When he signed the new bill to expand medicare coverage to pay for catastrophic care, President Reagan said it would protect elderly Americans from bankruptcy, because of the costs of long-term care. The bill, signed in July, does go a long way toward that goal. But it has also sent financial planners and tax advisers scrambling to find ways to minimize its effect on their clients, or at least warn them that a tax increase is coming.
``Folks will be playing all kinds of games to cut their taxable income'' because of this law, says Peter Weston, a financial planner in Birmingham, Ala.
But if the game isn't played right, you could be even further behind.
Under the law, everyone who is over age 65, or is eligible for disability or social security benefits, will be required to pay a 15 percent surtax on his or her federal income tax next year. That will mean a premium rate of $22.50 for each $150 of federal tax liability. In 1990, the premium will jump to 25 percent, or $37.50 per $150 of tax, and by 1993 the surtax will be 28 percent, or $42 per $150 of tax.
Like any graduated tax, this one will hit upper incomes the hardest. In 1989, there will be a cap of $800 per person on the surtax, but by 1993, the cap will stand at $1,050. After that, increases will be pegged to the inflation rate for medical expenses, as paid by medicare.
But 56.2 percent of those eligible for medicare won't pay anything more than a basic premium of $4 a month, says Peggy Hannan, a spokeswoman for the American Association of Retired Persons. For another 24.4 percent of those eligible, the extra tax will be less than $250 a year, she says. This means that more than 80 percent of those over 65 will pay no more than $298 next year for the surtax and the $4 monthly premium.
So the top rate will apply only to the wealthiest 5.7 percent of taxpayers eligible for medicare or social security. They are the ones who will be looking for help from financial and tax advisers.
``Most of my clients don't have any understanding of what this is all about,'' Mr. Weston says. ``And they won't know about it until April of 1990.'' That's when they will fill out their income tax forms for 1989 and will suddenly discover they owe Uncle Sam more money.
People who make quarterly estimated tax payments will get an earlier warning, since the first payment they make next spring will have to include the medicare surtax.
Since the bill was passed, there has been a great deal of debate about its need, especially for those who have or can afford private insurance and those who do not wish to pay for any form of medical insurance. But while Congress wanted to address the catastrophic-health-care question, it was in no mood to add to the federal deficit or to raise taxes for the overall population, Ms. Hannan says.
``We were not thrilled with the final outcome,'' she says. ``To put the whole burden on the elderly is extremely expensive and unprecedented.''
``Upper-income people are going to be in for a shocker,'' she acknowledges. ``But ironically, those are the people most able to absorb the costs.''
In addition to paying for hospital, doctor, and prescription bills above certain deductibles, the expanded coverage will also pay for any skilled nursing facility, Christian Science sanitorium, or hospice where medicare payments are accepted. The deductible for hospitalization next year will be $560, and will rise slightly each year. At present, only the first 60 days are free, and only 150 days a year are covered.
There will also be deductibles of $1,370 for doctors' bills and $600 for prescriptions. Now, there is no limit.
Since the medicare surtax is based on the federal income tax that people owe, many of them will be looking for ways to lower that tax burden.
The most obvious answer is to shift income-producing investments from those turning out taxable income, like corporate or utility stocks and bonds, to investments paying tax-free interest, like municipal bonds. For some people, this may help. Since the surtax is based on $150 of federal tax, each reduction of the income tax will remove some surtax obligation.
But it may not always work that way. For some people, particularly those in upper-income brackets, part of the the money they get from social security is taxable. And earlier Congresses have done damage to the wonders of tax-free bonds.
``You could be solving one problem and creating another'' by investing too heavily in tax-free instruments, says Neil Kauffman, a financial planner in Philadelphia. For one thing, tax-free yields are at historic highs right now, but that may not last forever. In the future, investors may still be better off in taxable instruments, even after adding in the medicare surtax.
Second, tax-exempt income may be partly taxable for some income groups. But the formula for figuring it all out is complicated, Mr. Kauffman says, so while you need to be aware of this new tax, you should consult a financial planner or tax adviser before trying to invest your way out of it.