Monday, April 5, 2010

Unexpected Boon for HSAs: Medicare Surtax Shields

HSAs have always shielded their owners from tax on ordinary income, investment income, and spending on medical expenses. Despite talk in early legislative sessions about extinguishing HSAs, the tax benefit of HSAs is now broader than before. While a significant portion of the Patient Protection and Affordable Care Act is funded by a 3.8% Medicare surtax, HSA holders are well equipped to avoid the additional tax.

Normally, HSA contributions are exempt from payroll taxes, like Medicare tax. In the case of high income individuals, however, the contribution limits of around $6000 cap the available tax benefit. Now, however, the tax shield is more effective because there are more taxes to protect against. High income individuals with investment income can shield a potentially unlimited amount of investment income from the Medicare tax, so long as the legal ownership of the investment is within the confines of an HSA trust account. 

The following description of how the surtax functions is excerpted from U.S. Trust Tax Alert 2010-2. 

 This surtax of 3.8% will be imposed on certain individuals, trusts and estates. The surtax will be imposed on individuals with “net investment income” to the extent that modified adjusted gross income exceeds: 
o $250,000 for taxpayers who are married filing jointly or surviving spouses; 
o $125,000 for taxpayers who are married filing separately; and 
o  $200,000 in all other cases. 
These amounts (e.g., $250,000 for a married couple) are not indexed for inflation.
Example: Assume the same facts as Example 1, and that husband and wife have net investment income of $100,000.  Their modified adjusted gross income exceeds the threshold by $300,000 (i.e., $550,000 minus the $250,000 threshold).  Accordingly, the Medicare surtax will be assessed only against the $100,000 of net investment income, resulting in $3,800 surtax.  

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