I’ve heard a lot of misinformation lately about the potential additional Medicare taxes included in the Affordable Care Act (ACA) in the U.S. A common misconception is that there will be a new tax on real estate sales. As with all misinformation, there is a tiny kernel of truth in this statement, but once you dig deeper, you find that the actual story is quite different.
Let’s break down the tax components of the ACA and discuss their implications for companies that relocate current or new hire employees. Two basic components make up the new Medicare taxes, which will be effective January 1, 2013.
1. Issue: Potential new 3.8% tax on unearned income, such as interest, dividends, capital gains (including real estate), and rent.
Applies to: Employees whose adjusted gross income (as opposed to straight wages) exceeds $200,000 (or $250,000 if married filing jointly) and applies only to the lesser of the unearned income amount or the amount by which the adjusted gross income exceeds the threshold. Capital gains for real estate — note this is not proceeds on the sale — may be subject to this tax as part of unearned income if there is a gain on sale that exceeds the capital gains exclusion ($250,000 for single, $500,000 for married) after the basis in the home has been subtracted.
Implication: Employees will not know if they are subject to the 3.8% tax until they have completed their income tax forms for the year in which the sale occurred. In order to prove to his/her employer that the taxes were indeed due because of the sale of the home, the employee would have to provide proof of tax paid, including all pertinent tax forms once the filing has occurred. This potential disclosure of the employee’s private information (spousal income, investment information, etc.) to the company may be enough to discourage these types of requests.
2. Issue: Potential increase of 0.9% (from 1.45% to 2.35%) on the employee portion of the existing Medicare tax.
Applies to: Employees whose wages exceed $200,000, and only for that wage portion over the $200,000 threshold. The tax will apply to any employee whose taxable relocation benefits put him/her over this threshold. Married employees who file jointly and whose combined income exceeds $250,000 may need to pay the additional tax at tax filing time even if the transferring employee’s wages do not exceed $200,000.
Implication: If FICA (of which Medicare is a portion) is not currently included in a company’s tax gross-up methodology, the issue is moot. If FICA is currently included in gross-up, examine your current gross-up philosophy—you may wish to cover this additional tax (again, only on the portion above the threshold) in keeping with current gross-up methodology.
Note: Some married employees may ask for additional tax assistance if relocation benefits drive combined income (employee and spouse) above the married filing jointly threshold. It is highly recommended that each individual case be examined carefully before committing to additional after-the-fact tax assistance as a matter of policy.
It’s important to remember to look at the totality of the relocation program when making tax gross-up decisions. “Keeping an employee whole” is simply not a current relocation philosophy at most companies. Some of these additional taxes may need to be borne by the employees; refer to the Miscellaneous Expense Allowance, if provided, for a way for the employee to cover additional tax liability.
There are other aspects of these additional taxes that employers should be aware of; please reference the excellent blog post from Pete Scott, the tax counsel for Worldwide ERC®, for more information.
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