Following a Supreme Court ruling that the massive health care reform law approved in 2010 is, in fact, constitutional, high-net-worth individuals will be on the hook to pay for the expanded coverage. And that poses a big challenge to investment advisers.
The 5-4 decision – which, in a surprise, included the Bush-administration-appointed Chief Justice John Roberts Jr. – said that Congress has the authority to penalize individuals who do not purchase health insurance under its taxation powers, resolving the primary question that threatened the viability of the law. By defining the penalty for forgoing coverage a tax, the court obviated what it called the coverage mandate's violation of interstate commerce provision of the Constitution.
Now that it will stay on the books, health care reform will be financed in large part by tax increases on the wealthy. One section of the measure imposes a 3.8% tax on investment income for individuals who earn more than $200,000 annually and for couples who make more than $250,000.
Another provision imposes a 0.9% tax increase on wages for people in the same earnings categories. The revenue generated by both taxes supports Medicare growth.
Although these tax hikes are scheduled to go into effect on Jan. 1, Tim Steffen, director of financial planning at Robert W. Baird & Co., cautioned advisers not to overreact and have their clients take capital gains immediately.
“I'm not saying that you don't do anything this year, but you don't need to do it today,” Mr. Steffen said. “You don't want to trigger capital gains that you weren't otherwise going to do in the relatively near future.”
Here's how the taxes will work: If a client earns $180,000 annually and realizes $30,000 in capital gains, the 3.8% tax on investment income would be applied to the $10,000 that exceeds the $200,000 threshold. If a client does not earn investment income but has an annual salary of $201,000, the $1,000 over the threshold would be taxed at a 0.9% higher rate.
The total amount raised by the taxes is estimated to exceed $35 to $40 billion annually, according to Clint Stretch, a tax expert and former legislation counsel to the congressional Joint Committee on Taxation.
The extra money will largely come from people who will not rely on the health-care reform law for insurance coverage, according to Scott Moser, chief executive of Moser Wealth Advisors.
“The people paying it aren't going to have any additional benefit out of that tax,” Mr. Moser said. “It's just another way to extract money out of the wealthy. It will be a significant burden on them.”
Determining how much they owe could be tricky because of the way the law defines the factors contributing to adjusted gross income.
“It's confusing,” said Diane Pearson, an investment adviser at Legend Financial Advisors Inc. “They just added more complexity to the tax calculation.”
Mr. Moser will consider deferring his clients' investment income through municipal bonds, growth stocks and pension plans. Ms. Pearson said she is advising clients to convert traditional individual retirement accounts into Roth IRAs, which don't require a minimum distribution.
There's still a chance that these maneuvers won't be needed, if the health-care taxes get caught in year-end congressional negotiations involving an extension of the Bush tax cuts and raising the debt ceiling.
The health care levies make more difficult the work that Congress will do in the lame-duck session after the election, according to Mr. Stretch.
Conservatives “have to build the case for repealing yet another scheduled tax increase and either adding to the deficit or making spending cuts to fund this,” Mr. Stretch wrote in an email statement. “For their part, Democrats will have to argue that, with expiration of the Bush tax cuts, capital gains rates should go from 15 to 23.8% all at once and at a time that the economy is still struggling.”
House Republicans will try to undermine the health care reform law long before the December tax negotiations. Majority Leader Eric Cantor, R-Va., announced on Thursday a July 11 vote to repeal the measure. Although passage in the Republican-controlled House is assured, the bill will go nowhere in the Democratic-majority Senate.
In the meantime, advisers should pay attention to other parts of the health care law, according to Carolyn McClanahan, founder of Life Planning Partners Inc. For instance, advisers should determine whether clients, especially those between 55 and 65 years of age, can take advantage of insurance subsidies.
“If you can keep them in a low tax bracket, they may qualify for significant credits,” Ms. McClanahan said.
Clients who run their own businesses will have to make hiring decisions regarding whether to exceed the 50-employee level that would require them to provide health insurance for their workers or pay $2,000 per employee into a health care exchange if they don't offer a plan.
“The one class of clients we need to focus on now is small business owners,” Ms. Pearson said.
While she's looking after them, Washington will fixate on what to do now that the Supreme Court has rendered its decision.