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The media has widely reported the coming “fiscal cliff” that arrives in just over four months. The cliff has two jagged edges to it, massive tax increases caused by the end of the so-called Bush tax cuts, and automatic spending reductions caused by last November’s failure of the budget “supercommittee” to reach agreement on spending cuts.
The combined effect of these measures is expected to be a reduction in the budget deficit from calendar 2012 to calendar 2013 equal to 5.1 percent of GDP. The bad news is that GDP is expected to shrink at an annualized rate of 1.3 percent for the first half of 2013 if we walk off the cliff.
No one really wants either complete elimination of the Bush tax cuts or all of the automatic cuts required by the 2011 Budget Control Act, at least not on Jan. 1, 2013. So our elected representatives are busily at work doing … nothing about this.
So it’s now pretty much agreed that our leaders will march, lemming-like, toward the cliff at least until after the November elections. At that point, they will either attempt a quick change in path, or simply jump into the sea in January and hope they can swim to safety.
Tax advisers are now practicing responses to clients who want to know what the tax system will look like in 2013. They want to shrug their shoulders and stare at their shoes until the client walks away, but professional standards require a Wizard of Oz-like theatric show of obfuscation.
To be honest, we do know that the provisions of the recently determined-to-be-not-unconstitutional Affordable Care Act will raise taxes for two groups. First, those who earn more than $250,000 (married) or $200,000 (single). Second, those who get tax benefits from having high medical costs.
Let’s start with the big earners. They will be hit with two new taxes. If they have investment income, such as capital gains, interest, dividends, rents, and so on, they will pay an additional 3.8 percent Medicare tax. Retirement income is not subject to this tax.
We tend to hear “$250,000 of income” thrown out without any explanation of what that means. It means “modified” adjusted gross income (AGI), which is the number at the bottom of page one of the tax return, before any itemized deductions, or personal and dependency exemptions.
A big earner with income from working will pay a 0.9 percent surtax on the Medicare portion of their Social Security taxes. If the worker is employed, it is only their share that is increased, not the employer’s. The surtax is also a single 0.9 percent for the self-employed, who otherwise pay both halves of Social Security taxes.
These high-income surtaxes are not terribly onerous, unless we also walk off the cliff. High-income tax rates on dividends may rise from 15 percent to 43.4 percent and capital gain rates from 15 percent to 23.8 percent if we also toss the Bush tax cuts for the high earners.
But, you ask, did you really mean to say that taxes would rise for those who have a lot of medical costs? Yes, I meant that, but it won’t be as bad as for the high earners.
Starting in 2013, medical expenses for those under age 65 will not be tax deductible unless they exceed 10 percent of adjusted gross income (the current level is 7.5 percent).
There are not many people who receive any tax benefit from medical costs anyway, except for the older crowd with more substantial costs, but those 65 or older will not be affected by this change until 2017.
Employees (typically of larger firms willing to accept the administrative tasks required) may have the option to contribute pre-tax dollars to a health-care account that allows them to be reimbursed for medical costs.
These Flexible Spending Accounts create the sale benefit as if all reimbursed costs were tax deductible. Beginning in 2013, contributions to health-care FSAs is limited to $2,500 per year.
Many FSA participants don’t contribute $2,500 anyway, as they can only be reimbursed for out-of-pocket costs, but those with knowledge of a family situation that will create large costs will now be limited in their ability to benefit from the FSA.
James R. Hamill is the director of Tax Practice at Reynolds, Hix & Co. in Albuquerque. He can be reached at jimhamill@rhcocpa.com.
