As people are completing their tax filings for 2012, many are beginning to think about the impact of the new tax laws for 2013.
For medical professionals, the actual effect of some of these new provisions may depend on the type of business entity they have chosen for their practice.
Two major income tax law changes went into effect Jan 1, 2013:
- The Patient Protection and Affordable Care Act, which has income tax provisions designed to pay part of the cost of the healthcare act
- The American Taxpayer Relief Act, which raised income taxes to keep the country from falling off the “fiscal cliff”
Both of these laws purport to raise income taxes only on the wealthiest Americans. Unfortunately, Congress was unable to agree on a universal definition of an income level above which a person would be considered “wealthy.”
By using a person’s adjusted gross income (AGI) or taxable income to gauge wealth, business owners – including many medical professionals – who have organized their businesses as S corporations, LLCs, partnerships or sole proprietorships may wind up paying these new taxes because the profits from their businesses are included in their personal income tax returns. Others who operate their businesses as C corporations include only their salary and any dividends from their business as personal income.
Here is a summary of the major new tax laws and the income thresholds at which they apply:
Patient Protection and Affordable Care Act
Those with high net investment income (NII) will pay a 3.8 percent surtax. The surtax applies to the lesser of NII or modified adjusted gross income (MAGI), to the extent either exceeds a threshold amount. For individuals, the thresholds are $250,000 for married couples filing jointly, $200,000 for singles and $125,000 for married couples filing separately.
- Income from a business in which a physician actively participates is included in MAGI, but not in NII.
- Income from a business that is a passive activity is included in both NII and MAGI.
- If a medical practice operates as a C corporation, the physician’s salary is included in MAGI, but not in NII.
- Dividends from the C corporation are included in both MAGI and NII.
An additional 0.9 percent payroll tax applies to wages and net earnings from self-employment in excess of a threshold amount: $250,000 for married couples filing jointly, $200,000 for singles and $125,000 for married couples filing separately.
The additional tax on wages is collected primarily by employers through payroll withholding. Any shortfall, plus the tax that applies to self-employment income, is assessed on the taxpayer’s income tax return.
Employers will withhold the additional tax only on compensation in excess of the threshold. However, if a physician’s spouse is employed or the physician also has net earnings from self-employment, the withheld amount may fall short. The physician will owe the difference with the income tax return.
American Taxpayer Relief Act
- A 39.6 percent tax rate bracket will apply to married couples filing jointly with taxable income above $450,000. The threshold is $225,000 for married couples filing separately and $400,000 for those who are not married. Note that the gauge for being considered “wealthy” in this context is taxable income, which can be considerably lower than AGI. If a practice operates as an S corporation, LLC, partnership or sole proprietorship, physicians are more likely to have higher taxable income than if their business operates as a C corporation and they receive salaries.
- At the same income levels, the maximum tax rate for long-term capital gain income is 20 percent on long-term capital gains in excess of the above thresholds. The 15 percent maximum rate continues to apply at lower income levels.
- The amount taxpayers would otherwise be entitled to for itemized deductions and exemptions begins to phase out as their AGI increases above a threshold amount: $300,000 for married couples filing jointly, $275,000 for a head of household, $150,000 for married couples filing separately and $250,000 for others who are not married.
While it seems unlikely that many business owners, including medical professionals, will change the tax structure of their business solely because of the new laws, it is always a good idea for them to review the particulars of their situation with a tax adviser to assess the impact of the new laws on their expected tax liability.