this $20 billion tax over the next ten years will not help the country’s jobs outlook, as the industry employs nearly 400,000 Americans. Several companies have already responded to the looming tax by cutting research and development budgets and laying off workers.

2. Higher Threshold for Itemized Medical Expense Deductions

This onerous tax provision will hit Americans facing the highest out-of-pocket medical bills. Currently, Americans are allowed to deduct medical expenses on their tax return to the extent the costs exceed 7.5 percent of their adjusted gross income.  The new provision raises that threshold to 10 percent, subjecting patients to a higher tax bill.

Potential concerns:

This tax will hit pre-retirement seniors the hardest. Over the next ten years, affected Americans will pay an estimated $15 billion in taxes related to this provision.

3. Cap on Flexible Spending Account Contributions

The 24 million Americans who have Flexible Spending Accounts will face a new federally imposed $2,500 annual cap. These pre-tax accounts, which currently have no federal limit, are used to purchase everything from contact lenses to children’s braces. With the cost of braces being as high as $7,200, this tax provision will play an unwelcome role in everyday kitchen-table health care decisions.

The cap will also affect families with special-needs children, whose tuition can be covered using FSA funds. Special-needs tuition can cost up to $14,000 per child per year. This tax provision will limit the options available to such families and cost taxpayers approximately $13 billion out of pocket over the next ten years.

4. Medicare Tax on Investment Income

Under current law, the maximum federal income tax rate on long-term capital gains and dividends is only 15%. Starting in 2013, the maximum rate on long-term gains is scheduled to go up to 20% and the maximum rate on dividends is scheduled to increase to 39.6% as the so-called Bush tax cuts expire.

But that’s not all. Also starting in 2013, all or part of the net investment income, including long-term capital gains and dividends, received by higher-income taxpayers will incur an additional 3.8% “Medicare contribution tax.” Therefore, the maximum federal rate on long-term gains for 2013 and beyond will actually be 23.8% (versus the current 15%) and the maximum rate on dividends will be a staggering 43.4% (versus the current 15%).

The additional 3.8% Medicare tax will not apply unless your adjusted gross income (AGI) exceeds: (1) $200,000 if you’re unmarried, (2) $250,000 if you’re a married joint-filer or (3) $125,000 if you use married filing separate status.

The additional 3.8% Medicare tax will apply to the lesser of your net investment income or the amount of AGI in excess of the applicable threshold. Net investment income includes interest, dividends, royalties, annuities, rents, income from passive business activities, income from trading in financial instruments or commodities, and gains from assets held for investment like stock and other securities. (Gains from assets held for business purposes are not subject to the extra tax.)

For example, a married joint-filing couple with AGI of $265,000 and $60,000 of net investment income would pay the 3.8% tax on $15,000 (the amount of excess AGI). If the same couple has AGI of $350,000, they would pay the 3.8% tax on $60,000 (the entire amount of their net investment income). The tax will take a minimum of $123 billion out of taxpayer pockets over the next ten years

5. The Medicare Payroll Tax increase

Right now, the Medicare tax on salary and/or self-employment (SE) income is 2.9%. If you’re an employee, 1.45% is withheld from your paychecks, and the other 1.45% is paid by your employer. If you’re self-employed, you pay the entire 2.9% yourself.

Starting in 2013, an extra 0.9% Medicare tax will be charged on: (1) salary and/or SE income above $200,000 for an unmarried individual, (2) combined salary and/or SE income above $250,000 for a married joint-filing couple, and (3) salary and/or SE income above $125,000 for those who use married filing separate status. For self-employed individuals, the additional 0.9% Medicare tax hit will come in the form of a higher SE bill.

Note that these taxes are both “progressive” (aimed at rich people) and “regressive” (aimed at the middle class and those with minimal incomes). The big ones–the 3.8% investment income hike and the Medicare tax increase–only hit you if you’re making more than $200,000 a year. The rest hit you no matter how much you’re making.

Richard Simms Founder

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