(Dow Jones) The Medicare tax in President Barack Obama's new health-care legislation will hit the rich hardest at first. But its impact may spread over time to not-so-wealthy taxpayers.
Like the alternative minimum tax, the Medicare tax's income thresholds are not indexed for inflation and thus do not take into account how people's income rises nominally over the years. So it is poised to take more and more taxpayers by surprise, just as the AMT has done to earn its nickname of "the stealth tax."
Gerald Prante, a senior economist at The Tax Foundation in Washington, predicts more people will fall under the tax "especially if the rate of inflation rises," he said. The tax is included in the reconciliation bill passed by both the Senate and the House last week, paving the way for Obama to sign it into law.
Financial advisors say the Medicare tax already is starting to factor into client's plans, as is the prospect of higher taxes in general. Its parallel with the AMT has them even more concerned, they say.
The bottom line, said Don Weigandt, a wealth adviser in the Los Angeles office of J.P. Morgan Private Bank, is that "there are going to be a lot of surprises with this tax, which has a much broader sweep than people think."
Congress put the AMT into effect in 1970, with the aim of making sure the wealthy paid at least minimal tax. In fact, the middle class has felt the biggest effect as the number of taxpayers subject to it has risen from about 1.3 million 2001 to nearly 4 million in 2008, according to The Tax Foundation.
Lawmakers have had the annual headache of keeping that growth in check with a so-called "patch" to the AMT exemption that raises the bar for people to fall under the tax. The patch aims to keep about 4 million people in the AMT. Without the most recent one, around 28 million would be subject in 2010.
As for the Medicare tax on investment income for the wealthy, it is a first: There has never before been a separate tax to support Medicare beyond a levy on wages. It looks to be the biggest revenue raiser in the health-care law over the next 10 years.
Its provisions are an additional 0.9% Medicare Hospital Insurance Tax on earned income over $200,000 for single taxpayers and $250,000 for married couples, and an "Unearned Income Medicare Contribution" of 3.8% on investment income for taxpayers with adjusted gross incomes over $200,000 for single filers and $250,000 for married filers.
Married taxpayers who earn $370,000 in wages and $1.5 million in investment income would see a $1,080 increase in Medicare taxes combined with a new Medicare unearned income tax of $57,000, for a total Medicare tax increase of $58,080, according to the Tax Foundation. Married filers who earn $5 million in investment income would be subject to an unearned income tax of $180,500.
Indeed, the tax "is very costly," said Mitch Drossman, national director of wealth planning strategies at US Trust, who has already been talking with clients about its possible effects.
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