Health Care Reform impacts high-income individuals

Months have passed since President Obama signed into law the "Patient Protection and Affordable Care Act ("PPACA"), the 2,049-page health care reform bill containing major changes to the laws governing health insurance practices, Medicare, Medicaid and other tax provisions. The legislation is intended to rein in runaway health care spending that both its supporters and detractors agree threatens to cripple economic growth in the United States.

The price tag for this reform is projected at $940 billion over the decade, although that figure is at best a guesstimate, presupposing a reduction in the historical growth rate of Medicare spending to 2 percent annually, from 4 percent. Experience, moreover, shows that ambitious federal programs often end up costing much more than their original estimates.

What is clearer, however, is where the proceeds to pay for this program are to come from. The PPACA makes provisions to raise $409 billion in additional revenues between 2010 and 2019. Those provisions include fees on drug manufacturers, health insurance providers and others, but the majority of the revenues - a projected $210 billion - will be generated by increasing taxes on high-income taxpayers.

I examine the impact of the legislation's provisions - the increase and broadening of the Medicare Hospital Insurance tax, the imposition of an excise tax on "Cadillac" health plans, changes to the health savings accounts, closing the Medicare Part D doughnut hole and the effect on small businesses - and outline their planning implications for high-income individuals.

1. The PPACA imposes a new 3.8 percent tax on unearned investment income for taxpayers having an adjusted gross income ("AGI") greater than $200,000 (individuals) or $250,000 (married couples), beginning in 2013.

Under current law, beginning 2013, high-income individuals will see effective rates of 43.4 percent on dividends and interest and 23.8 percent on capital gains.

I believe taxpayers may want to accelerate the recognition of capital gains in 2010, while deferring recognition of capital losses until 2011. The new Medicare tax may tip the odds in favor of converting a traditional individual retirement account to a Roth IRA.

2. Beginning 2018, the PPACA imposes a 40 percent nondeductible excise tax on so-called "Cadillac" health coverage plans costing $10,200 or more per year for an individual and $27,500 or more for a family.

3. One aim of the PPACA was to close the so-called "doughnut hole" in the Medicare drug-benefit legislation that went into effect in 2006. Under the former law, once total spending by elderly patients and their drug plan exceeds $2,830, beneficiaries hit a gap in coverage on the next $3,610 in which they must pay the full cost for medications.

4. The act preserves the popular HSA, while making minor changes. Under current law, individuals and families with high deductible health plans may establish tax-deductible contributions into a health savings account to use for qualified health expenses.

5. Under the act, for-profit small employers with fewer than 25 full-time employees and average annual wages below $50,000 will be eligible for a tax credit, provided they contribute at least 50 percent toward their employees' health insurance.

6. The act increases the threshold for claiming itemized deductions for unreimbursed medical to 10 percent of AGI, from 7.5 percent (effective January 1, 2013). This change will have a significant impact, given that the money spent on medical care by senior citizens far outpaces that of younger population groups.

7. PPACA extends the gross-income exclusion on employer-provided coverage to cover adult dependent children under age 27 as of the end of the tax year.

8. The act creates a national voluntary insurance program for buying assisted living services and support (long-term care). Premiums are paid through payroll deductions if the individual's employer participates in the program.

The PPACA is a historic piece of legislation. It represents one of the most ambitious undertakings since the last wave of social welfare legislation in the 1960s and expands the role of the federal government. It attempts to reshape the way health care services and coverage are provided. It addresses the shortcomings in earlier Medicare drug-coverage legislation and, to a certain extent, seeks to implement a national strategy that is aimed at preventing disease and promoting wellness by offering preventive measures and services.

The PPACA also carries a historic price tag. The cost of the legislation will add significantly to the tax burden of high net-worth individuals and families. Beginning in 2013, individuals earning more than $200,000 and married couples with wages in excess of $250,000 will pay a Medicare payroll tax of 2.35 percent, up from 1.45 percent. Additionally, high-income taxpayers will pay a 3.8 percent tax on unearned income such as dividends, interest and royalties above the threshold - any income other than that which is derived from a business activity or from tax-exempt sources, such as tax-exempt municipal bond interest, income from certain active partnerships and S corporations. The act also puts a 40 percent excise tax on so-called "Cadillac" health plans and increases the threshold for claiming deductions for unreimbursed medical expenses to 10 percent of AGI, from 7.5 percent (effective January 1, 2013).

More important, many debate whether PPACA will prove effective in reining in health care spending. If the bill's proponents are wrong, I believe the battle to raise taxes on high-income individuals and families will intensify.

• William Creekbaum, MBA, CFP, a Washoe Valley resident, is senior investment management consultant of Morgan Stanley Smith Barney LLC. He can be reached at William.a.creekbaum@mssb.com or 689-8704.