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Posted: July 28, 2011

New medical taxes are coming your way

Is buying a house more important than our health?

Wayne Farlow

In March 2010, the Patient Protection and Affordable Care Act (PPACA) was passed by Congress and signed by the President. This act includes several "features" that will raise the amount of taxes we pay on medical related services, regardless of your income bracket.

It has always seemed inequitable to me that we may deduct 100 percent of our mortgage interest payments from federal income taxes, but are only allowed to deduct medical expenses that exceed 7.5 percent of our Adjusted Gross Income (AGI). From this inequity, we must assume that our government places a higher priority on buying a house than it does on medical expenses.

When PPACA was first introduced, I assumed that it would address this inequity by eliminating the 7.5 percent AGI deduction hurdle on medical expenses. This would definitely provide "more affordable (medical) care," much like the home mortgage deduction makes home ownership more affordable. However, I was shocked to see that PPACA not only does not remove the 7.5 percent tax hurdle, it makes medical treatment more expensive by raising the AGI threshold hurdle to 10 percent.

This medical tax increase hurts the middle class much more than the wealthy, as very few taxpayers whose AGI exceeds $200,000 can claim a medical deduction.

Consider a couple with $70,000 AGI and $7,000 in medical bills. Under current tax law, this couple could deduct $1,750 in medical expenses from their federal income taxes. However, staring in 2013, PPACA will reduce their in medical deductions to $0, while they will still be able to deduct 100 percent of their home mortgage interest payments.

Another area where PPACA increases the middle class' medical costs is through its reduction of Flexible Spending Account (FSA) medical contributions. Under current law, you may contribute up to $5,000 each year to an FSA, to pay for medical expenses that are not covered by insurance. The $5,000 FSA contribution is directly deducted from your income, meaning that it is fully tax free, including FICA taxes.

A single person in the 25 percent federal tax bracket (AGI exceeds $34,000), with state income taxes of 5 percent, has combined federal, state and FICA taxes of 37.65 percent. This represents $1,882 in total taxes on $5,000 of income. By putting $5,000 into an FSA, they save $1,882, as long as they have at least $5,000 in uncovered medical expenses during the year.

Starting in 2013, PPACA lowers the maximum amount that can be contributed to an FSA to $2,500, cutting the tax saving for a medical FSA in half. The relatively low income person shown above will pay an additional $941 in taxes, thanks to PPACA.

For higher income taxpayers, PPACA has additional Medicare taxes. Starting in 2013, single taxpayers earning over $200,000 and couples earning over $250,000 per year will be pay an additional 0.9 percent in Medicare taxes on income that exceeds these limits.

Another Medicare tax is the new 3.8 percent "unearned" income tax on single taxpayers with an AGI exceeding $200,000 and couples with an AGI exceeding $250,000. Virtually any income that does not come from employment will be subject to this tax.

As an example, consider a couple with an AGI of $300,000, of which $200,000 comes from their joint earned income and $100K comes from royalties, rents, annuity distributions, capital gains and dividends. $50K of their income would be subject to the 3.8 percent Medicare tax, increasing their tax bill by $1,900.

It can always be debated whether the "wealthy" are paying their fair share of taxes. Thus, the PPACA provisions that require higher income individuals to pay more in taxes are open to political debate.

However, it seems unconscionable for an act that is supposed to make health care more affordable, to increase the price of health care on the middle class. The PPACA has already been modified to remove the $600, 1099 reporting requirement. Perhaps it is now time to help our government understand that 1) medical expenses should have at least the same deductibility as home mortgage interest payments and 2) FSAs are good for people of all income brackets, so leave them alone.

Medical costs continue to skyrocket. The last thing that we need is to increase the taxes that everyone must pay on these expenses.

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Wayne Farlow is the founder of Financial Abundance, LLC, a Registered Investment Advisor firm.  He is a Certified Financial Planner (CFP®), focusing on Retirement Planning, Investment Management, Small Business Owner Planning and Sudden Wealth/Inheritance Planning.  His book, “Financial Abundance Guide,” is available free at www.farlowfinancial.com .  He can be reached at wayne@farlowfinancial.com or at 303-554-0309.

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