Three tax changes for 2013 – all related to healthcare costs or expenses – may cause some taxpayers to owe more when they file their 2013 federal income tax return. But even those who are already affected by the changes may not know it, and taxpayers who rely on specific tax breaks may be surprised if they don’t begin planning now to offset the reduction in tax breaks.With the deadlines for the implementation of the Affordable Care Act (Obamacare) rapidly approaching, some of the less known provisions are beginning to affect taxpayers by changing the way tax deductions are handled or increasing payroll deductions. Among them are:
- A decrease in the amount a taxpayer can contribute to a Flexible Spending Account (from $5,000 to $2,500)
- An additional Medicare tax of 0.9% for those taxpayers who earn more than $200,000 ($250,000 if married filing jointly)
- A decrease in the amount of medical expenses that can be included as an itemized deduction (from the amount that exceeds Adjusted Gross Income by 7.5% to the amount that exceeds Adjusted Gross Income by 10%).
Two of these three changes mean a reduction in tax breaks – the decrease in maximum FSA contributions and the decrease in medical deductions as an itemized expense. The other change, the additional Medicare tax, is a tax increase. All three items will increase the amount of revenue that the IRS collects, which will go towards funding the provisions of the health care reforms passed by Congress in March, 2010.
Increased Medicare Taxes
Many people who earn more than $200,000 ($250,000 if married filing jointly) don’t realize that they’re already paying an additional 0.9% in Medicare taxes. That’s because the payroll tax holiday expired on December 31, 2012, and the additional 0.9% in Medicare taxes began to be withheld on January 1, 2013.
The media heavily publicized the expiration of the payroll tax holiday because it affected every W-2 employee, but the Medicare tax increase affects a smaller number of taxpayers, so it received little publicity.
Many high-income wage earners simply assumed that the change in their net payroll check changed because of the expiration of the payroll tax holiday.
Higher Medical Deductions Threshold
Until this year, taxpayers who itemize tax deductions could deduct medical expenses that exceeded 7.5% of their Adjusted Gross Income (AGI). However, in 2013, taxpayers will only be able to deduct medical expenses above a higher threshold of 10% of AGI.
Senior citizens over age 65 get a bit of a break from the IRS for itemized medical tax deductions. Older taxpayers will be able to use the old threshold of 7.5% through 2016 during a phase out period. But taxpayers under 65 with high medical expenses will feel the effect this year.
What kind of impact will the change have on how much a taxpayer owes? Consider the case of a single 30-year-old taxpayer with an AGI of $50,000 who is injured in an accident that results in total out-of-pocket medical expenditures for the year (not covered by insurance) of $5,000. In 2012, this taxpayer would claim an itemized deduction of $1,250 [$5,000 – ($50,000 x 7.5%)]. In 2013, this taxpayer would have an itemized deduction of $0 [$5,000 – ($50,000 x 10%)].
Flexible Spending Accounts Capped
Flexible spending accounts (FSAs) are a way for employees to divert pre-tax salary into an account managed by their employer’s benefits administrator to cover out-of-pocket healthcare expenses like co-pays, deductibles, orthodontia and fertility treatment that aren’t covered by the company’s health insurance plan.
In the past, there was no statutory cap on flexible spending accounts, although most benefits plans set annual caps of $5,000. For 2013, there is a cap of $2,500 in contributions to the flexible spending accounts.
This means that those who were contributing the maximum amount will see a $2,500 increase in their paychecks this year, but it also means that it may be harder to accumulate enough money in the pre-tax accounts to pay for more expensive out-of-pocket expenses. Still, from a tax standpoint, participating in an FSA is a good move for taxpayers in higher tax brackets.
For instance, a taxpayer with a combined federal and state income tax rate of 40% can divert $2,500 of income into an FSA and save approximately $1,000 in taxes.
It’s still possible for some taxpayers to put more money into an FSA in one of two special circumstances:
- The taxpayer holds two or more jobs with unrelated employers, and each employer offers an FSA. The employee can contribute $2,500 to each plan.
- Married couples in which both spouses qualify for an FSA (even if both work for the same employer) can still contribute $5,000, if each spouse contributes the maximum amount of $2,500.
Note that an FSA and a healthcare savings account are different. If you have a healthcare savings account to help cover costs not covered by a high-deductible health insurance policy, then the money in an FSA is limited to covering dental and vision expenses.
For more information on how these changes might affect your tax bill for 2013, talk to your tax advisor or review IRS Notice 2012-40. To schedule a free tax consultation with a tax advisor from 1-800Accountant, click here.