Barbara’s Blog

Starting on January 1, 2013, there is an additional Medicare tax of 0.9% on earned income over a threshold amount (this threshold depends on your filing status). This tax was created by the Patient Protection and Affordable Care Act as a way to help pay for health care reform and will take effect in 2013 regardless of any resolutions Congress may come to with respect to the so-called fiscal cliff.

This new tax is only on the worker; not on the employer. The IRS recently provided some guidance in the form of proposed regulations and employers should master them to they can field questions from employees and adjust their payroll system if they handle payroll in-house. The new tax also affects self-employed individuals who have net earnings over the same threshold amounts.

The thresholds and the tax
The thresholds depend on filing status and only reflects earned income:
•    Joint filers: $250,000
•    Single filers: $200,000
•    Married persons filing separately: $125,000

Once earnings pass the threshold, the 0.9% additional tax then applies to amounts over the threshold. Thus, if a single individual has a salary of $185,000 and receives a year-end bonus of $40,000, the additional tax applies to $25,000 (the amount of earnings over the $200,000 threshold for a single filer). In effect, the employee pays the basic 1.45% Medicare tax on earnings up to the threshold amount ($200,000 in this example), plus 2.35% Medicare tax on earnings over the threshold amount ($25,000 in this case). The employer pays 1.45% on all of the employee’s earnings.

Earned income for purposes of the additional Medicare tax has the same meaning as used for the basic Medicare tax. Thus, taxable fringe benefits on top of big wages could trigger or increase the additional Medicare tax; tax-free fringe benefits have no impact on the tax.

Withholding
The tax is paid by the individual when he or she files the return. However, employers must withhold the additional Medicare tax once earnings exceed $200,000. (There is no withholding for this tax in anticipation of having excess earnings.) The employee’s filing status or income from another employer or from self-employment is not taken into account by an employer. If it turns out that the employee does not owe the additional tax (e.g., she is a joint filer and she and her spouse have earnings below $250,000), the over-withholding is claimed as a tax credit on the employee’s income tax return.

The employee cannot ask an employer to withhold any additional Medicare tax. However, if the employee wants a tax-withholding cushion, he or she can have additional income tax withheld. This is done by filing a new Form W-4, Employee’s Withholding Allowance Certificate, with the employer. Then, at tax time, the extra income tax withholding is effectively credited toward the additional Medicare tax.

Special concerns for self-employed individuals
Since self-employed individuals do not have wage withholding, they must incorporate the new tax into their quarterly estimated tax payments. Certainly, a payment need not include any anticipated tax based on expected net income; wait until net income reaches the applicable threshold. Of course, many self-employed individuals do not know their net income until well after the year has ended (some do not know theirs until receiving a Schedule K-1 from a business in which they have an ownership interest).

Use the estimated tax safe harbor rules to avoid any underpayment penalties. Essentially, if estimated taxes for 2013 are based on 100% of tax liability for 2012 (110% if adjusted gross income in 2012 exceeds $150,000, or $75,000 if married filing separately), then you won’t incur any penalty even if your estimated tax payments fell short of your 2013 tax liability.

Final thought
This additional Medicare tax on earned income dovetails with another additional Medicare tax on net investment income (called the NII tax). Earned income is specifically exempt from the NII tax but is factored in (as part of modified adjusted gross income) when determining the threshold for imposing the NII tax.

Bottom line: 2013 is going to be a new tax day!

Why do we work long hours? The Enterprise Council on Small Business reported that nearly half of self-employed individuals work more than 44 hours a week. Why do small business owners forego vacation? A Manta survey found that half won’t take any time off this year. We must be crazy!

As best as I can figure from what I learned from the media, we work hard to be profitable so that we can pay taxes. Then we are denigrated for not paying our fair share. Don’t get me wrong about paying taxes. I agree with Nancie J. Carmody, author of The Sunny Side of Life, who said, “I am thankful for the taxes I pay because it means that I’m employed.”

But some of the tax money we work so hard to earn then goes in part to support nonworkers. I don’t fault those who cannot work because of disability or the bad job market. Unemployment insurance and certain social programs have their place as safety nets for those who are unable to work. However, I do fault those who do not work because of choice. And now the government is making it easier for some people to obtain assistance without getting a job. A recent Policy Directive by the Department of Health and Human Services (HHS) undercuts welfare reforms (Assistance for Needy Families (TANF of 1996) enacted by a bi-partisan Congress during President Clinton’s Administration which required recipients of welfare benefits to work in most cases. Now, the HHS move effectively eliminates the need for gainful employment as a requirement for TANF by re-defining work for purposes of welfare to include the following 10 tasks:

1. Bed rest
2. Personal care activities
3. Massage
4. Exercise
5. Journaling
6. Motivational reading
7. Smoking cessation
8. Weight loss promotion
9. Participating in parent teacher meetings
10. Helping a friend or relative with household tasks and errands.

Instead of sitting at my computer for 10 hours today, I think I’ll work by getting some bed rest, getting some exercise, and doing some motivational reading! What’s wrong with this picture?

So the U.S. Supreme Court says Obamacare is constitutional. What does this mean for you and your business?

Here are 5 results of this court decision that are problematic to me.

1. The IRS governs health care?

Apparently so, according to the Supreme Court’s ruling that the individual mandate is constitutional. The rationale for upholding the mandate: the penalty that individuals will have to pay if they don’t have required medical coverage starting in 2014 is merely a tax. And who’s going to collect the tax? The IRS!

While the law prevents any criminal action for those who won’t pay the penalty, who knows how enforcement by the IRS will be actualized. Will the IRS ultimately be able to say what medical treatments will be covered by insurance?

2. There’s a loss of privacy for your tax return

Currently, your personal and business tax returns are subject to strict privacy rules. If IRS employees divulge any information, there are serious consequences. Now, under Obamacare, the IRS must tell the “Health Choices Commissioner” and state health programs about taxpayers, including their filing status, modified adjusted gross income, the number of dependents, and “other information as prescribed by” regulations (Secs. 431(a) and 245(b)(2)(A)) of the Patient Protection and Affordable Care Act) (purportedly to verify new tax credits for those who cannot afford to pay health premiums). Also, the Social Security Administration can obtain from the IRS tax data on anyone who may be eligible for the low-income drug subsidy under Obamacare (Sec. 1801(a) of the Act). In sum, tax information is no longer confined to the IRS; it will be shared with certain other government agencies.

In this environment of increasing identity theft, there has to be concern about more eyes on a tax return.

3. Health care premium costs are not coming down anytime soon

The theory about the personal mandate lowering costs, if I have it correct, is that with more people being brought into the insurance pool, premiums will fall. I haven’t seen any indication of that yet. Of course, the mandate is not set to take effect until 2014, so for now the premiums for self-employed individuals and small businesses are continuing to increase.

4. There are increased tax burdens on many small business owners

Earn $200,000 in salary from your business or self-employment activities as a single person and you will pay an additional 0.9% Medicare tax starting in 2013. (The threshold for the tax for married persons filing jointly is $250,000, or $125,000 for those filing separately.) This tax is on top of the basic Medicare tax of 1.45% (or 2.9% if you’re self-employed) that you already pay, and it’s not deductible.

If you do your payroll in-house, you’ll probably have to start soon to get ready to withhold the additional Medicare tax for employees with wages over the threshold amount.

5. There’s still uncertainty

While the legal challenge to Obamacare is settled, the political challenge has just begun. If there are significant changes resulting from the November election, Obamacare may be repealed with the expectation of replacing it with another health care law. Whether there will be such a political shift, and if so, what, when, and if such new law is enacted, leaves us with uncertainty about tax-related provisions. Are current tax rules to be changed? Will good provisions in Obamacare that have already taken effect, such as coverage for a child up to age 26 on a parent’s medical plan, be retained?

Bottom line

What’s that adage about good intentions and some road? There has to be a better way to bring the cost of medical coverage down and make it available to those who are presently uninsured.

Self-employed individuals are at a disadvantage to owners of corporations when it comes to Social Security and Medicare taxes. These taxes, called “self-employment tax,” are levied on net earnings from self-employment. Thus, regardless of what self-employed individuals take out of the business, they are taxed on their share of all of the profits. In contrast, for owners of corporations (C or S), Social Security and Medicare taxes (in the form of FICA) are levied only on salary and other taxable compensation. While S corporation owners are also taxable on their share of profits for income tax purposes, these profits are not subject to FICA.

To make matters worse for self-employed individuals, net earnings for self-employment tax purposes do not reflect all of the business-related deductions such individuals are allowed to take. Net earnings are not reduced by:

• Health insurance premiums paid for a self-employed person, spouse, dependents, and children through age 26. This deduction is claimed as a personal write-off; it is an adjustment to gross income (an “above-the-line” deduction).
• Contributions to qualified retirement plans on behalf of a self-employed person. This deduction is also taken as an adjustment to gross income.
• Net operating loss carry-forwards. This write-off is deducted as a negative entry on the line for “other income” on Form 1040. (The recent case of DeCrescenz0 highlights this problem.)

Under the Small Business Tax Act, net earnings for purposes of self-employment tax were allowed to be reduced by health insurance premiums covering self-employed individuals and their families for 2010. This break ran only for one year.

Congress needs to make changes to create greater parity between self-employed individuals and corporate owners. Change the deductibility of all business-related deductions to allow self-employed individuals to claim them as business write-offs. This won’t change the income tax results (since write-offs on the personal portion of the return effectively produce the same income tax liability). It will, however, change the results for self-employment tax.

This change can produce significant tax savings since the self-employment tax usually is 15.3%, comprised of 12.4% for Social Security taxes on net earnings up to the wage base amount ($110,100 in 2012), plus 2.9% for Medicare taxes on all net earnings. In 2011 and 2012, there is a 2 percentage point reduction in the Social Security tax on the so-called employee portion of self-employment tax, but this rule is not set to run beyond this year.

It would also be helpful to allow the net operating loss carry-forward to be taken into account in figuring net earnings for self-employment tax in the carry-forward year.

These suggestions for tax reform are not new. However, if Congress is serious about job creation (and self-employment must be viewed as self-job creation), these easy fixes to the tax law will go a long way in helping unincorporated small business owners.

The goal of the new law, which passed the Senate on September 16 and is expected to pass the House and then be signed into law any day now, is to help small businesses create 500,000 jobs.  According to the NFIB and to common sense, this likely won’t happen. But the new law does have $12 billion in tax breaks that could benefit certain businesses. Here’s a quick rundown of how you may be able to lower your tax bill: 

• Self-employed tax savings. Until now self-employed individuals could not reduce their self-employment tax by the amount of medical insurance premiums they paid to cover themselves, their spouses and dependents (although premiums for staff are a deductible business expense). Under the new law, for 2010 only, they can. For instance, if you are self-employed and pay $10,000 in premiums this year, you’ll save about $1,500 in self-employment tax.

• Increased write-offs for certain business investments. Under the so-called Section 179 deduction rule, if you buy new or pre-owned equipment and machinery, you can deduct up to $500,000 in 2010 and 2011 rather than depreciate the cost over a number of years. The dollar limit phases out when total equipment purchases for the year exceed $2 million. Eligible equipment includes off-the-shelf software and, for the first time, qualified leasehold, restaurant, and retail improvements up to $250,000 in 2010 and 2011. In addition, you can claim bonus depreciation on new equipment purchases, which amounts to an additional 50% deduction in excess of any Section 179 deduction claimed.

• Increased exclusion for qualified small business stock gains. If you invest in a small C corporation after the date of enactment and before January 1, 2011, you won’t pay any capital gains when you sell the stock as long as you’ve held it for at least five years.

• Increased write-off for start-up costs. Instead of being able to deduct up to $5,000 of start-up costs in the first year of business, you can deduct up to $10,000 for costs this year. The dollar limit phases out when total start-up costs exceed $60,000, but very few small business start-ups have initial costs that approach this figure.

To help pay for these tax breaks, businesses of all sizes (no small business exemption) that are recipients of rental income will have to report payments to service providers (e.g., painters, plumbers, accountants) of $600 or more in a year, starting in 2011.

Will any of these new tax breaks help you? Do any inspire you to create jobs? Please let me know.

If you pay at least half of the health care premiums for your staff and meet a slew of requirements, you can claim a federal tax credit based on your payments. The IRS recently released a draft of Form 8941, Credit for Small Employer Health Insurance Premiums; this form will accompany 2010 tax returns. The 25-line form walks an employer through the eligibility requirements. Instructions to the form have not been released.

In addition to the form, the IRS has a chart containing 3 “simple” steps for determining eligibility. The steps are helpful, but hardly simple.

The credit was enacted to encourage small businesses to pay for health coverage. To date, I have not heard from any business owner who has decided to offer coverage solely because of the credit opportunity.

Those who already pay for coverage may be glad to reap some tax savings, but the amount of the savings is not sufficient incentive to go out and incur the cost of coverage. Those whose businesses are strictly family owned and run do not qualify for the credit. Self-employed individuals with no employees do not qualify for the credit.

I would be interested to learn whether you have purchased coverage solely because of the credit or know of any other business owner who has done so. You can send me an email at info [at] barbaraweltman [dot] com or comment here.

A report by the SBA’s Office of Advocacy found that fewer than 2% of small business owners had a Keogh (self-employed) plan and only 18% participated in 401(k) plans.  Only about 36% had IRAs, and just one-third of them made an annual contribution for the 2005 tax year (the most recent year in the report).

What does this say about small business owners?  The report does not indicate the reasons for not contributing, but here are some that I can think of:

1. Owners are unaware of the tax advantages to saving for retirement through qualified plans and IRAs;
2. Owners are cash-short and unable to fund these plans;
3. Owners are too tightfisted to contribute on behalf of employees, something they would have to do in most cases if they wanted to personally benefit from retirement plans;
4. Owners don’t want to bother with the paperwork, investment responsibilities, and other details of having a plan;
5. Owners expect to sell their businesses as a way to create retirement funds.

The report did find that busness owners were more likely to have a retirement account if they were older, non-minority, better educated, and with an established business or more than one business.  The report also learned that being a male busines owner reduced the probability of IRA ownership from 35.6% to 31.2% but increased the probability of having a Keogh or participating in a 401(k) plan from 1.7% to 3.7% and from 17.4% to 20.3%, respectively.

Even though the deadline for setting up a 401(k), profit-sharing, or most other types of qualified retirement plans for 2009 ended on December 31, 2009, if you have not yet filed your income tax return for 2009 and determine that your business was profitable in 2009, you can still create and fund a Simplified Employee Pension (SEP) until the extended due date of your return.  For example, if you are a sole proprietor with a filing extension for your 2009 return, you have until October 15, 2010, to put tax-deductible funds into a SEP for 2009.  Your contribution limit for 2009 is up to $49,000, but your actual contribution depends on your earnings and funds on hand for making the contribution.  If you have employees, you’ll have to contribute to accounts for them.  For details about SEPs and other retirement plans, see IRS Publication 560, Retirement Plans for Small Business.