Given all the chatter the last few months, Thursday’s Supreme Court ruling was a surprise for both parties—most assumed the ruling would be very different. It might seem that with higher taxes imminent, investors should start scrambling; however, as we’ve said before, sometimes an active portfolio decision is to do nothing. We do not know the impact of this ruling yet. Investors do not like someone who says, “I don’t know.” However, nobody really knows. We have several other hurdles that our markets must contend with this year: the European sovereign debt crisis, the presidential election and the debt ceiling debate.
Regardless of your political inclinations, we will spend a significant amount of time evaluating the financial ramifications of this ruling. The majority of the provisions become effective in 2013 and 2014. Some of the highlights include:
2013 Payroll/Medicare Tax Increase:
Change: Starting in 2013, employers will be required to withhold an additional 0.9% in Medicare payroll tax on earned income for high wage earners. High wage earners are defined as individuals with adjusted gross income (AGI) of $200,000 or more; $250,000 for married filing joint and qualifying widows or widowers, and $125,000 for married filing separately.
Impact: The current Medicare withholding tax is 2.9%, with employers and employees each contributing 1.45%. In 2013, the Medicare withholding tax increases to 3.8%—meaning each party will have to contribute 0.45% more.
2013 Medicare Tax Applied to Passive Income for High-Income Individuals:
Change: In addition to Medicare taxes being increased to 3.8%, they will be expanded to cover passive income for high wage earners. Passive income is defined as investment income, capital gains, rent, etc. Threshold amounts are $200,000 (AGI) for individuals and $250,000 (AGI) for families.
Impact: This is best explained by example: John and Denise are married and file a joint tax return. They have $275,000 in combined earned income and $60,000 of investment income from dividends and capital gains. Their adjusted gross income is $335,000. They do not have any foreign income exclusions. The impact of this change is an additional $2,280 in taxes.
Step 1: Calculate their net investment income = $60,000
Step 2: Calculate their modified adjusted gross income in excess of the threshold amount = $335,000 – $250,000 for joint filers = $85,000
Step 3: Take the lower of net investment income or modified adjusted income over the threshold = $60,000 in this case.
Step 4: Multiply that amount by the new tax = $60,000 x 3.8% = $2,280
2012 Flexible Savings Account (FSA) Limit Decrease:
Change: The FSA maximum reimbursement cap will be set at $2,500 for health care FSAs.
Impact: In 2012, FSAs are generally capped at $5,000. Most people put away less than this; however, if you take full advantage of your employer’s maximum, you will see a reduction in the amount you can save in 2013. For example, if you are in the 25% tax bracket, you save $250 in taxes for every $1,000 you contribute to your FSA. Reducing the FSA withholding amount from $5,000 to $2,500 means you will pay an additional $625 in taxes.
2014 Employer Mandate
Change: Employers with 50 or more employees may be subject to two potential penalties: the No Coverage Penalty and the Unaffordable Coverage Penalty. The penalties effectively require employers to offer coverage or pay a penalty.
Impact: An employer must offer full-time employees, and their dependents, an opportunity to enroll in employer coverage. the coverage must be both affordable and valuable to avoid penalties. Employers with more than 50 employees that offer coverage, but such coverage is “unaffordable” or not “qualified,” and have at least one full-time employee receiving a premium tax credit, will pay the lesser of $3,000 for each employee receiving a premium credit, or $2,000 for each full-time employee. Coverage would be considered unaffordable if the premiums for the class of coverage selected by the employee exceed 9.5% of their family income.
Going Forward
While planning for higher taxes should begin now, we also ask that you not to make knee-jerk reactions. If you make investment decision on emotion, you will generally never win. If you are working with an adviser, know that they need to put time and effort into how the health care laws affect your personal financial situation. Investment analysts need to research how companies operate and profit in countries with similar government mandates. Analysts must to determine how much impact these laws are already priced into the stocks. The market is forward looking, and it may have predicted this outcome before the general population did.
To reiterate, there are numerous issues that still need to unfold, including the European debt crisis, our presidential election, which very well may change the tax laws again, and the U.S. debt ceiling. It is going to make for a volatile market and emotional roller coaster.
As each issue is resolved our recommendations for how to move forward may change. Please know we are here to help you Live Ready through these turbulent times. If you have questions, the experts at Henssler Financial will be glad to help. You may call us at 770-429-9166 or email at experts@henssler.com.
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