You have undoubtedly read a lot about the impact the 2010 healthcare reform legislation may have on your medical practice. But do you know how that legislation may affect your personal bottom line?
Now that the Supreme Court has upheld most of the provisions of the new healthcare laws, two new taxes will go into effect Jan. 1, 2013, to help pay for the cost of the legislation.
One is a 0.9 percent hospital insurance tax that will apply to earned income. The other is a 3.8 percent unearned income Medicare contribution tax that will apply to investment income.
New tax on earned income
The additional 0.9 percent hospital insurance (HI) tax will apply to wages and net earnings from self-employment in excess of a threshold amount. The threshold is $250,000 for married couples filing a joint return, $125,000 for married couples filing separately and $200,000 for those who are not married.
Since these amounts are not adjusted for inflation, even if you are below the threshold in 2013, you may become subject to the HI tax in the future. If you and your spouse both have earned income and the combined amount exceeds the threshold, the tax will apply to the excess.
If you operate your medical practice as a sole proprietor, partnership or LLC, your self-employment income will be subject to the additional HI tax. You will also be required to collect the additional tax through payroll withholding if you pay wages to employees in excess of the thresholds. But, unlike the regular 1.45 percent HI tax, there is no employer matching contribution.
New tax on net investment income
The 3.8 percent unearned income Medicare contribution (UIMC) tax will be imposed on the lesser of:
- Your net investment income; or
- The excess of your modified adjusted gross income over a threshold amount.
The threshold amounts are the same as those used for the new HI tax – also not indexed for inflation.
Net investment income is the sum of the following items, less deductions properly allocable to such items:
- Gross income from interest, dividends, annuities, royalties and rents, other than such income derived in the ordinary course of a trade or business to which the UIMC tax does not apply
- Income from a passive trade or business
- Net gain attributable to the disposition of property, other than property held in a trade or business that is not passive, which can include gains from the sale of your personal residence to the extent the gain is otherwise included in taxable income – i.e., the gain in excess of the amount eligible to be excluded from taxable income
Business income from a passive activity is considered investment income for purposes of the UIMC tax. If you invest in rental real estate or a business in which you do not “materially participate,” your losses may be limited by the passive loss rules, and your profits may be subject to the UIMC tax.
The new UIMC tax will likely not apply to your share of the income from your medical practice, since it is most likely active business income.
Planning for the new taxes
You should meet with your tax adviser to begin planning for the UIMC tax now. In 2013, the UIMC tax will be combined with the scheduled increase in the top marginal tax rate, significantly increasing the tax you may be paying on investment income.
If you can minimize either your modified adjusted gross income or your net investment income, or both, you will reduce the impact of the UIMC tax.
Here are a few strategies you may consider:
- Choose investments that produce tax-exempt or tax-deferred income, such as non-dividend-paying growth stocks, tax-deferred annuities, or state and local government bonds.
- Accelerate income into 2012 through making sales earlier or electing out of the installment sales method of reporting gains.
- Elect installment reporting to spread the capital gain from a sale in 2013 or later over several years, reducing modified adjusted gross income and deferring the recognition of net investment income.
- Try to avoid or reduce the UIMC tax by making tax-deductible retirement plan contributions to reduce modified adjusted gross income below the threshold level, if your income is near the threshold.
- Pay attention to all passive activities, whether they produce profits or losses.
- Consider the use of family limited partnerships and other income-shifting techniques to transfer investment income to your children. Although your children’s investment income may be taxed at your marginal tax rate under the “kiddie tax” rules, your children will not be subject to the UIMC tax, unless their modified adjusted gross income exceeds $200,000, assuming they aren’t married.
While you may have been focused on year-end tax planning for 2012, it is not too early to begin planning for 2013 taxes, too.