Make no mistake about it… many of your clients – and probably even many of you – largely ignored the 2010 Health Care Acts tax provisions because they thought there was no chance the Supreme Court wouldn’t strike them down as unconstitutional. Well, assumption overruled! No matter what side of the aisle you sit on, and whether you like these laws or not, it now appears they are here to stay, at least for the foreseeable future.
At first glance, it might seem that these new laws won’t apply to IRA planning all that much. But first looks can be deceiving. Upon closer inspection, although there aren’t many provisions that directly affect IRAs and other retirement plans, there are certainly a host of indirect effects that advisors must be aware of in order to properly guide their clients.
Understanding how the health care laws impact IRAs can be challenging, and the difficulty of explaining that impact to clients can be even greater. Nevertheless, savvy advisors who master the intricacies can provide valuable tax-saving strategies to high-income clients, solidifying existing relationships and opening doors to new ones.
The Coming 3.8% Surtax
The one provision of the health care laws most likely to affect clients is a 3.8% levy on investment income scheduled to take effect beginning next year, in 2013. This 3.8% surtax on investment income won’t affect all your clients equally. In fact, it’s likely that some, if not many of your clients won’t be affected at all. The new investment surtax will only apply to clients whose modified adjusted gross income (MAGI) exceeds $200,000, or $250,000 for married couples filing joint returns. For this purpose, MAGI is a taxpayer’s regular AGI, plus any foreign income excluded from AGI.
Similar to the thresholds for the alternative minimum tax (AMT), these threshold amounts are not indexed for inflation, so if Congress does not pass further legislation to increase these amounts, it’s likely that as time passes more and more of your clients will be impacted by this provision, especially if you have not helped them to take steps to avoid it.
Raising MAGI via IRA distributions and Roth conversions can push a client above the applicable threshold amount, causing them to be subject to the 3.8% surtax, where they otherwise would have avoided it. Similarly, a higher MAGI may also increase the amount of investment income that’s subject to this surtax.
How the 3.8% Surtax is Applied – The “Lesser of” Rule
A couple of examples might help to see how IRAs interact with this new surtax.
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