The Patient Protection and Affordable Care Act & the Health Care and Education Reconciliation Act of 2010:
A closer look
By Jeff Hert, CPA and Daniel Lynn, CPA
On March 23, Congress passed and President Obama signed the Patient Protection and Affordable Care Act. On March 30 this bill was followed up with the passing of the Health Care and Education Reconciliation Act of 2010. The legislation has many far reaching aspects, but we want to make you aware of the income tax ramifications for individuals and businesses.
The focus of the legislation is to allow U.S. citizens and legal residents to obtain health insurance. This goal and how we will pay for it has been strongly debated.
The individual mandate
U.S. Citizens must obtain health insurance effective December 31, 2013. If an individual does not have minimum essential health insurance coverage, he or she will pay a tax penalty, phased in over 2014-2016. Minimum health insurance coverage includes government sponsored programs (Medicare, Medicaid, etc.), eligible employer-sponsored plans, certain grandfathered group plans and any other coverage approved by the Department of Health and Human Services and the IRS. Beginning in 2014, the penalty will be the greater of $95 per person (maximum of $285 for a family) or 1 percent of taxable income above the minimum amount required to file a tax return. By 2016, the penalty phases up to the greater of 2.5 percent of taxable income or $695 ($2,085 per family). No penalty will be assessed for individuals who do not have health insurance for three months or less during a tax year. The coverage requirement also does not apply to those under financial hardship, American Indians, those with household incomes below the filing threshold ($9,350 for single and $18,700 for couples in 2010), incarcerated individuals, those exempted for religious reasons (recognized religious sect exempted from self-employment taxes) and those residing outside of the U.S. and having minimum coverage.
In order for low and middle income taxpayers to meet the requirement to maintain affordable health insurance coverage, the legislation has enacted state exchanges where residents will be able to purchase health insurance and receive a refundable tax credit or a premium assistance credit beginning in 2014. The credit will be available to individuals and families with income of up to 400 percent of the federal poverty level ($43,320 for individuals, $88,200 for a family of four, using 2009 poverty levels) who are not eligible for Medicaid, employer-sponsored insurance or other acceptable coverage.
Raising revenue
One of the revenue raisers in the Act is a higher Medicare payroll tax on wages. Under current law wages and self-employment income are subject to a 2.9 percent Medicare payroll tax (in the case of employees, this tax is shared equally by the employee and employer). Under the new law, single people earning more than $200,000 and married couples earning more than $250,000 will be taxed an additional .9 percent on the excess of these base levels. This tax will go into effect for wages and self-employment income received after December 31, 2012. Though this tax is borne entirely by employees, employers are responsible for withholding the tax on wages.
At the same time, a Medicare tax on investment income. A 3.8 percent tax will be imposed on net investment income for those single filers with adjusted gross income over $200,000 and joint filers over $250,000. Net investment income includes income from interest, dividends, royalties, rents, annuities, capital gains, and other income derived through passive trade or business activities. Investment income does not include distributions from qualified retirement plans, tax exempt interest, and gain on the sale of a principal residence.
With the maximum long-term capital gain rates increasing from 15 percent in 2010 to 20 percent in 2011, the effective combined federal long-term capital gain rates could be as high as 23.8 percent beginning in 2013. Furthermore, beginning in 2011, qualified dividend income will no longer be taxed at 15 percent, but rather at higher ordinary income rates (with a maximum rate of 39.6 percent). As such, dividends, interest, and passive income could be taxed at federal rates as high as 43.4 percent in 2013 and thereafter.
Some other revenue raisers under the new law include: the increase of the floor on medical expenses deduction from 7.5 percent to 10 percent (effective 2013), limiting the reimbursement of over-the-counter medications from HSAs, FSAs and MSAs (effective 2011), and limiting flexible spending arrangements to an annual cap of $2,500.
Business impacts
The effects of the new law are far reaching on businesses. One of the provisions, the “Small Business Health Care Tax Credit,” is effective January 1, 2010. The U.S. Department of Treasury recently issued new guidance on the credit. IRS Notice 2010-44 includes employers who are eligible for the credit, calculation of the credit, how to claim the credit and transition relief for the 2010 tax year.
For tax years 2010 – 2013, the credit is generally 35 percent (50 percent for tax years beginning after 2013) of the employer’s non-elective contributions toward the employees’ health insurance premiums. Premiums include those payments for dental, vision and long-term care insurance. The credit (a dollar for dollar reduction in tax) can offset an employer’s regular tax or its alternative minimum tax liability, but is non-refundable. In order to qualify as a small business, the employer must have no more than twenty-five full-time equivalent employees (FTEs) whose average annual wages is no more than $50,000, and paid at least 50 percent of their health insurance premium cost for that tax year. The premiums must be paid in a uniform percentage for all employees. Small tax-exempt IRC Section 501(c) organizations are allowed the credit (25 percent) against certain payroll taxes.
There are phase-outs to the credit. Those employers with no more than ten FTEs and an average wage of less than $25,000 will receive the full amount of the credit. For all other eligible employers, their credit will be reduced based upon how much they exceed these levels.
The new law also provides an excise tax for large employers who
- Do not provide their employees healthcare coverage
- Offer minimum health insurance coverage that is deemed to be unaffordable, or
- Offer minimum coverage where the employer pays less than 60 percent and any employee turns down that coverage and purchases insurance through a state exchange and receives a tax credit or cost sharing reduction.
A large employer is defined as one that employed an average of at least fifty FTEs based on business days during the previous calendar year. This provision could be a trap for the unwary, as penalties may be assessed for circumstances beyond the employers control in the instance where an employee declines coverage in favor of insurance provided by a state exchange.
The employer penalties are $2,000 per year for each employee or $167 per month. The penalties for offering minimum essential coverage that is unaffordable according to the legislation are $3,000 per year for each employee or $250/month. Both of these excise taxes are effective for tax years ending after December 31, 2013.
Cadillac plans
You may have heard the references to “Cadillac plans” in the media. The new law provides for a 40 percent excise tax, beginning in tax years after December 31, 2017, on insurance companies. This excise tax is not on the employers themselves unless they are self-funded and act as the plan administrator. If an employer contributes to an HSA or Archer MSA, the employer will also pay the excise tax. A health insurance plan is considered to be a Cadillac plan to the extent that the annual premium for single coverage is $10,200 and $27,500 for family coverage. These dollar thresholds will be increased if the inflation rate for group premiums through 2017 is higher than projected.
These are just some of the highlights of the new law. You or your business’ navigation through the regulations and planning for the future should begin this year. The small business credit for healthcare could be available to your business right now. Also in 2010, the new law requires that plans extend healthcare coverage on children under the age of twenty-seven. With 2011 fast approaching, new IRS Form W-2 requirements will be in place. Employers are to report the value of their employees’ health insurance coverage on their W-2. FSAs and HSAs can no longer be used to purchase over-the-counter drugs. Though the 3.8 percent Medicare tax on investment income is not effective until 2013, careful planning and structuring of investment holdings and interests in passive businesses should begin now. We will be following any changes to the new law and advise you on any new guidance.
Any advice in this communication is not intended or written by Rehmann to be used, and cannot be used by a client or any other person or entity for the purpose of:(I) avoiding penalties that may be imposed on any taxpayer or;(II) promoting, marketing or recommending to another party any matters addressed herein. The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation.