Close to a month ago, Congress passed and the President signed into law legislation that overhauls the U.S. health care system and affects nearly all taxpayers, many employers, and many elements of the health care industry (the Patient Protection and Affordable Care Act & the follow up Reconciliation Act, i.e. Health Care Act). The massive overhaul contains a host of tax changes, many of which are both complex and novel. To compound the challenge, the tax changes go into effect over a number of years. We’ll start with a few of the main tax law changes and then present a timeline that highlights when the tax law changes that might impact you take effect.
Of course this is just a brief overview of the Health Care Act. Please feel free to contact me if you have any questions.
Highlights
Higher Medicare taxes on high-income taxpayers. High-income taxpayers will be hit with a double whammy: a tax increase on wages and a new levy on investments.
Higher Medicare payroll tax on wages. Under current law, wages are subject to a 2.9% Medicare payroll tax. Workers and employers pay 1.45% each. Self-employed people pay both halves of the tax. Unlike the payroll tax for Social Security, which applies to earnings up to an annual ceiling ($106,800 for 2010), the Medicare tax is levied on all of a worker’s wages without limit.
Under the provisions of the new law, which take in 2013, most taxpayers will continue to pay the 1.45% Medicare hospital insurance tax, but single people earning more than $200,000 and married couples earning more than $250,000 will be taxed at an additional 0.9% (2.35% in total) on the excess over those base amounts. Employers will collect the extra 0.9% on wages exceeding $200,000 just as they would withhold Medicare taxes and remit them to the IRS. Companies wouldn’t be responsible for determining whether a worker’s combined income with his or her spouse made them subject to the tax. Instead, some employees will have to remit additional Medicare taxes when they file income tax returns, and some will get a tax credit for amounts overpaid. Self-employed persons will pay 3.8% on earnings over the threshold. Married couples with combined incomes approaching $250,000 will have to keep tabs on their spouses’ pay to avoid an unexpected tax bill. It should also be noted that the $200,000/$250,000 thresholds are not indexed for inflation, so it is likely that more and more people will be subject to the higher taxes in coming years.
Medicare payroll tax extended to investments. Under current law, the Medicare payroll tax only applies to wages. Beginning in 2013, a Medicare tax will, for the first time, be applied to investment income. A new 3.8% tax will be imposed on net investment income of single taxpayers with AGI above $200,000 and joint filers over $250,000 (unindexed). Net investment income is interest, dividends, royalties, rents, gross income from a trade or business involving passive activities, and net gain from disposition of property (other than property held in a trade or business). Net investment income is reduced by properly allocable deductions to such income. However, the new tax won’t apply to income in tax-deferred retirement accounts such as 401(k) plans. Also, the new tax will apply only to income in excess of the $200,000/$250,000 thresholds. So if a couple earns $200,000 in wages and $100,000 in capital gains, $50,000 will be subject to the new tax. Because the new tax on investment income won’t take effect for three years, that leaves more time for Congress and the IRS to tinker with it. So we can expect lots of refinements and “clarifications” between now and when the tax is actually rolled out in 2013.
Tax credits to certain small employers that provide insurance. Beginning in 2010 the new law provides small employers with a tax credit (i.e., a dollar-for-dollar reduction in tax) for nonelective contributions to purchase health insurance for their employees. The credit can offset an employer’s regular tax or its alternative minimum tax (AMT) liability.
Small business employers eligible for the credit. To qualify, a business must offer health insurance to its employees as part of their compensation and contribute at least half the total premium cost. The business must have no more than 25 full-time equivalent employees (“FTEs”), and the employees must have annual FTE wages that average no more than $50,000. However, the full amount of the credit is available only to an employer with 10 or fewer FTEs and whose employees have average annual FTE wages from the employer of less than $25,000.
Calculating the amount of the credit. For tax years beginning in 2010, the credit is generally 35% (50% for tax years beginning after 2013) of the employer’s nonelective contributions toward the employees’ health insurance premiums. The credit phases out as firm-size and average wages increase. Tax-exempt organizations meeting these requirements are eligible for payroll tax credits of up to 25% (35% in tax years beginning after 2013).
Self-employed individuals (or family members), including partners and sole proprietors, two percent shareholders of an S corporation, and five percent owners of the employer are not treated as employees for purposes of this credit.
Here is a link to the IRS website addressing this credit in more detail:
http://www.irs.gov/newsroom/article/0,,id=220809,00.html.
Tax Changes Taking Effect in 2010
Tanning services excise tax. For indoor tanning services performed on or after July 1, 2010, a new 10% excise tax is imposed on any indoor tanning service, whether paid for by insurance or otherwise. The tax is imposed on tanning service recipients (although the provider is secondarily liable).
Small employer health insurance credit. See Highlights above.
Expanded dependent coverage in employer health plans. Effective on Mar. 30, 2010, the general exclusion for reimbursements for medical care expenses under an employer-provided accident or health plan is extended to any child of an employee who hasn’t attained age 27 as of the end of the tax year. This change is also intended to apply to the exclusion for employer-proved coverage under an accident or health plan for injuries or sickness for such a child. Similarly self-employed individuals will be allowed to take a deduction for health insurance costs of any child of the taxpayer who has not attained age 27 as of the end of the tax year.
Eased rules for adoption credit and exclusion for employer-provided adoption assistance. For tax years beginning after Dec. 31, 2009, the maximum adoption credit is increased to $13,170 per eligible child (a $1,000 increase) for both non-special needs adoptions and special needs adoptions. The adoption credit is made refundable. The maximum exclusion for employer-provided adoption assistance also is increased to $13,170 per eligible child (a $1,000 increase).
Tax Changes Taking Effect in 2011
W-2 must include cost of employer-provided health insurance. For tax years beginning after Dec. 31, 2010, an employer must disclose on each employee’s annual Form W-2 the value of the employee’s health insurance coverage sponsored by the employer. (Code Sec. 6051(a)(14)) (Tax Planning & Practice Guide ¶ 203)
Restricted definition of medicine for health plan reimbursements. The cost of over-the-counter medicines can’t be reimbursed with excludible income through a health flexible spending arrangement (FSA), health reimbursement account (HRA), health savings account (HSA), or Archer MSA, unless the medicine is prescribed by a doctor.
Boosted tax on nonqualifying HSA and Archer MSA distributions. For disbursements made during tax years starting after Dec. 31, 2010, the additional tax on distributions from an HSA or Archer MSA that are not used for qualified medical expenses is increased to 20% of the disbursed amount.
Tax Change Taking Effect in 2012
Information reporting required for payments to corporations. For payments made after Dec. 31, 2011, businesses that pay any amount greater than $600 during the year to non-tax-exempt corporate providers of property and services will have to file an information report with each provider and with IRS.
Tax Changes Taking Effect in 2013
Increased HI tax for high-earning workers and self-employed taxpayers. See Highlights above.
Surtax on unearned income of higher-income individuals. See Highlights above.
Higher threshold for deducting medical expenses. For tax years beginning after Dec. 31, 2012, unreimbursed medical expenses will be deductible by taxpayers under age 65 only to the extent they exceed 10% of adjusted gross income (AGI) for the tax year. If the taxpayer or his or her spouse has reached age 65 before the close of the tax year, a 7.5% floor applies through 2016 and a 10% floor applies for tax years ending after Dec. 31, 2016.
Dollar cap on contributions to health FSAs. For tax years beginning after Dec. 31, 2012, for a health FSA to be a qualified benefit under a cafeteria plan, the maximum amount available for reimbursement of incurred medical expenses of an employee (and dependents and other eligible beneficiaries) under the health FSA for a plan year can’t exceed $2,500.
Tax Changes Taking Effect in 2014
Larger employers not offering affordable health insurance coverage must pay penalty. For months beginning after Dec. 31, 2013, a large employer (generally, one with at least 50 full-time employees) that (1) doesn’t offer health care coverage for all its full-time employees, (2) offers minimum essential coverage that is unaffordable (coverage with a premium required to be paid by the employee that is more than 9.5% of the employee’s household income, as defined for purposes of certain premium tax credit rules), or (3) offers minimum essential coverage that consists of a plan under which the plan’s share of the total allowed cost of benefits is less than 60%, must pay a penalty if any full-time employee is certified to the employer as having purchased health insurance through a state exchange with respect to which a tax credit or cost-sharing reduction is allowed or paid to the employee.
Individuals not carrying health insurance face a penalty. For tax years beginning after Dec. 31, 2013, nonexempt U.S. citizens and legal residents must pay a penalty if they do not maintain minimum essential coverage, which includes government sponsored programs (e.g., Medicare, Medicaid, Children’s Health Insurance Program), eligible employer-sponsored plans, plans in the individual market, certain grandfathered group health plans and other coverage as recognized by HHS in coordination with IRS. There are a number of exceptions, such as one for certain lower-income individuals.
Refundable tax credit for low- or moderate-income families buying certain health insurance. For tax years ending after Dec. 31, 2013, a new refundable tax credit (the “premium assistance credit”) applies to qualifying taxpayers who get health insurance coverage by enrolling in a qualified health plan through a State-established American Health Benefit Exchange.
Tax Change Taking Effect in 2018
Excise tax applies to high-cost employer provided health insurance coverage. For tax years beginning after Dec. 31, 2017, a 40% nondeductible excise tax will be levied on insurance companies and plan administrators for employer-sponsored health coverage to the extent that annual premiums exceed $10,200 for single coverage and $27,500 for family coverage. An additional threshold amount of $1,650 for single coverage and $3,450 for family coverage will apply for retired individuals age 55 and older and for plans that cover employees engaged in high risk professions.
Of course this is just a brief overview of the Health Care Act. Please feel free to contact me if you have any questions.