Use Obamacare tax increases to sell life insurance and annuities before year end, Pt. 1Article added by Ken Davis, Retired CPA, CLU, ChFC on July 27, 2012
Ken Davis

Ken Davis, Retired CPA, CLU, ChFC

Scottsdale, AZ

Joined: November 23, 2009

Tax increases always help life insurance agents. New tax laws taking effect in 2013 will hit our wealthy clients hard. This creates an opportunity for us to educate our clients about those changes and what we can do to mitigate them.

The time for us to act is before year end 2012. So, arm yourself with the facts in this article and then employ the strategies I will share with you to have a great end to your sales year.

Next year, our best clients will be hit with a double tax whammy. The new 3.8 percent Obamacare Medicare Investment Tax (What I term as OMIT) kicks in January 1, 2013. Add to that the loss of the Bush tax cuts and we find ourselves with top two income tax brackets increasing to 36 percent and 39.6 percent. That means the top tax bracket, with OMIT included, will be 43.4 percent! Add in your state income taxes and we are pretty much at 50 percent, folks.

Please note that there is an additional Medicare wage tax increase of 0.9 percent on high income earners which is not discussed at length in this article because we are focusing only on taxes we can impact with insurance planning.

There is even worse news for retired folks with high modified adjusted gross income (MAGI). A few years back, Medicare premiums increased as much as $3,434 per year for these people. Add the tax bracket increase, OMIT and the increased Medicare premiums together and we have an outrageous tax situation.

Insurance professionals can help. We have a home court advantage because our annuity contracts don’t generate 1099 income until liquidated or annuitized. And if done correctly, our life insurance contracts never create any income subject to income taxes.

The tax strategies we will employ all revolve around reducing gross income, AGI, MAGI and taxable income. We will simply show our clients how to reallocate their money into tax deferred insurance contracts.

The list of tax pitfalls we are trying to avoid are:
  • Triggering Medicare investment tax of 3.8 percent

  • Being pushed into the higher 36 percent and 39.6 percent income tax brackets

  • Avoiding the higher Medicare premiums of as much as $3,434 per year

  • Medicare investment tax

  • The 10 percent AGI limitation on itemized medical expenses (It jumps from 7.5 percent to 10 percent because the Bush tax cuts will expire at the end of 2012)

  • The impact higher AGI has on the alternative minimum tax being triggered

  • Up to 85 percent of Social Security income into taxable income

    Note: The 85 percent Social Security income inclusion falls squarely in the lap of almost all of our clients and in particular our middle class clients. So much for taxing the rich.
Federal income tax basics

To understand how we can improve our clients tax situation, we must first understand seven basic tax terms. Once you get these down, the tax planning strategies presented in this article will make more sense to you.
  • Gross income is the amount of income that our Internal Revenue Code (IRC) requires us to include on the tax return.

  • Adjusted gross income (AGI) is the number found on the bottom of page one of Form 1040. It is an amount after certain business and retirement types of deductions are taken from gross income. It is also an amount calculated before exemptions, standard deduction or itemized deductions.

  • Modified adjusted gross income (MAGI) for purposes of OMIT, effective January 1, 2013, is AGI plus amounts having to do with international taxation that most of us do not have to deal with.

  • Modified adjusted gross income (MAGI), for purposes of the taxation of Social Security income, is AGI plus municipal bond income and half of the Social Security income received.

  • Modified adjusted gross income (MAGI), for purposes of determining Medicare premiums, is AGI plus municipal bond income.

  • Taxable income is the amount on page two of the Form 1040 after exemptions and deductions have been taken out. This number determines the tax rate and the resulting computed taxes.
How bad do these and existing taxes on the wealthy hurt our clients?

OMIT kicks in at $200,000 MAGI for individuals and $250,000 MAGI for couples filing jointly. OMIT applies to the lesser of the amount by which MAGI exceeds these threshold amounts or net investment income. Net investment income includes interest, dividends and capital gains, but is broader than just that. There are some great articles on the Web for the more technical amongst you that go into more detail.

The top income tax brackets assessed against taxable income will increase in 2013 to 36 percent and 39.6 percent.

I am sure by now you see the opportunity presented to us to help our clients reduce or eliminate these new taxes. Let’s also review other existing taxes that our insurance strategies could favorably impact so that we can see how dramatic our planning can be in total.

Medicare premiums

A few years ago, the combined Medicare Part A and B premiums increased for people covered by both Medicare Part B and D. Individuals making over $214,000 MAGI, and couples making over $428,000 MAGI, now pay $3,434 more in Medicare premiums each year per person than the base rate. That is $6,868 additional Medicare premiums per couple per year under this new law.

An interesting note here is what happens to a widow at the death of her husband. While the husband lives, a couple with MAGI of $214,000 would pay excess premiums of $1,557.60 per person per year or $3,115.20 in total. As soon as the husband dies, the widow now pays $3,434 per year in excess premiums. So, the widow grieving her husband’s death sees an increase in her premiums instead of what we might expect to be a decline.
The 85 percent inclusion of Social Security income money grab

MAGI also affects the taxation of Social Security income. For example, a couple with joint Social Security income of $48,000, and with AGI over $44,000, would have to include $40,800 of the Social Security income in their tax return. That causes a tax of $17,707, with the taxpayer subject to the new maximum rate of 39.6 percent and the OMIT of 3.8 percent.

New limits on medical expenses

The AGI limitation of deduction of medical expenses rises to 10 percent next year.

Alternative minimum tax

Higher AGI also has a negative impact on the alternative minimum tax formula. All of the tax damage listed above is affected by AGI and MAGI limits. Part two in this series will show insurance professionals how to employ life insurance and annuities to reduce or eliminate their impact.

Although the author believes the content of this article to be accurate to the best of his abilities he makes no warranty nor offers any legal or tax advice herewith. It is the responsibility of the reader to engage their own tax advisor for their personal or client use of any of the information included in this article.

IRS Circular 230 Disclaimer: To ensure compliance with IRS Circular 230, any U.S. federal tax advice provided in this communication is not intended or written to be used, and it cannot be used by the recipient or any other taxpayer (i) for the purpose of avoiding tax penalties that may be imposed on the recipient or any other taxpayer, or (ii) in promoting, marketing or recommending to another party a partnership or other entity, investment plan, arrangement or other transaction addressed herein.
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