Help! I’ve Been Taxed and I Can’t Get Up

Like many of you, the passage of the healthcare bill wasn’t met with the popping of champagne in my house. I found myself chanting “Uncle Sam, Uncle Sham” as the day wore on. Higher taxes and other major changes are headed our way. And yet, I think there’s something in the bill that’s even more dastardly.

If you’re a supporter of the bill, you’d point to its benefits: Poor adults will get Medicaid. Low-income families will get federal subsidies to buy insurance. Small businesses may get tax credits. Kids will be able to stay on the parents’ policy until they turn 26. Seniors get additional prescription drug coverage. People with pre-existing medical conditions can’t be denied or dropped.

While no one is really against any of those things, the elephant in the room (or boa constrictor in the bed) is how those things are going to be paid for. Here’s how: the “wealthy” will pay higher taxes; businesses with 50 or more employees will have to insure them or pay a penalty; individuals will have to pay a fine if they don’t buy insurance; premiums will rise for many who already have insurance; and seniors with Medicare Advantage policies could lose those plans or pay more to keep them.

Regardless of how you feel about the bill, the fact is that taxes are going up, and not necessarily just on the “wealthy.” The healthcare plan will cost $940 billion over the next decade, almost $100 billion a year.

I haven’t read the 2,407-page bill (almost twice as long as the Gutenberg Bible), but there are plenty now who have. Here’s a summary I compiled, from various sources, that outlines the tax ramifications of what is now the law of the land.

Assuming the Senate passes the package of changes, the biggest tax increases will be in Medicare payroll taxes. Those take two forms, both starting in 2013:

• Singles earning more than $200,000 and couples earning $250,000 will pay 0.9% more on wages and self-employment income.

• All investment earnings will be taxed an additional 3.8%. This includes capital gains, dividends, and interest, the first time in history the Medicare tax is applied to them.

But keep in mind that the Bush tax cuts expire at the end of this year, which will push the Medicare tax on capital gains to 23.8% in 2013 on these earners. Dividends, currently taxed at the top rate of 15%, will be taxed as ordinary income, with the top rate scheduled to rise to 39.6% (from 35%).

This means that the tax on dividends could go as high as 43.4% when the new Medicare tax goes into effect in 2013. (Obama has proposed a top dividend tax rate of 20%, so if Congress enacts his proposal, the top tax rate for dividends would “only” rise to the 23.8% level in 2013.)

You may think you’ll escape this tax if you’re not “rich.” But it’s those darn Unintended Consequences politicians never seem to think about that could still sting you. For example, the 3.8% Medicare surtax could snag you if you happen to sell some real estate for a big gain.

The other major tax increase is the one imposed on health insurance plans that are more generous, the so-called “Cadillac” health plans. And this tax increase doesn’t just apply to high-income earners; those state and union workers that lobbied for better health coverage instead of big pay increases are going to find they’re included with the “rich” in a new excise tax. Starting in 2018, family insurance plans valued at more than $27,500 ($10,200 for individuals) would pay a 40% tax above that level.

Ouch.

And there’s other ways you’ll be taxed, particularly through the magic of “passing it on to the consumer.”

For example, pharmaceutical manufacturers will pay an annual fee based on their market share starting in 2011; same for health insurers, starting in 2014. A 2.3% excise tax on the sale of medical devices will start in 2013. A 10% excise tax on indoor tanning services goes into effect this July.

How will all these businesses afford the additional tax? They won’t. You’ll pay it, through higher prices.

Further, were you one of those who incurred medical expenses above 7.5% of your income, thus allowing you to deduct them? That ceiling will be 10% starting in 2013. (It remains 7.5% for those over 65.)

There’s more, most of it in the form of greater restrictions, increased penalties, and higher fines on various entities, businesses, health plans, or individuals. But what I especially cringed at was this: the bill vastly expands the responsibilities of, and gives greater strength to, the IRS. The agency will hire as many as 16,500 additional auditors, agents, and other employees just to enforce all the new taxes and penalties.

Specifically, the bill will empower the IRS to do the following: verify citizens have “acceptable” health care coverage; impose fines up to $2,085 or 2% of income (whichever is greater) for failure to purchase “minimum essential coverage”; confiscate tax refunds; and increase audits.

The upshot is that this will force many taxpayers to be more conscientious of monitoring their income and tax withholding.

Perhaps most damaging to the government’s plans is if the bill leads some to ask the Ayn Rand/Atlas Shrugged questions: What if I just stop being productive? What if I stop working once my income approaches the threshold? What if I invest less so that I stay under the limits?

And last, here’s the time bomb that could trump the tax concerns: none of these taxes are indexed to inflation. Since the bill fails to index to inflation the exemption threshold for the Medicare taxes on both earned and unearned income, it’s almost certain many taxpayers will get to these tax levels a whole lot quicker than they think.

What this essentially means is there is now more incentive on the part of the government that we have inflation. If inflation reaches 10% at some point, which is below the 14%+ rate it hit in 1980 and far below any hyperinflationary level that’s possible, the $100,000 earner gets to the magical $200,000 level in seven-and-a-half years. From the government’s perspective, it makes the printing of money a lucrative affair.

Yes, higher taxes are coming. But with the government’s built-in incentive for inflation, along with the reward that comes from getting more citizens to higher tax rates, many may find the tax issue an annoying mosquito bite compared to the alligator chomp of inflation. And high inflation affects every citizen, regardless of income or tax rate. Those who think they’ve escaped the cold may find they’ve walked into a freezer.

With this added push to inflate, our investment strategy for the foreseeable future is now clear: We must invest in assets that not just keep up with inflation but outpace it.

All wise citizens do tax planning. Have you done inflation planning?

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