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$969 billion to come from higher tax rates, limits on deductions

NORTH BAY -- Tax professionals are warning that a series of budgetary changes proposed by the Obama administration along with the recent health overhaul passed in March could spell more complicated filings and increased taxation for high-income individuals.

The recent health care legislation alone will be paid for, in part, with $210 billion collected from higher Medicare taxes on individuals and joint filers making more than $200,000 and $250,000, respectively, according to a recent report, “Paying for Change,” detailing the changes and costs associated with them by Deloitte, an international accounting and consulting firm.

In addition, the president’s proposed fiscal 2011 budget would raise another $969 billion through the restoration of higher individual income tax brackets, a permanent estate tax and a limitation of certain exemptions or deductions, the report says.

The Medicare tax increase will impose a 0.9 percent Medicare tax on individuals who are self-employed and employees earning more than $200,000, or $250,000 for joint filers, which will begin in 2013.

An unearned income Medicare contribution, also beginning in 2013, will apply a 3.8 percent contribution to income generated from interest, dividends, capital gains, annuities, royalties and rents.

The Medicare contribution and the 0.9 percent tax will apply independently of one another – for example, an individual who makes $190,000 a year in wages and $30,000 a year in investments would not have to pay the tax. However, the Medicare contribution would still have to be paid on modified income in excess of $200,000, according to the report.

While the health overhaul will have an impact on the taxes of high earners, the largest increase will come from the proposal to restore the top two tax brackets to levels before 2001.

The current tax percentages would rise from their current levels, at 33 and 35 percent, to 36 and 39.6 percent.

According to the report, the 36 percent bracket would tax income over $190,650 for individuals and $231,300 for joint filers. The 39.6 percent bracket would be taxed on incomes of more than $373,650.

Although such levels were in place prior to 2001, the most recent proposal caps the benefit of deductions for the 39.6 percent bracket at 28 percent for itemized deductions. A bonus of $10,000, for example, would result in nearly $4,000 of additional taxes, while a charitable contribution of $10,000 would save only $2,800 in taxes.

Business owners should take note of the proposed changes, too, the report says.

“S corporation owners and sole proprietors in the higher individual income tax rate brackets may want to determine if incorporation as a C corporation would be preferable, particularly if Congress reduces the corporate tax rate as some lawmakers have proposed,” the report says.

However, the increase in individual taxes should be weighed against the cost of such incorporation and a host of other factors, such as state taxes, business goals and the benefit S corporations enjoy if the company is sold or liquidated, the report says. S corporations can typically avoid the corporate income tax, and losses can be claimed by the shareholder.