Filed Under:Annuities, Fixed Indexed

PPACA and her sister: IRS posts tax proposals

HCERA Section 1402(a)(1) will impose a 3.8 percent tax on certain individuals, estates, and trusts.
HCERA Section 1402(a)(1) will impose a 3.8 percent tax on certain individuals, estates, and trusts.

New taxes created by the big federal health tax laws could hit some high-income annuity and trust users starting in 2013.

The Internal Revenue Service (IRS) has given more information about how it expects to handle the taxes in three new batches of documents:

The proposed regulations and the FAQ answers relate to provisions of the Patient Protection and Affordable Care Act of 2010 (PPACA) and PPACA's sister, the Health Care and Education Reconciliation Act of 2010 (HCERA).

Congress enacted HCERA to make last-minute changes to PPACA.

The Obama administration refers to the two-bill package that includes PPACA and HCERA as the Affordable Care Act (ACA).

In the Section 1411 draft regulations and the FAQ answers, IRS officials refer to life insurance policies; 401(k) plans, 457 plans and other retirement plans that qualify for special treatment under the Employee Retirement Income Security Act (ERISA); non-qualified deferred compensation plans; and estates and trusts.

In the additional Medicare tax draft regulations, officials refer briefly to non-qualified deferred comp plans.

The IRS released the documents Friday. The Federal Register is set to publish the proposed regulations Wednesday.

Comments for the net investment income tax proposals will be due 90 days after the official Federal Register publication date, and comments on the additional Medicare tax draft will be due 60 days after the publication date.

The net investment income tax

The net investment income tax proposals implement Section 1402 of HCERA, which created IRC Section 1411.

IRC Section 1411 is supposed to impose a 3.8 percent tax on the unearned income of high-income taxpayers starting Jan. 1, 2013.

The tax, which is supposed to raise more than $210 billion over 10 years, will affect individual filers who earn more than $200,000 in adjusted gross income (AGI) and couples with an AGI over $250,000.

The income subject to the tax will include investment income from non-qualified annuities as well as income from interest, dividends and capital gains, IRS officials said in the FAQ answers.

Types of income not subject to the tax will include Social Security benefits income; distributions from qualified plans such as 401(a) plans, 403(a) plans, 403(b) plans, 408 plans and 457(b) plans; and unemployment compensation.

"Estates and trusts will be subject to the net investment income tax if they have undistributed net investment income and also have adjusted gross income over the dollar amount at which the highest tax bracket for an estate or trust begins for such taxable year," officials said.

For tax year 2012, the threshold amount is $11,650, officials said.

In the preamble to the net investment income tax draft, officials include a section on treatment of annuities.

"Gain or loss from the sale of an annuity would be treated as net investment income," officials said. "To the extent the sales price of the annuity does not exceed its surrender value, the gain recognized would be treated as gross income... If the sales price of the annuity exceeds its surrender value, the seller would treat the gain equal to the difference between the basis in the annuity and the surrender value as gross income ... and would treat the excess of the sales price over the surrender value as gain from the disposition of property....

Later, officials noted that "any income of the trust of a qualified plan or arrangement that is applied to purchase a participant's life insurance coverage...is not included in net investment income."

Charitable remainder trusts (CRTs)
The IRS is creating special rules for charitable remainder trusts (CRTs).

Officials are proposing that "distributions from a charitable remainder trust to a beneficiary for a taxable year consist of net investment income in an amount equal to the lesser of the total amount of the distributions for that year, or the current and accumulated net investment income of the charitable remainder trust."

If a CRT has more than one beneficiary, the amount of net investment income that the beneficiary must report will be based on the share of the total CRT distribution amount that it gets.

Officials reported that they chose this method rather than a more complicated method that would have involved class-by-class calculations.

Additional Medicare tax (IRC Section 3101(b)(2))
Officials refer briefly to non-qualified deferred comp plans in the draft additional Medicare tax regulations.

The new IRC Section 3101(b)(2) provision would increase the Federal Insurance Contributions Act (FICA) Medicare withholding tax rate for single filers earning more than $200,000 and married joint filers earning more than $250,000 by 0.9 percentage points -- to 2.35 percent, from 1.45 percentage points.

The percentage point change would increase the dollar value of the Medicare tax that affected taxpayers pay by 62 percent.

Calculating wages for purposes of the new additional Medicare tax will be the same as calculating wages for other FICA withholding tax purposes, officials said.

"For example, if an employee has amounts deferred under a nonqualified deferred compensation plan and the nonqualified deferred compensation (NQDC) is taken into account as wages for FICA tax purposes under the special timing rule ..., the NQDC would likewise be taken into account under the special timing rule for purposes of determining an employer’s obligation to withhold additional Medicare tax, officials said.

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