The Affordable Care Act Is Less Affordable For Married Taxpayers

Much has been made about the controversial provisions of The Patient Protection and Affordable Care Act and Health Care and Education Affordability Reconciliation Act of 2010 (“ACA”). As documented through many other sources, the Act contains important changes that will have a substantial impact on small business owners and individuals. The most controversial of these changes include penalties for small businesses failing to provide adequate health insurance for employees and an individual mandate that people obtain health insurance, or be subject to a penalty. Much to the chagrin of many, the individual mandate was upheld by the Supreme Court, and the provision mandating that small businesses provide health insurance to their employees, or face a penalty has been merely delayed till 2016. But hidden within the Byzantine act, are two new tax provisions that unfairly impact couples filing as “married” while seemingly appear to ignore couple who file as “single.”

The two new tax provisions are:

I.      Increased payroll taxes (effective January 1, 2013). The law increases the Medicare Hospital Insurance tax by 0.9% on wages and self-employment earnings in excess of $200,000 (or $250,000 if married filing jointly, $125,000 if married filing separately). Therefore, the current tax on individual wages/earnings would be increased from 1.45% to 2.35%.

For example, a single individual with W-2 wages of $500,000 will incur additional taxes of $2,700 ($300,000 multiplied by 0.9%). The same result occurs if the same individual realized self-employment earnings of $500,000 rather than W-2 wages.

II.      Medicare Contribution Tax on investment income (effective January 1, 2013). A new 3.8% Medicare Contribution Tax is imposed on the lesser of (a) “net investment income” or (b) adjusted gross income (AGI) over the threshold amount. The threshold amount is $250,000 for married filing jointly or surviving spouses, $125,000 for married taxpayers filing separately, and $200,000 in other cases.

“Net investment income” includes interest, dividends, annuities, royalties, and rents derived from passive activities (within the meaning of Code §469). On the other hand, profits from operating businesses (e.g., S corporations and LLCs) will not be subject to the new tax. Proceeds from the sale of assets, partnership interests, LLC membership interests, and S corporation stock are also subject to the 3.8% tax if the related income was passive. For example, proceeds derived from the sale of rental real estate may be subject to the new tax.

In both situations, the ACA looks at $250,000 as the threshold for married individuals and $200,000 for single individuals. This pernicious red-eye penalizes married couples. For example, under the first provision, if both spouses report $350,000 in combined W-2 wages, they will be responsible for an additional $900 in payroll taxes. On the other hand, if an unmarried couple report $350,000 in W-2 wages, they may be able to escape the jaws of the new tax altogether. To wit, assuming a taxpayer reports $175,000 in W-2 wages and a girlfriend/boyfriend reports $200,000, they have successfully avoided the new payroll tax because neither one of them will report an amount that exceed $200,000; even though they report total W-2 wages in excess of the married couple who is victim to the new tax (the only occasion where an unmarried couple would be subject to the new payroll tax, where a married couple would not, is in the instance of an individual filing as single makes between $200,000 – $250,000 and the other individual makes close to $0).

The new Medicare Contribution Tax will be even more devastating to married couples.   The tax is imposed on married taxpayers who report passive income and have an AGI over $250,000. The tax is calculated as the lesser of: actual AGI less the threshold amount, versus the amount reported as passive income. For example, a married couple with an AGI of $300,000 and rental income of $30,000 will be subject to an additional $1,140 in taxes. As in the discussion above, an unmarried couple may be able to completely avoid this tax. For instance, an unmarried couple who each report $150,000 in AGI, and own real estate as if they were business partners may completely avoid this tax, even if the rental income increased to a total of $100,000!

Married taxpayers will now be subject to additional taxes that have been hoisted upon them on a seemingly arbitrary manner. Socrates has been quoted as saying, “By all means, marry. If you get a good wife, you’ll become happy; if you get a bad one, you’ll become a philosopher.” Unfortunately, our marriage to the IRS may have made philosophers out of us all.