Guest Article

Obama's Trojan Horse

A 3.8% Medicare Surtax? No.
A Free-Standing Second Income Tax? Yes.
A Well-Kept Secret? You Bet.

by Alvin D. Lurie

July 8, 2014

Preface and Premonition of Things to Come

Barack Obama, in his first campaign for the presidency, had promised to make health care reform his first and chief legislative priority, if elected. But the positions of the two major political parties on health reform legislation quickly hardened, and turned into outright hostility during their initial skirmishes over that issue in the first year after his election. The die was cast. Not only did this foreclose any possibility of achieving constructive and beneficial health reform in this country through joint efforts of the leadership of both parties, but it led directly to the ensuing dysfunction of the Congress on other crucial matters of the greatest national importance — e.g., remedying the burgeoning financial crisis, extending unemployment insurance, revamping the laws governing financial institutions, increasing the debt ceiling. These had no relation to health care reform per se, but the seeds of that governmental breakdown can be traced to the earliest struggles between the parties over the health insurance "public plan" option, that the Administration fought so hard to embed in the law and the Republicans fought just as hard — ultimately successfully — to reject.

The parties have continued to wage this war over innumerable aspects of the Affordable Care Act, most especially the technical failures that occurred during the rollout of the federal insurance exchange at the end of 2013 and into the first quarter of the current year. Doubtless this will continue to be one of the principal themes trumpeted by the Republicans during the upcoming midterm elections in November 2014. What is surprising is that they have not, even at this writing -- over four years after enactment of the ACA, two national elections held since then, and another one barely six months away -- launched any attacks against inclusion in the ACA of a tax that is misnamed (misleadingly so) as a "Medicare contribution" levy, purportedly (again misleadingly) to provide the revenues to support the government expenses associated with administering the ACA. One would have thought that tax would have provided the Republicans with their best point of attack against the Affordable Care Act.

In truth, the tax, imposed specifically on "net investment income," is a new income tax, now actually a part of the Internal Revenue Code (numbered section 1411), operating exactly the same as the long-standing regular income tax, calculated on a new form created for it and the total now reportable on a line added to Form 1040. It is, in fact, much more challenging to calculate than most of the long-time familiar ordinary, alternative minimum and capital gains components of the regular income tax, because of many new technical rules and difficult factual determinations necessary for its proper application. High rates of miscalculation by taxpayers are a certainty because of the difficulties inherent in the process, and because the rules themselves will be in flux for a lengthy period, until the Treasury, IRS and ultimately the courts put their respective stamps on the statute.

The tax will add significantly to the expenses of relatively high-bracket taxpayers within its reach, not just in payment of the tax itself, but for the associated costs of compliance, including professional advice, record-keeping, calculating and return preparation, all specifically related to this tax; and, one must assume, the budgets of Treasury and IRS will grow apace to absorb the additional manpower and machine power necessary to administer this difficult new tax. Self-evidently, this all comes at substantial new costs to the Nation continuing indefinitely, with much uncertainty before the process works itself out and the dust settles, which in itself will impact the economy in unpredictable ways.

In brief, that is the subject of this paper. The question one may ask is, even assuming the tax could legitimately be claimed as supplying the necessary revenues for administration of the ACA, was it fit and proper to impose such a difficult and costly tax on the taxpayers within its reach and on the economy at large in order to achieve such an outcome. Other far simpler revenue raising measures obviously could have been devised to raise the same tax revenues, without the complications and burdens, the most obvious being a direct rate increase of existing components of the regular income tax regime.

In sum, framed in terms of Darwin's survival hypothesis, is this tax fit to survive?

Why a "Trojan Horse"

Back when the Affordable Care Act was crawling out of its swaddling clothes, the Republicans in Congress sought to smear the President and the ACA with the same can of paint. They dubbed the new law "Obamacare." The word stuck for a time as a term of derision, until the President decided to co-opt the term and turn it into a victory cry. It may, in the fullness of time, survive as the definitive word to describe the Obama years, but whether as one of high achievement or as a skillful deception played upon the public only time will tell. The case for the latter usage of the term can be rested solidly on the presumably deliberate intent of the draftsmen (likely on instructions from "higher authority") to put a section of the ACA into the service of concealing, as if it were an integral part of the health reform law, what is on all counts a free-standing income tax having absolutely no relation to health care.

Its revenues are not even actually dedicated to that legislation. The tax collections from the section do not go into the Medicare Trust Fund, but instead into the General Fund of the U.S. Treasury exactly the same as income taxes collected under the Internal Revenue Code generally. Indeed, while the tax is added to the body of U.S. laws as a section of the Health Care and Education Reconciliation Act of 2010 (the second of the two health care reform acts that together comprise what have come to be called collectively the Affordable Care Act), it is actually just an amendment of the Internal Revenue Code adding section 1411 to the IRC. That section is in every respect a full-fledged section of the Tax Code, notwithstanding its having ridden piggy- back into the tax law on the back of the health reform law.

It is possible — in fact, likely — that such tactic was expressly designed not only to enact the tax in such a way as to avert its detection by the opposition, but, presumably even more importantly to the Obama Administration, to avoid the requirement, applicable in case of tax legislation generally, that a conference occur between the House and the Senate to reconcile their differences with respect to the tax. That very evasive maneuver may have rendered Section 1411 unconstitutional for having failed to satisfy the even more fundamental requirement that tax legislation be initiated in the House of Representatives.

Article I, Section 7 of the U.S. Constitution has provided, since its very inception, that "all bills for raising revenue shall originate in the House of Representatives, but the Senate may propose or concur with Amendments as on other Bills." While that language is not without some ambiguity, it certainly would not seem to encompass the process by which section 1402 of the Health Care and Reconciliation Act (HCRA) included — among an extensive collection of more than 30 disparate sections, bundled together under a title called "Coverage, Medicare, Medicaid, and Revenues" — one section in particular that amended the Internal Revenue Code by adding, as a new IRC provision, section 1411, titled "Unearned Income Medicare Contribution."

One has to believe it was no accident that the Tax Code amendment is buried deep within and close to the end of the nearly 3,000- page two-part legislative package. Doubtless only a relatively few who read the ACA before (or even after) its enactment got as far as section 1402 of HCRA; and, of those few, even fewer were searching for new tax legislation in that section or recognized the enormous impact of Section 1411 as an income tax rather than the payroll tax that its "Medicare" title connoted.

In one of the lighter moments of the oral argument in the Supreme Court in 2012 on the ACA's constitutionality, when a comment was made that the Justices would have to read the statute in its entirety to rule on the key issue of severability of its possibly constitutionally flawed tax provisions, Justice Scalia quipped, "I'd call that 'cruel and unusual punishment.'" The truth that lay beyond the quip was doubtless lost on his listeners. It is probable that even Scalia at that time had not appreciated the explosive potential of what one might find lurking in this enormous piece of legislation.

Facially, Section 1411 gives no hint that its actual purpose is to add a completely new income tax to the Internal Revenue Code. The section in its entirety runs only two pages (barely the length of introductory portions of tax sections of much lesser breadth). But in its sparse words it imports, for purposes of application of the section, many concepts, regulations, and business and investment activities that generate tax under Section 1411, which are lifted directly from large chunks of regular income tax law and learning. So, in effect, it is not a 2-page statute, but many hundreds of pages of law and regulation.

Even that does not give a true measure of the length and breadth of the statute, because the regulations under Section 1411 themselves (as partially finalized, as this is written, and partially still in proposed status) number several hundred pages; and those regulations make clear that the lifted regulations imported into the new Section 1411 regulations will require modification in some places to prevent the frustration of special requirements applicable to the ascertainment of taxable investment income under Section 1411 that are not applicable to the regular income tax on which the new section draws so heavily.

Section 1411 gives no hint that it is entirely independent of and unrelated to Medicare, let alone that it is not connected to a provision of any kind in the ACA having a nexus with health care. Indeed it also gives no hint whatsoever of its revenue raising objectives. Such unheralded designation of a tax bill is not characteristic of how tax law gets added to the Internal Revenue Code. A tax bill typically signals its tax pedigree right up front in its title, insuring it gets the attention of those of the sponsoring congressmen's supporters most interested in its enactment, as illustrated by the following random sample of actual titles of tax-related statutes: Taxpayer Relief Act; Economic Growth and Tax Relief Reconciliation Act; Technical and Miscellaneous Revenue Act; and even one pointedly named Katrina Emergency Tax Relief Act.

In contrast, Section 1411 actually misstates its purpose. Nowhere is it identified as an income tax, but rather it is called a "Medicare contribution," which is a complete misnomer. One would have to be na?ve indeed not to see that as a ploy for the obvious purpose of appearing to set it within the framework of the health care reform legislation. That further confounds its standing under the Constitution as legislation within the legitimate taxing powers of the Congress. The tactic obviously well served the object of the drafters of the legislation to conceal its true nature as a tax, not just from the public but also from the Congress, for the very purpose, one must believe, of slipping it covertly past the gates of the enemy (read "Republicans in Congress"). Hence, my use of the "Trojan horse" figure of speech for its resemblance to the time when the Greeks, eons ago, triumphed over their Trojan rivals by concealing their soldiers in a giant wooden horse right under the noses of the Trojan gatekeepers, who then hauled the battle-ready Greeks into their city, who proceeded to defeat the Trojans.

But it is not clear how that strategy will play out in the Supreme Court when, as seems likely, a case testing the tax standing of Section 1411 appears on the Court's docket. Will a majority of the current Justices be as ready to ignore the label Congress stamped on the ACA law as a "penalty" and treat it as a tax, for purposes of its standing under the taxing power of Congress — as a majority did in the case of National Federation of Independent Business v. Sebelius (567 U.S. ___, 132 S. Ct. 2566 (2012)), probably the Court's leading decision in 2012, which upheld the constitutionality of the ACA — when the Court decides whether the ACA can be considered constitutional under the Taxing Power if the statute fails to satisfy the rule requiring origination of a revenue raising bill in the House of Representatives.

For one thing, there is a considerable question whether Chief Justice Roberts, who surprisingly abandoned his customary conservative colleagues on the Court and supplied the swing vote to sustain the law in NFIB, and whose motivation for upholding the law's constitutionality then was less than clear, would again vote to uphold the constitutionality of the ACA in the face of an origination challenge that was not presented then, but that would likely be central to the High Court's determination of the law's legality this time around. It is anyone's guess — probably including the Chief Justice himself — which way he will swing.

Tell-Tale Signs of a Tax

Section 1411 has all the signs of an income tax. It easily passes the tax law's simple rule of thumb: If it looks like a duck, swims like a duck, and quacks like a duck, then it probably is a duck. Often erroneously called a Medicare surtax (even by some experts), it is in actuality not that at all, and, as I hope I have demonstrated, is in every respect a completely separate, full-blown, second income tax, casting its net over a vast stretch of the tax landscape and its targeted taxpayers: individuals, trusts and estates, indirectly on passive owners of interests in S corporations, LLCs and partnerships, and on recipients of interests in qualified pension and other qualified plans, and charitable remainder trusts, inter alia — an extraordinarily wide swath of taxpayers.

This is no ordinary piece of income tax legislation, but rather an extraordinarily complex tax that, as already observed, will prove very difficult and costly for taxpayers to comply with, and for their professional advisers to provide the requisite guidance, because of its dependence on facts that are difficult to ferret out and on regulations keyed with great exactitude to such facts.

It is remarkable that in so many venues, whether in the broad press for the general readership or in technical journals for the professional practitioner, the Medicare label is so glibly applied and unchallenged, as if the statute were not seen for what it actually is, a true income tax, not a payroll-type Medicare tax. Interestingly the ACA actually does also contain an increased Medicare hospital insurance tax, adding 0.9% to the existing hospital insurance tax for employees and self-employed persons in the top income tax bracket (nota bene, not increasing employers' shares), dispelling any doubt that Congress could distinguish between a payroll tax and an income tax, and, in assigning the 3.8% tax to the Internal Revenue Code, had made it clear beyond doubt that it intended a regular income tax to be imposed under the new 3.8% Net Investment Income Tax, notwithstanding labeling it a "Medicare contribution."

Of course, to speak of Congress' intent is a fiction. What Congress likely did is rubber-stamp an Administration package, taking the bill as is from its authors (presumably principally the White House staff and the Democratic staffers in Congress), with additional technical input from the gifted staff of the Joint Committee on Taxation. Few in Congress would have had any knowledge of the fine points of the bill, and how it miraculously created an entirely new income tax in a two page tour de force (not counting, of course, the multi-hundreds of pages of regulations that really spell out the law).

No Scrutiny, No Repeal

The flagrant mislabeling has doubtless been the principal reason why the tax has so far escaped public scrutiny and avoided any repeal attempts of Section 1411 (apart from the Republican failed attempts to repeal it as a part of the ACA as a whole). It has been in force for the entire 2013 year and, at this writing, now continues for 2014, imposing tax obligations in years that began after 12/31/12 on the high-bracket taxpayers to whom it is directed. It has required inclusion in and since the first quarterly estimated 2013 income tax reports of taxpayers and, subsequently, in the filing of Form 1040 and other returns due in April 2014 and later. Very many — perhaps most — taxpayers potentially liable under Section 1411 were, without a doubt, taken by complete surprise when and if they became aware of this new tax. Doubtless there are many still unaware of it, if their income tax return was not prepared professionally or electronically. (Needless to say, unawareness of a tax liability is no defense.)

Even more problematic than the misleadingly false labeling of the tax is the fact of its establishment, as part of the Affordable Care Act, purportedly for the sole purpose of providing the funds for the government's administration of the health reform law (also a falsehood). The federal government has almost endless ways to extract revenues from the public that would not have imposed on taxpayers generally the burdens and costs (other than the tax dollars themselves) — and on the government itself the huge compliance expenses — that are entailed in the implementation of this incredibly complex tax. It will spawn an entirely new and endlessly evolving body of law that has no other relation to health reform than the deceptive claim that it is enacted to pay the government's bills for administering the Affordable Care Act. That deceptive provenance of the law is in itself a powerful reason to strike this tax from the law, even if not a jot and tittle of the rest of the ACA were to be changed, except for replacing Section 1411 with a different, essentially self-implementing excise tax, or adding points to the top bracket of the regular income tax, for the specific purpose of funding the administration of the ACA.

Were it not for the fact of its occupying a niche below the radar screen of most Americans, principally due to its application only to relatively high-bracket taxpayers meeting elevated income levels established in the statute, and so of no concern to the overwhelming majority of taxpayers, it is very possible (one might even say likely) that Section 1411 would have drawn heavy fire from exposed taxpayers and their representatives in Congress; and that reaction could have led to its repeal, if not repeal of the entire ACA statute as a part of which the new section was enacted.

There are sure to be many taxpayers who honestly think the new tax is no concern to them, but they could be very wrong. The tax is insidious. It reaches into places that can entrap even sophisticated taxpayers, people who regularly pay income taxes, and who know there is a new 3.8% tax, including some who even know it is not the Medicare surtax it has been called, but believe the kind of income they receive is beyond the pale of the tax. So they are presumably blissfully unaware of their exposure to the Section 1411 tax. Take the case of those who waited years to see real estate in their community recover some of its lost value and, when it did, jumped at the chance to realize the appreciation and completed the closing of a sale of their personal residences ASAP, which, in their case, we will assume occurred after December 31, 2012, thus falling neatly into the time that investment gains became taxable under Section 1411 (in addition, of course, to the regular capital gains tax). Let us assume they had made relatively small investments in the stock market or other investment vehicles, except possibly for modest contributions to their employer's 401(k) plan or to an IRA, so they reasonably concluded their investment income was well below the threshold levels of taxation under 1411, and they gave no further thought to the tax. It never occurred to them that their home was an "investment," and so possibly productive of a gain that is taxable under Section 1411. In fact it might not be taxable, depending on a variety of elements, such as: on its sale, depending on how much taxable gain, if any, was realized after giving effect to the exclusion allowable under the Code for such sales, there might not be any tax under 1411; whether they are married, and, if so, whether they will file a joint return (which would provide a higher exclusion amount that might eliminate any otherwise reportable tax under 1411); and whether some unusual deductions or permissible deferrals of income claimed in the year of sale of the residence have reduced their adjusted gross income to an amount that has the effect of reducing or completely eliminating the taxable home sale profit because of the impact of the amount of AGI on the taxability of investment gains under Section 1411.

These are merely illustrative of the many factors that affect the calculation of the net investment income tax, and they also illustrate how the tax can easily be a trap for the unwary (and even for the wary).

Survival of an Unfit Statute: A Confluence of Unrelated Factors

Apart from the limited reach of Section 1411 to just the top brackets and so of no direct concern to the overwhelming majority of taxpayers, four improbable factors — unrelated to each other and to the merits of the statute — explain why their collective effect has been to enable Section 1411 to remain on the statute books, free of any attack to this date: (1) a bizarre Supreme Court opinion by one man, Chief Justice Roberts, upholding constitutionality of ACA on a tortuous analysis that none of his colleagues agreed with; (2) the brouhaha that accompanied the calamitous opening of the federal insurance exchange in October 2013; (3) the startlingly deceptive mislabeling of Section 1411, as already noted; (4) fear by the Republican leadership that, by appearing to support repeal of a tax that only hits high-bracket taxpayers, they will be vulnerable to Democratic charges of repeating the fatal Romney 47% gaffe during his run to win the Republican primary, when he was essentially accused of not caring about the poor who pay no income tax.

A fifth factor has been suggested by some observers as having a bearing on the retention of Section 1411 on the statute books — not in and of itself but as a part of the ACA as a whole — that one could characterize as a conspiracy theory. Its argument, as it has been described, is that the very complexity of the new section was a deliberate tactic to bring about in time a single-payor health care system, as a preferable alternative even to those who most oppose Obamacare.

I know of no direct evidence to support this theory. It would require a showing that some highly placed persons in government actually wanted a single-payor system in the first place (which is undoubtedly true), such as exists in parts of Europe, but settled for the ACA system that was enacted in the belief that it was the best that could be hoped for at the time. Still harboring a hope for realization of the single-payor goal, the conspiracy theory goes, that group will resist any efforts at present to reduce the burdens of Section 1411, lest that were to placate some of the most rabid supporters of repeal of the present health reform law, whom they would like to count as allies in a contemplated attempt to replace the ACA with the single-payor system. The theory, presumably, is that the anti-1411 bloc can be bought off to join the single-payor group in return for elimination of the new tax.

I am dubious as to whether a foundation for the conspiracy theory exists, but even more dubious that, if it does, it has had any effect upon the continuation of Section 1411 in the Internal Revenue Code free of any resistance. Contrariwise, I believe the four factors adverted to above would appear to have separately and in concert inoculated Section 1411 against effective resistance from any significant quarters of the public. These are my reasons for such belief:

• Roberts' opinion as to the constitutionality of the ACA rested shakily on the "taxing" power of Congress, based on his ruling that, though the "penalty" for failing to observe the insurance mandate was deliberately so labeled by Congress, it was nevertheless a "tax" for constitutional purposes, notwithstanding that, in that same opinion — in order to avoid the undesirable consequence of being obliged to dismiss the case as premature for adjudication in the courts before the "tax" had actually become due from taxpayers (as specified in the federal Anti-Injunction Act) — Roberts held, in complete contradiction to the first part of his opinion, that the "penalty" characteristics of the levy, as deliberately titled by Congress in the ACA, prevailed and must be respected in accordance with Congress's having explicitly used the "penalty" designation. See National Federation of Independent Business v. Sebelius, supra.

  Roberts' opinion and his decision that rested upon it were completely unexpected by all the pundits. (Was it a legitimate application of King Solomon's biblical precedent of decreeing the splitting of the baby in half, or just devious pettifogging to keep this very high profile and leading case on his Court's calendar? The reader can judge for him/herself.)

  If ACA's insurance mandate had led to unconstitutionality of that provision of the statute — and it was one Justice shy of the Court's so holding — it is almost certain that Section 1411 would also have fallen with that ruling, since the key severability principle would not have supported retention of a tax whose claimed purpose was to contribute to the very considerable revenues needed to cover the enormous costs to the federal government of administering the ACA. The vulnerability of Section 1411 to a ruling that the ACA was unconstitutional would not be lessened, of course, by the falsity of the claimed dedication of Section 1411 revenues to the Medicare trust fund.

  To carry out its manifold responsibilities under the statute — principally on the shoulders of three separate, giant administrative agencies (IRS, DOL and HHS), each with its own huge budget — the Section 1411 tax, and the 0.9% boost of the employees' and self-employed persons' shares of the health insurance payroll tax, were estimated by the Congressional Budget Office to deliver 20 percent of the required federal government costs to run the ACA, which the CBO projected to generate over $300 billion of additional tax revenues in the next 10 years (the limit on the length of CBO projections). The justification for these two taxes having been tied to their significant contributions to the funding of the ACA, it would follow that, were the ACA to fail to withstand a constitutional challenge, these tax sources would lose their raison d'etre and, hence, their legitimacy.

• The uproar over the monumental technical collapse of the initial rollout of the federal insurance exchange, coupled with the early failure to sign up health policy applicants in numbers anywhere close to the White House's glowing projections — all the while that the chief occupant of the White House strove mightily to avoid having to admit blame for his misleading remarks as to the ability of health care policyholders to retain both their more favorable pre-ACA policies and their doctors, further compounded by his minimizing the disastrous functioning of the federal exchanges as merely some very short-lived software "glitches" — drew not just the public's anger but even that of many of his staunchest fellow Democratic supporters in Congress. That caused a swift and sharp drop in the public's view of the President's credibility generally and that of his Health and Human Services Secretary, Kathleen Sebelius. He was forced — painfully, one can be sure — to acknowledge fault and to reluctantly grant administratively what Republicans had been sharply calling for and what he had just as sharply refused, namely, a one year postponement of the effective date of the penalty for noncompliance with the individual health insurance mandate.

  All this to-do about the faulty performance of the federal exchange obscured the real long-term problems with the ACA, high among which, I submit, is the unbelievably complex and costly means required to determine one's tax liability under Section 1411. The totally unexpected insurance exchange scandal produced such a preoccupation of the public with that aspect of the problems with the ACA as to distract attention from more seriously flawed elements of the law. The resulting failure of the media to throw light on Section 1411 led directly to large- scale public ignorance of the law (and, may I add, to many professionals in ACA-related fields), and, more surprisingly, even to Republicans bent on overturning the ACA, who appear to have said nothing about it in their many verbal assaults against the law. That very ignorance saved Section 1411 from public scrutiny and rage, and, at least for the present, even from remedial measures, let alone wholesale scrapping.

• The third of the specific reasons noted above that I contend are the main reasons for the Section 1411 tax to have escaped repeal efforts so far — and probably the most controlling one — is its false labeling. It sailed into port flying false colors, titled a "Medicare contribution," which, as I have now underscored several times, it very definitely is not; and there is little basis for doubting that was a conscious tactic by the draftsmen of the statute — almost certainly on instructions from a "higher authority" — with intention to slip it past "Customs" (read "the luggage inspectors"). Section 1411 is contained in the second of the two laws that together make up what have come to be called the Affordable Care Act, and was actually passed as part of that completely separate bill one week after the first bill. See Health Care and Education Reconciliation Act of 2010, sec. 1422(a)(2). The first bill, the Patient Protection and Affordable Care Act, was 15 times longer than the second and included far and away the bulk of the health reform measures that were the principal claims of the supporters of the reform legislation, and, hence, its main objects of attention.

  The second act, which is largely a potpourri of lesser provisions, includes Section 1411 under a title of that act named, inconspicuously, "Coverage, Medicare, Medicaid, and Revenues," which is itself a catch-all grab bag of provisions. Its last subtitle is titled "Provisions Relating to Revenue"; and that, in turn, contains several miscellaneous sections unrelated to each other, imposing, among others, items styled "excise taxes" and "fees." (One section, which affects just the timing of a deduction for Medicare expenses, has a closer connection with Medicare than can be claimed for Section 1411.) There are several other assorted sections in that subtitle, one of which is titled "Unearned Income Medicare Contribution," which is the only section in the entire paired acts of the ACA that is relevant to this paper.

• The concerns of the Republican leadership now quite clearly appear to be to broaden their base so as not to continue to be seen as the party of the rich, whereby the GOP has continued to lose the hearts and minds — and, hence, the votes — of the majority of the electorate. In that way they hope to reverse the winning pattern by means of which the Democrats have corralled a majority of voters in the last two presidential elections. That could well be the principal reason the Republican leadership has so far refrained from employing, as ammunition for its continuing assault on the ACA, the glaring vulnerability of Section 1411, which impacts only high-bracket taxpayers.

Stealth New Chapter of Internal Revenue Code

The ACA section titled "Unearned Income Medicare Contribution," buried deeply within the recesses of the ACA, is the section most directly related to the argument of this paper. It comprises an amendment of the Internal Revenue Code adding a new chapter 2A to Subtitle A, the "Income Taxes" subtitle of the Code. It too is titled "Unearned Income Medicare Contribution." On close inspection one sees a section which, like many other income tax provisions of the IRC, "impose(s) (in addition to any other tax imposed by this subtitle) fore each taxable year a tax equal to 3.8 percent" on a tax base explicitly defined in the statute.

Nowhere in the above-cited new Code chapter 2A can one find anything to sustain a "Medicare" connection; and, I will confess, it was helpful to see spelled out in the preamble of the Proposed Regulations for Section 1411 that:

Amounts collected under section 1411 are not designated for the Medicare Trust Fund. The Joint Committee on Taxation in 2011 stated that "[i]n the case of an individual, estate, or trust an unearned income Medicare contribution tax is imposed. No provision is made for the transfer of the tax imposed by this provision from the General Fund of the United States Treasury to any Trust Fund." See JCT 2011 Explanation, at 363; see also Joint Committee on Taxation, Description of the Social Security Tax Base (JCX-36-11) (June 21, 2011), at 24.

See 77 Fed. Reg. 72611, at p. 72613 (Dec. 5, 2012).

That gratuitous reference in the regulations to the Medicare Trust Fund seems to provide implicit recognition by Treasury and the IRS that the public will very likely be misled by the Medicare terminology in the title of the new chapter of the Code (as, indeed, many already have been).

To put a fine point on it, the preamble adds that the Section 1411 tax "is subject to the estimated tax provisions," a sure indicia of its income tax properties as distinct from Medicare taxes. There is a vast chasm between an income tax and a payroll tax, and even in the amount of tax each produces, despite the stated rate of tax — 3.8% in this case — being the same irrespective of which tax scheme is intended by the legislature. An obvious difference lies in the income base to which the tax applies. A payroll tax is limited and easily ascertainable; the principal issue for highly compensated individuals is likely to be the year in which deferred compensation becomes taxable. But for that, a payroll tax is essentially self- enforcing. No difficult determinations of the underlying law or the calculations of tax are required. If the salary is $100,000 and the tax rate is 3.8%, the tax is $3,800. The taxpayer's only burden is to pay it.

An income tax, on the contrary, can range over a wide variety of kinds and sources of income, rates of tax, and allowable deductions and credits. The calculations require extensive knowledge of the intent of the Congress in enacting the tax, judicial and administrative interpretations of its language and reach, ascertainment of the facts, marriage of the three, possibly an overlay of related law and facts (like carryovers, years of realization, etc.). Application of an income tax to a given taxpayer often necessitates the services not just of a single-discipline tax specialist, but sometimes a veritable cohort of accountants, lawyers, CLUs, CFPs, actuaries and other experts in various configurations in order to reach the correct result (e.g., to enter the correct figures in the taxpayer's return). That will prove to be the case for the proper preparation of the new Form 8960. There is, of course, no shortage of competent practitioners in those professions willing and able to fill that need. But was it appropriate to erect such an elaborate structure for the sole purpose of funding the government's Obamacare responsibilities?

A further question might then be posed, and I put this to the reader, not argumentatively, but simply as an inquiry: is it right, strictly as a matter of tax policy, to impose the tax on one segment of the private sector and sell it as a tax on the "rich" irrespective of how un-rich its targets at the lower end of the spectrum could be, considering the relatively low level of taxable "net investment income" which Section 1411 establishes as the threshold figure at which a taxpayer can be caught in the its tax net ($200,000 for a single person, $250,000 for a married couple filing jointly)? Could those levels more aptly be considered "middle class"? If so, could application of the "rich" label be viewed as political, akin to the "Medicare" label, as a way to win support for passage of the President's signature legislation?

What Does One Even Call This Tax?

Section 1411 does not give a name to the tax it establishes. The only thing even approaching a name is the designation that the second act of the ACA applies to the title of its section 1402, i.e., "Unearned Income Medicare Contribution," which amends the IRC to establish a new chapter of the Code also named "Unearned Income Medicare Contribution," which consists of just a single Code section, 1411, that is called prosaically "Imposition of Tax."

Commentators on the new section in print and on the lecture circuit have called it, literally and accurately, "Net Investment Income Tax" (or "NIIT"); and they seem to have gotten it just right, because the new Form 8960 also has named it "Net Investment Income Tax," together with a second line reading "Individuals, Estates, and Trusts," which is as official as one can make it. Alert readers of both the proposed and the final regulations would have caught at the top of the first page, in the title of the regulations, the words "Net Investment Income Tax." No shilly-shallying about "Medicare contributions" or other such dissimulations. (The final regulations can be found at 78 FR 72393, Dec. 2, 2013.)

Remember Section 89?

As I have now repeated several times in this paper, Section 1411 is in every respect a full-fledged income tax, with all the trappings: its own special tax reporting form, subject to inclusion in the quarterly estimates of the year's income taxes, and with a new line added to the Form 1040, for reporting the tax. Is it now a permanent part of the U.S. income tax scheme? It certainly is for the next two years, unless this Congress reconsiders, repeals or replaces the current NIIT, and, then, upon the President's anticipated veto, overcomes it by the requisite majorities in both houses of Congress. That iron-fisted Congressional response is not a far-fetched scenario, given that the taxpaying portion of the public is increasingly becoming aware of Section 1411 now that they are experiencing its impact upon them, due to the tremendous compliance burdens and costs it entails. By now the IRS is also fully cognizant of how difficult and costly effective enforcement of this new tax will be for its agency, and has surely begun to document these costs in its annual budget proposals to the Office of Management and Budget.

These very factors at least once before in the Nation's tax history, in the 1980s, combined to bring about the swift repeal of Internal Revenue Code Section 89, a well-intentioned piece of benefits reform legislation. If, as presently seems to be the case, early disappointments with the performance of the ACA, as compared with its promise, turn a roughly evenly split public into a decidedly anti-ACA majority, and that provides winning majorities for the Republicans in the next mid-term elections, the odds of repeal of the ACA — and, of course, of the NIIT with it — would increase significantly.

It is no exaggeration to say that Section 1411 has so far led a charmed life, like a slender craft maneuvering around Scylla and Charybdis, that easily could have wrecked a sturdier craft. Of course, as it is regularly said in insurance and securities proposals, the past is no predictor of future performance. Taxpayers within the reach of Section 1411 are discovering that beneath the "Medicare" mask hides a very over-the-top tax. I have attempted to give in this piece a possible explanation of why those who so oppose the overkill of the ACA and ardently wish its demise have so far refrained from using the enormous potential firepower that underscoring the hugely complex and costly Section 1411 tax could add to their futile efforts until now.

The prior occasion when a tax provision — IRC Section 89 — was enacted to eliminate discrimination in employee fringe benefits was so onerous as to be amended two years later to simplify its operation. Within a year after that, when it still proved too difficult to administer and required tremendous compliance efforts by employers, it was repealed retroactively and never took effect.

That is a lesson of history that, if forgotten, would leave in place legislation many times more onerous than Section 89 — not just for employers, but for individual taxpayers across the board, passive and active investors, qualified trusts, IRAs, deferred compensation plans, estates, S corporations, partnerships, charitable remainder trusts, trustees of many varieties of qualified and nonqualified trusts, controlled foreign corporations, and passive foreign investment companies. The compliance costs and burdens imposed on these individuals and entities, on the federal government to administer the Section 1411 tax, and on the federal courts to adjudicate the issues that will continuously and increasingly emerge, are enormous. It is within the prerogative of Congress to follow the lesson and precedent of Section 89.

The Real Devil, The Real Details

Section 1411 has imposed unparalleled burdens on all taxpayers, trustees, fiduciaries, advisors and others required to comply, or to assist taxpayers, beneficiaries, partners, investors and clients to comply, with its provisions. Formidable responsibilities also have been imposed, principally on the IRS charged with enforcing such compliance and administering the new tax generally. These burdens are entirely disproportionate to the requirement to fund the ACA statute, and are not integral to providing improved health care law in the Nation, since revenue sources not weighted with the enormous complexities of Section 1411 were readily available to provide the requisite funds for the federal government.

Let there be no misunderstanding. It is not the argument of this paper that health reform legislation must be scrapped, seriously shrunk or otherwise reformed to spare higher-bracket taxpayers from a costly new tax. It is the tax itself that must be reformed, so that the requisite revenues are generated, without the frightful compliance costs that are the direct consequence of the flawed tax scheme designed by anonymous authors (presumably connected with the White House) and made to appear as an integral and inconspicuous part of the Affordable Care Act, presumably in order to assure its uneventful passage by the Congress.

These compliance costs can be properly viewed as an added tax, in many cases more costly to taxpayers than the Section 1411 tax itself, but with none of it flowing into the tax collections of the U.S. Treasury. The devil here is not in the details of the tax that on its face would appear only two pages long. The real devil is contained in the enormously complex shadow structure developed by IRS and the Treasury in the 57 pages of final regulations in the Federal Register (which were 217 pages in the public inspection version before being converted to fine print for publication) that have been issued on Section 1411, where the real tax is set forth. This is not meant as a criticism of IRS or Treasury, whose technical personnel produced remarkable regulations with the sole goal of explicating the confusing net investment income tax that Congress enacted at the President's urging.

It is not to be anticipated that the President will now take the initiative to alter in more than modest ways what he regards as the signature legislative achievement of his first term of office. While that once loomed large in what the President hoped to be his legacy, a series of missteps in his handling of foreign affairs midway into his second term have forced him and his advisers to shift emphasis from legacy burnishing to salvaging a vestige of the once-high regard with which a majority of the electorate twice held him on Election Days. Little time or energy will be left for dealing with ACA-centered attacks. If Section 1411 is to be overturned during the remainder of this Administration, it is Congress that will have to do it. The outcome of the midterm elections (four months away as this is written) will provide a good indication of whether that is a reasonable expectation of things to come.

There is, of course, another path to repeal of Section 1411. It is by vote of five of the Nation's citizens. Not any five citizens — a very select five. That would be a majority of the Justices of the Supreme Court. That could occur well before the next term of Congress would be able to accomplish the task, if, as I suspect, the Court grants certiorari on a case that presents them with the issue of whether Section 1411 of the Internal Revenue Code is unconstitutional for its failure to have satisfied Article I, Section 7.

Copyright 2014, A. D. Lurie

Alvin D. Lurie is a practicing pension attorney. He was appointed as the first person to administer the ERISA program in the IRS National Office in Washington. He is general editor of Bender's Federal Income Taxation of Retirement Plans (LexisNexis), a 2-volume treatise, and he is also editor of the annual compendium of articles published under the title New York University Review of Employee Benefits and Executive Compensation (LexisNexis). Mr. Lurie is the first recipient of the Lifetime Employee Benefits Achievement Award sponsored by the Employee Benefits Committee of the American Bar Association Tax Section. He can be contacted at Alvin D. Lurie, P.C. in Larchmont, New York, at (914) 834-6725 or via email: <allurie1@verizon.net>.

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