The Affordable Care Act (commonly referred to as Obamacare) is typically thought of as a law about health insurance coverage. However, it also resulted in major changes to the income and Medicare taxes paid by millions of Americans. These tax changes first took effect in 2013, and continue to affect primarily higher income taxpayers.
Everyone who works—whether a business owner or an employee—is required to pay Social Security and Medicare taxes. Employees pay one-half of these taxes through payroll deductions; the employer must pony up the other half and send the entire payment to the IRS. Business owners must pay all of these taxes themselves.
For all taxpayers, these taxes consist of a 12.4% Social Security tax up to an annual income limit, and a 2.9% Medicare tax on all wage or net self-employment income. Starting in 2013, however, Obamacare imposed an additional 0.09% Medicare tax on higher income taxpayers--married taxpayers with wage or self-employment income of $250,000 and single taxpayers with income of $200,000. Only the amount over these thresholds is subject to the additional 0.9% tax. Thus, for example, a self-employed single person with net self-employment income of $300,000 must pay a 2.9% tax on the first $200,000 and a 3.8% tax on the remaining $100,000. If a single employee has wage income of $300,000, the employer must withhold a 1.45% Medicare tax up to the $200,000 threshold and 2.45% after that. Employees must pay the entire additional 0.9% tax out of their own pockets. Thus, employers continue to pay a 1.45% Medicare tax on their employees’ wages. Employees continue to pay 1.45% until their wages reach the $200,000 or $250,000 ceiling. Then they pay the additional 2.35%.
The Medicare tax discussed in the previous section applies only to “earned income”—employee wages or the income earned by the self-employed. Starting in 2013, however, Obamacare did something revolutionary: It imposed a new Medicare tax on the "unearned income" higher income people make from their investments.
A 3.8% a Medicare contributions tax is imposed on the lesser of (1) the taxpayer’s net investment income, or (2) anyexcess of modified adjusted gross income over $200,000 ($250,000 for married taxpayers filing jointly). Thus, all single taxpayers with MAGI over $200,000 and married taxpayers with MAGI over $250,000 are subject to this tax. This is a small proportion of the population.
The tax applies only to investment income. This includes:
This includes just about any income not derived from an active business or from employee compensation.
Example: Sue and Sam, a married couple filing jointly, have a MAGI of $300,000 which includes $100,000 of net investment income. Their MAGI is $50,000 over the $250,000 threshold, thus they must pay the 3.8% tax on $50,000 of their investment income. This results in a $1,900 tax.
All taxpayers are entitled to a personal income tax deduction for medical and dental expenses for themselves and their dependents. Eligible expenses include both health insurance premiums and out-of-pocket expenses not covered by insurance. However, there are significant limitations on the deduction, which make it virtually useless (unusable) for most taxpayers.
To take the personal deduction, you must (1) itemize your deductions on IRS Schedule A, and (2) only deduct the portion of your medical expenses that exceeds an adjusted gross income threshold. For many years, the threshold was 7.5% of AGI. However, starting in 2013, the threshold for the itemized medical expense deduction for most people went up to 10% of AGI.
Example: Sue and Sam are each 50 years old and have an AGI of $100,000 and $30,000 in uninsured medical expenses. They may deduct only the portion of their expenses that exceeds 10% of their $100,000 AGI ($10,000). Thus, they may only deduct $20,000 of their expenses.
Older people were spared this increase in the threshold until 2017—that is, the 7.5% threshold continues to apply to taxpayers 65 and older through the 2016 tax year. After that, the 10% threshold applies to everybody.