Planners craft strategies to avoid new U.S. healthcare taxes

September 8
11:20 AM 2012

Tax planners are developing ways to help well-to-do U.S. clients avoid the full impact of taxes set to take effect next year under President Barack Obama's healthcare overhaul.

With some legal uncertainty still surrounding the new levies, advisers are devising methods for high-income taxpayers to shelter investment and other forms of income.

Obama's healthcare law imposes a 3.8 percent tax on investment income and a 0.9 boost in payroll taxes, both applying only to individuals earning more than $200,000 a year or households earning more than $250,000.

That is about 4 percent of the tax-paying population, according to the non-partisan Tax Policy Center.

Among ways these taxpayers might be able to avoid the full brunt of the new taxes: cashing in gains this year instead of next; characterizing income as active instead of passive; and moving profits into vehicles or structures not subject to the tax, said a range of tax experts.

"It is a brave new world for all of us," said Robert Spielman, a partner at accounting firm Marcum LLP.

The strategies under development underscore the complexity of the 70,000-page tax code and the time and effort devoted to finding ways to comply with it while minimizing payments.

For every tweak in the code that comes along, legions of accountants and lawyers go to work devising work-arounds, supporting an enormous tax planning industry.

At the center of the tax industry is the U.S. Internal Revenue Service, which has yet to spell out in regulations exactly how the new healthcare taxes will be applied.

"We are all kind of waiting for it collectively," said Garrett Fenton, an attorney at law firm Miller Chevalier.

Cloudier sections of the law include how the taxes apply to certain profits of private equity managers, real estate investors and partnerships, according to tax professionals.

More clarity from the IRS is unlikely to come before the November 6 presidential and congressional elections, some observers said.


Combined, the new taxes are expected to raise about $210 billion over a decade to help fund the healthcare law, which aims to expand insurance coverage to 32 million Americans.

No matter who wins the presidential election, the taxes will kick in January. Even if Republicans capture the White House and both houses of Congress, they would have an uphill climb repealing what they derisively call "Obamacare" because the Senate would likely still be closely divided.

As a result, at least in the near term, the 3.8 percent tax is on track to be assessed on top of the existing 15 percent tax rate on income from capital gains, dividends and other investments for the $200,000-in-income-and-up set.

The tax applies to investment income from dividends, interest, annuities, royalties and rents - except for income earned in the ordinary course of a trade or business.

That includes defining activities as "passive" and whether income is from a "trade or business" involving trading in financial instruments and commodities.

It only gets more complicated from there.

For example, in law firms or real estate partnerships, a tax adviser might say that distributions, even if they enjoy the lower capital gains rate, are exempt from the 3.8 percent tax because of the way the law is written.

In such a case, Karen Field, a principal at accounting firm KPMG, said she would argue the 3.8 percent tax does not apply.

Board members are asking tax advisers if they should take income this year to avoid the 3.8 percent tax, according to Michael Mundaca, co-director of national tax services at accounting firm Ernst & Young and a former tax adviser to Obama.

With tax rates potentially rising across the board, plus the 3.8 percent tax looming, "that might be enough to get people to pull the trigger" on accelerating gains into 2012, Mundaca said.


Gray areas exist in how the 3.8 percent tax might apply to the income of private equity managers, an area of heightened attention because Romney co-founded Bain Capital, one of the most profitable private equity firms around.

Taxes paid by private equity managers are already controversial, as managers pay the lower capital gains rate on most of their profits, a benefit that helped keep Romney's tax rate below 15 percent in 2010.

"The tricky part is how you characterize the person providing the service," said Spielman. "It is a nightmare."

Another area perplexing some tax experts is how the healthcare taxes will apply to deferred compensation plans used by the upper echelon of corporate executives to stash away unlimited amounts of compensation and defer taxes.

The healthcare law exempts some deferred compensation plans available to more employees, but it is silent on executive plans, leaving an open question as to whether the investment build-up in such plans may be subject to the 3.8 percent tax.

"It is hard to say one way or the other," Fenton said. "An argument could be made they are similar to investment earnings, but a strong following says no."

This article is copyrighted by Reuters

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