With the enactment of an enhanced federal role in medical care comes the need for revenue enhancement. The age of the Obama tax hikes has officially begun. The big news for high-income folks is a new 3.8% "Medicare" tax on investment income and an additional 0.9% Medicare tax on wages, both of which are to take effect in 2013. But workers at all income levels could be squeezed by new limits on medical flexible spending accounts and medical deductions.
The 3.8% investment tax, combined with the expected (and Obama- favored) Jan. 1, 2011 expiration of the Bush tax cuts for high-income taxpayers, would produce a 2013 top federal income tax rate of 23.8% on long-term capital gains from the sale of securities, up from 15% now. The top rate on interest, rents, royalties and certain "passive income" would rise to 43.4% from 35%. (Neither 2013 rate includes the return next year of the phaseout of itemized deductions for the better off, which can add one percentage point to both rates.)
"The high-net-worth, high-income taxpayers--they are in the crosshairs. They have a target on their backs and their fronts,'' says Mitchell A. Drossman, national director of wealth planning strategies for Bank of America ( BAC - news - people )'s U.S. Trust unit.
Play defense. Consider these strategies now.
FSAs and Medical Expenses
Beginning next year money stashed in pretax FSAs, health savings accounts and health reimbursement accounts may no longer be used for over-the-counter medications other than insulin, unless prescribed by a doctor.
Even more significantly, beginning in 2013, the amount you can shelter pretax in an FSA will be restricted to $2,500 a year, an amount that will then be indexed for inflation. (Currently there's no legal limit, and 78% of large employers set it at $5,000 or higher, according to Hewitt Associates ( HEW - news - people ).) That means you should plan to put aside pretax money in 2011 or 2012 for such big-ticket items as orthodontia and Lasik surgery. You must have the procedure done that same year, since any pretax money not used each year is forfeited.
Note that it will also become more difficult as of 2013 to write off out-of-pocket medical costs on your 1040--taxpayers under 65 will be able to deduct such costs only to the extent they exceed 10% of adjusted gross income, up from 7.5% now. (Older taxpayers can still use the 7.5% threshold through 2016.)
Roller Coaster
The top tax rates on both capital gains and ordinary income are heading back up again.
Additional Medicare Wage Tax
Beginning in 2013 there's an additional 0.9% Medicare tax on gross compensation--meaning before 401(k) or other pre-income-tax deductions--of more than $200,000 for individuals or $250,000 for couples. This tax is paid solely by the employee and is on top of the current 2.9% Medicare payroll tax, split evenly between employer and employee. The new charge, along with the expected 2011 reversion of the 33% marginal income tax rate to its pre-Bush 36% and the 35% top rate to its pre-Bush 39.6%, means high earners should think hard before deferring compensation. Similarly, if you've got nonqualified stock options that you can exercise, consider doing it this year--your gain at exercise is all taxed as compensation, subject to the ordinary income tax plus Medicare taxes, notes Drossman.
If you're well paid, don't marry another high earner. The marriage penalty was already pretty severe for upper-middle-incomers (with typical deductions, two $200,000 earners would see the second income kicked up from 28% and lower brackets to 33%). The penalty will get a lot worse, with a greater gulf between rates in the two highest brackets and rates in the brackets below.
Surtax on Investment Income
There's yet another marriage penalty here, since the new 3.8% investment surtax for 2013 hits singles with more than $200,000 in adjusted gross income and joint filers with more than $250,000. (Unlike the tax brackets, neither threshold is indexed for inflation.) The surtax will apply to interest, capital gains, annuities, rents, royalties, passive activity income and dividends. (It's unclear what the total rate on dividends will be. Obama purports to favor making permanent an expiring provision of the Bush cuts that taxes dividends at the lower long-term capital gains rate. But if Congress doesn't act, the top rate on dividends will zoom from 15% to 43.4%.)
Exempt from the surtax: retirement account distributions, capital gains from selling a principal residence and business income from a venture, such as a partnership or Subchapter S corporation you actively manage. (That means self-employed professionals can still cut their Medicare taxes by incorporating as an S corp. and treating some of their earnings as profits, not wages.)
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