May 13th 2010
The new health care law finalized March 25 – the Patient Protection and Affordable Care Act – includes sweeping changes for both employers and individuals.
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Alert: Although some new law provisions take effect right away, most are prospective. But even future changes can affect tax planning this year. At its core, the new legislation requires individuals to obtain health care coverage or pay penalties. If an employer doesn’t provide coverage to its employees, it may be subject to an additional tax (but certain small businesses are exempt).
Individuals and small businesses will be able to obtain coverage from state-based group health plans as well as private plans. Both employers and employees may benefit from grandfather provisions in the law. In addition, the new health care law imposes extra taxes on wages and investment income of high-income taxpayers, increases the AGI floor for the itemized medical expense deduction and includes a number of other tax-related changes. Here’s a quick rundown.
Coverage for individuals: After 2013, any individual not eligible for Medicare or Medicaid must obtain minimum essential coverage or pay a nondeductible penalty based on a flat dollar amount or a percentage of household income (see table below). But the flat dollar penalty is cut in half for individuals under age 18 or college students. Also, the flat dollar penalty for a family can’t exceed 300 percent of the dollar amount for the applicable year.
Flat dollar Percentage of:
|* Indexed for inflation after 2016
** Reduced by 50% for individuals under age 18 or college students
*** Paid in lieu of flat dollar penalty if greater
The new law also provides coverage subsidies to qualified lower-income individuals through premium assistance tax credits and reduced cost-sharing. Furthermore, it creates a reinsurance program for employer-sponsored early retiree coverage. The IRS will be responsible for determining eligibility for premium assistance tax credits.
Employer requirements: Beginning in 2014, an employer failing to offer minimum essential coverage in any month for an eligible full-time employee will be liable for an additional tax. The tax equals 1/12 of $2,000 times the number of all full-time employees. This penalty applies to employers with 50 or more workers, but the first 30 workers are subtracted from the calculation. For instance, a company with 55 workers only has to pay the required tax for 25 workers.
Employers also may be hit with an additional tax if they impose waiting-period restrictions. If your company provides minimal essential coverage to employees, it must file information returns with the IRS.
Small businesses: The new law allows a small business to use a special tax credit to offset employer-provided coverage. For this purpose, a small business is one with no more than 25 employees and average annual wages of less than $50,000 per employee. For 2010 through 2013, a small business may qualify for a credit up to 35 percent of the contribution toward employee health insurance premiums. After 2013, a credit of up to 50 percent for a two-year period is available to employers that purchase coverage through a state-run exchange.
Tax bonus: A full credit can be claimed by employers with fewer than 11 employees and average annual wages of less than $25,000. The new law also creates a special safe-harbor rule skirting nondiscrimination rules for cafeteria plans operated by a qualified small business.
Medicare taxes: Beginning in 2013, high-income taxpayers will face extra Medicare tax burdens. Currently, 2.9 percent Medicare tax applies only to wages and net self-employment income (i.e., earned income). For an employee, half the tax – or 1.45 percent – is withheld from wages; the employer pays the other 1.45 percent. Self-employed individuals pay the whole 2.9 percent tax themselves. Currently, there is no Medicare tax on investment income (i.e., unearned income).
Under the new law:
- An additional 0.9 percent Medicare tax is imposed on wages of unmarried individuals with earned income above $200,000, and married joint filers with combined earned income above $250,000.
- An additional 3.8 percent Medicare tax applies to net investment income received by unmarried individuals with a modified adjusted gross income (MAGI) above $200,000, and married joint filers with a MAGI above $250,000.
- Higher-income individuals can potentially get hit by both Medicare tax increases.
For purposes of the additional 3.8 percent Medicare tax, investment income includes interest, dividends, royalties, rents, capital gains from investment property, and income from passive activities like partnership and S corporation businesses in which the taxpayer does not materially participate. But distributions from qualified retirement plans and IRAs don’t count as investment income.
Tax on health insurance plans: Beginning in 2018, insurers will have to pay a 40 percent excise tax if the annual premiums for a health insurance plan exceed $10,200 for individual coverage and $27,500 for family coverage. These thresholds will be indexed for inflation. Also, higher premium levels apply to retirees and employees in certain high-risk professions.
Employers are required to disclose the value of employer-provided benefits to employees on their annual W-2 forms. Note that the tax on these Cadillac health insurance plans applies to insurers, not individuals. But your clients’ insurance companies may effectively pass along the cost in the form of higher premiums.
Health care accounts: The new law modifies the definition of medical expenses for various health care accounts – including flexible spending accounts (FSAs), health reimbursement arrangements (HRAs), and health savings accounts (HSAs) – to conform with the definition used for the medical expense deduction. In addition, the new law:
- Caps the annual amount of health care FSA contributions at $2,500, beginning in 2013 (indexed for inflation after 2013)
- Hikes the excise tax on nonqualified distributions from HSAs from 10 percent to 20 percent beginning in 2011
- Increases the excise tax on nonqualified distributions from Archer Medical Savings Accounts (MSAs), the precursor of HSAs, from 15 percent to 20 percent, beginning in 2011
Medical deductions: Under current law, an individual may deduct only qualified medical expenses in excess of 7.5 percent of adjusted gross income (AGI). Beginning in 2013, the new law generally raises this floor to 10 percent of your AGI. However, a taxpayer who is age 65 or older or whose spouse is age 65 or older is exempt from this unfavorable change until 2017. Note: The new law does not make any adjustment in the allowable medical expense deduction for computing alternative minimum tax (AMT) liability. Thus, the medical deduction floor for AMT purposes, which was already at 10 percent of AGI, remains the same.
Health insurance exclusion: Effective for plan years beginning after September 23, 2010, insurers won’t be able to deny coverage for adult children up to the age of 26 if the policy covers dependent children. Accordingly, the income tax exclusion for employer-provided health insurance coverage is extended to these children.
Adoption credit: The new law makes the adoption credit refundable, retroactively raises the dollar limit on the credit for 2010 from $12,170 to $13,170, and enhances the credit for adopting special needs children (TS, April 2010). The credit, which was scheduled to be cut back after 2010, is extended through 2011.
Information reporting: Beginning in 2012, employers must report the value of the employer- sponsored health insurance coverage on employees’W-2 forms. Also, a business must file information returns for annual payments of $600 or more to any corporate or noncorporate recipient (other than tax-exempt entities).
The new health care law features numerous far-reaching changes unrelated to taxes, such as repealing bans on coverage for pre-existing conditions and closing the doughnut hole for Medicare prescription drugs.
Advisory: Many of the tax provisions with earlier effective dates were delayed or are being phased in. We will pinpoint more planning ideas in coming issues.
Silver ‘tax lining’ for some investors
The dreaded new 3.8 percent Medicare tax on net investment income will be triggered if a joint-filing couple’s MAGI in 2013 exceeds $250,000 ($200,000 for unmarried taxpayers).
But some clients may not have to pay the 3.8 percent tax on all of their investment income.
Here’s how it works: The tax actually applies to the lesser of net investment income or the amount by which MAGI exceeds the threshold amount. Thus, a high-income taxpayer may escape tax on part of his or her investment income.
Example: Brett Hayward is a joint filer with a MAGI of $275,000 in 2013 consisting of $225,000 in wages and $50,000 in net capital gains. Brett must pay the extra 3.8 percent tax because his MAGI exceeds the $250,000 threshold for joint filers. However, because he exceeds the threshold by only $25,000, the extra tax is limited to $950 (3.8 percent x $25,000). There’s no extra Medicare tax on the other $25,000 of capital gains (but the entire $50,000 is subject to capital gains tax).
Note that Brett has to pay the 3.8 percent Medicare tax on $25,000 of net investment income in this example, but he does not have to pay the extra 0.9 percent Medicare tax on excess wages. Reason: His wages fall below the $250,000 threshold for the additional 0.9 percent Medicare tax.
Reprinted with permission from The Tax Strategist, May 2010. For continuing advice on this and numerous other tax strategies, go to www.TaxStrategist.net. Receive 2 FREE Bonus reports and a 40 percent discount on The Tax Strategist when you use Promo Code WNOO13.