Obama Health Care Proposal Recommends Hospital Insurance Tax on Annuity Income

President Obama unveiled his recommendations February 22 on how to reconcile the differences between the House-passed health care bill and that pending in the Senate. One proposal in the Obama draft is causing alarm bells to go off at NAIFA. It proposes to apply a 2.9% Medicare Hospital Insurance tax on income from annuities.

Little is know about the details of the President’s plan and this is no exception. For example, does income from annuities also include income from defined benefit pension plans or annuities derived from defined contribution plan funds? Nonetheless, the Congressional Joint Committee on Taxation (JCT) released a preliminary analysis of the overall HI proposal on February 24. It described the HI tax as follows:

“The proposed expansion in the Medicare hospital insurance ("HI") tax would be applied to both earned and unearned income. Under present law, the HI tax rate is 1.45 percent of earned income, and is imposed on both employer and employee, resulting in a total tax rate of 2.9 percent. For self-employed individuals, the HI tax rate is the same as the combined employer and employee HI rates, or 2.9 percent. Because there is no limit on the amount of earnings subject to the HI tax, the rate is applied to all wages and self-employment income.

Under the first part of the President's proposal, the HI tax rate on wages and self-employment income would be raised by 0.9 percentage points for single filers earning in excess of $200,000 and joint filers earning in excess of $250,000; the increased rate would be imposed only on the employee. The resulting HI tax rate on the employee portion would be 2.35 percent, and the employer portion would remain 1.45 percent, resulting in a total HI rate of 3.8 percent.

This proposal would also apply a 2.9 percent tax rate (equal to the combined employer and employee share of the HI tax under current law) on income from interest, dividends, annuities, royalties and rents, other than such income which is derived in the ordinary course of a trade or business which is not a passive activity (e.g., income from active participation in S corporations) on single filers earning in excess of $200,000 for singles and joint filers earning in excess of$250,000. We have assumed that the unearned income subject to the surtax would be reduced by any investment or miscellaneous expenses associated with the generation of the unearned income. A taxpayer's unearned income is subject to the 2.9 percent tax if the taxpayer's adjusted gross income exceeds the $200,000 ($250,000 in the case of joint filers) threshold. The unearned income surtax would be phased in over $40,000 of adjusted gross income. The $200,000 and $250,000 thresholds that apply for purposes of both the earned and unearned income portions of the proposal are indexed for inflation.”

For a copy for the full JCT analysis click here.

The President’s health care proposal illustrates two key propensities of this Administration. First, it will be relentless in its search for new revenue to pay for new, favored programs, of which healthcare is the highest priority. (The lesson from this proposal is nothing is sacred.) Second, taxing “high earning” individuals is a preferred source of additional tax revenue.

A word to the wise?

NAIFA Staff Contact: Michael Kerley, Senior Vice President – Federal Government Relations, at (703) 770-8155.