“What am I supposed to do here?  Make a left turn or right?”

 “I thought you had to make a left, but that’s a one-way street going the other way.”

 “I don’t want to pull over and ask for directions again.   We’ve already done that three times.  The street signs are so confusing around here.”

 “I’ve got it!  Finally, here’s a road map to explain it all.   Just go straight ahead.  The next turn for us is not for a while yet.   This map will get us there.”

Does the scene above remind you of the new health reform legislation?   I would expect that it does.  One of the most controversial and comprehensive laws enacted in recent years, the Patient Protection and Affordable Care Act (“the Act”) was signed into law on March 23, 2010.  In this article, we will cover many of the important tax changes.  Moreover, due to the phase-in of effective dates, I will map out the changes in the order of the year in which each provision will become effective.

2010

Health benefit for children under age 27

 Under our pre-existing tax law, an employee’s taxable income excludes reimbursements under an employer-provided health plan for health care expenses for one’s self, one’s spouse, and dependents.   In order for those dependents to qualify, they must not have reached age 19 (or age 24 if students). 

However, effective on March 30, 2010, the Act extends the income exclusion to any child of an employee who has not reached age 27 at the end of tax year, whether or not the child is the taxpayer’s dependent for tax purposes, or is a student.

For retirees who have maintained separate accounts of qualified pensions or annuities, the under age 27 rule also applies to their children.  The new rule also applies to self-employed individuals.  They can claim a business deduction for health insurance premiums paid for a child who is under age 27.

For plan years beginning on or after September 23, 2010, all health plans that provide coverage for dependent children must continue to make coverage available for an adult child until that child (but not that child’s child, if any) turns 26 (i.e., through age 25).

Small Employer Health Insurance Credit

If you’re a small company, and you primarily employ low or moderate income workers, then this provision may be for you.

Qualified employers: employers who have no more than 25 Full Time Equivalent employees during the tax year, pay Average Annual Wages below $50,000, and pay at least 50% of the premiums for all employees.

A qualified employer can be any type of entity: a C corporation, an S corporation, a partnership, an LLC, or a sole proprietorship. Even a tax-exempt organization can qualify.

Shareholders owing at least 2% of the stock of an S corporation, 5% owners of any other entity, sole proprietors, and their family members are not counted as employees. Nor do the costs of their premiums apply for the credit.

Full Time Equivalent is determined by dividing (1) total number of hours of service by (2) 2,080, and rounded down to a whole number.

Example: You have 6 full time workers who work 40 hours a week for 52 weeks, and 6 part time workers who work 20 hours a week for 52 weeks. Then the Full Time Equivalent employees equal 9 [(6 x 40 x 52 + 6 x 20 x 52)/2080] 

What if an employee works more than 2080 hours a year (i.e. works overtime)? The excess hours worked are not taken into account to calculate the number of employees.  However, the wages from overtime are included in the computation of Average Annual Wages.

Seasonal workers who work fewer than 120 days are not counted at all in determining the number of employees or Average Annual Wages.

Average Annual Wages is determined by dividing (1) the aggregate amount of wages subject to Medicare tax by (2) the number of Full Time Equivalent employees (rounded down to the nearest $1,000).

Example: The aggregate amount of wages paid by employer during the tax year is $610,000, and the number of Full Time Equivalent employees is 20, then the Average Annual Wages equal to $30,000 ($600,000/20, as rounded down).

Controlled groups of corporations, commonly controlled businesses and affiliated service groups are treated as a single employer for purposes of computing the number of Full Time Equivalent employees and Average Annual Wages.

Only non-elective contributions (contributions other than employees’ contributions under a salary reduction arrangement) are taken into account in calculating the credit.  Therefore, the amount of premiums counted in the credit is only the portion that the employer actually paid.

Qualified employers can take the credit for up to SIX years. For tax years beginning in 2010, 2011, 2012, and 2013, they can take 35% of premium’s costs (25% for tax-exempt employers).  For tax years beginning after 2013, the credit is increased to 50% of the premium’s cost (35% for tax-exempt employers), but only if the insurance is purchased through the Insurance Exchange, which each state must establish not later than January 1, 2014.

The maximum credit is available for employers who have 10 or fewer Full Time Equivalent employees and whose employees have Average Annual Wages of not more than $25,000. The credit is completely phased out when the employer has either more than 25 Full Time Equivalent employees OR the Average Annual Wage exceeds $50,000.

Partial credit is allowed for employers with more than 10, but no more than 25 Full Time Equivalent employees and those whose employees have Average Annual Wages greater than $25,000, but not more than $50,000.

To see if you qualify for the credit, please fill out the worksheet at http://www.irs.gov/pub/irs-utl/3_simple_steps.pdf.

This general business credit can be carried back for one year and carried forward for 20 years.  It can offset the alternative minimum tax (AMT).

The employer’s deduction for health care coverage expense is reduced by the amount of credit taken. 

Other tax changes beginning 2010 that may interest you

•      New tax on any indoor tanning service: It’s for services performed on or after July 1, 2010. Customers have to pay an extra 10% as an excise tax for the tanning services.  The service providers will collect the tax and pay to IRS quarterly.  If they don’t collect it, then they are liable for this 10% tax. 

•       Adoption credits:  For tax years beginning on in 2010, the adoption tax credit is increased by $1,000 from $12,170 to $13,170, and the credit is refundable.  In addition, if the qualified adoption expense is paid by the employer, the expense is not included in employee’s gross income, and the maximum exclusion will also increase $1,000 from $12,170 to $13,170.

2011

Medical expense reimbursements that are excludable may be limited

Under the Act, not all reimbursements from an HRA, HSA, FSA or MSA will be excludible from taxable income, beginning 2011.  Only prescription drugs and insulin will qualify for the exclusion.  If you are reimbursed for a drug issued without a physician’s prescription (i.e., an over-the-counter drug), the reimbursement will be taxed.

Reporting requirement on W-2 form

Employers are required to report the aggregate cost of applicable employer-sponsored health coverage on employees’ W-2 forms.  This requirement begins with the 2011 W-2 forms, which will be due to employees by January 31, 2012 (and to the Social Security Administration by February 29, 2012).

2012

1099 Information reporting for payments of $600 or more extends to corporations

Before year 2012, businesses that pay $600 or more to individuals or unincorporated businesses for services or rents have to file an information return (Form 1099-MISC) with IRS.  Payments made to corporations generally are exempt from the information reporting requirement.   (Payments to professional corporations for legal services have been an exception to this general rule.)

For more information on the pre-Act law reporting, you may want to see a previous article on our website titled “Gaining Independence from Your Independent” at http://www.lissokun.com/article_GainingIndep.shtml.

Effective with payments made in 2012, corporations (except tax-exempt organizations) that receive at least $600 for services or rents during the calendar year must also be issued Form 1099-MISC.

2013

Additional 0.9% Medicare Tax on High Earners

Wages and Salaries

In addition to the 1.45% Medicare tax that applies to all salaries and wages presently, beginning 2013 there will be an additional 0.9% Medicare tax on the wages and salaries of “high earners.”  For this purpose, high earners will be:

These thresholds are not indexed for inflation, so we will see more people paying this additional tax as time goes on.

The additional Medicare tax is imposed only on employees, not employers.  However, an employer is required to withhold the additional 0.9% tax on wages over $200,000 paid by that employer.  If the employer does not withhold, then the employer is liable for the taxes owed to IRS.

You may have a question in your mind now: What if both spouses earn less than $200,000, or one earned less than $200,000, but the combined total is more than $250,000?

Example:  H earns $260,000; W earns $100,000.  H’s employer needs to withhold 1.45% of H’s first $200,000 and 2.35% (1.45% plus 0.9%) of the remaining $60,000, so the total amount is $4,310 ($2,900 plus $1,410).  W’s employer doesn’t have to withhold the additional 0.9% tax on W’s wages since they do not exceed $200,000.  However, the law states the threshold for joint filers is $250,000 combined.  Therefore, this couple will owe more tax when they file their joint return at the end of year because the combined Medicare withholding by their employers is not enough.  As a result, they may have to make estimated tax payments to avoid the penalty for paying in too little tax.

Note:  Due to the additional Medicare tax on higher earnings, there may be an incentive to accelerate bonuses, otherwise payable in 2013, into 2012.

Self-employment income

In addition to the 2.9% Medicare Tax presently paid on all Net Earnings from Self-Employment, those who earn above the aforementioned thresholds will need to pay an additional .9% on the excess earnings.   Unfortunately, that additional 0.9% will not qualify for the “One-Half Self-Employment Tax” deduction taken by the taxpayer.

3.8% Medicare Tax on Unearned Net Investment Income of High Income Taxpayers

Beginning 2013, high-income individuals, estates, and trusts will be subject to a 3.8% Medicare tax on their unearned income.

For individual taxpayers, the new 3.8% tax surcharge will be imposed on the lesser of (1) net investment income or (2) the excess of Modified Adjusted Gross Income (MAGI) over the threshold amount for the applicable filing status.

The threshold amounts are:

                Note: MAGI is Adjusted Gross Income plus the foreign earned income exclusion, minus certain deductions and exclusions with respect to the foreign earned income.

For example, in 2013, a single taxpayer has net investment income of $20,000, wages of 250,000, and MAGI of $210,000. He will be subject to an additional tax of $380 [3.8% times the lesser of $20,000 or $10,000 ($210,000-200,000)].  Note:  As mentioned above, in additional to this tax, he also has to pay extra 0.9% on $50,000 ($250,000-200,000), or $450.

Net investment income is the total income you receive from investing your capital (investment income), minus expenses that are incurred related to that income.

Investment income includes:

•          Income from most nonbusiness interest, dividends, annuities, royalties, and rents;

•          Income derived from a trade or business that is considered a “passive activity” of the taxpayer or a trade or business of trading in financial instruments or commodities; and

•          Net gain from disposition of property held as an investment other than property held in an active trade or business.

Moreover, if as a shareholder, you actively work in an S corporation, you should receive a salary and also your share of the S corporation’s operating profit (“pass-through” earnings). Your salary is subject to the regular Medicare taxes (and the increased Medicare tax on high earnings, if applicable).  However, your distributive share of earnings from the S Corporation is not subject to Medicare taxes since you actively work in the corporation (i.e., it is not a passive activity).  Similarly, the net income of a sole proprietor in an active role is not subject to the tax on Net Investment Income.

Note that investment income doesn’t include interest from tax-exempt bonds, veterans’ benefits, the excluded gain from the sale of a principal residence, and distributions from qualified retirement plans.

Note:  There may be an added incentive to shift some investments to tax-exempt securities, as the effective after-tax yield may look better than taxable securities in light of the new tax on Net Investment Income.

This new tax doesn’t apply to nonresident aliens; it applies only to US citizens and legal resident aliens.

Estates and trusts will also have to pay this tax.  For those entities, it will apply to the lesser of:

•          undistributed net investment income, OR

•          The excess of AGI over the dollar amount at which the highest tax bracket begins (presently $11,200).

Additional 2013 Provisions

1)      Employees’ contributions to a health flexible spending account (Health FSA) by means of a salary reduction agreement will be limited to $2,500.

2)      Under present law, when you itemize your deductions, the medical care expense is equal to total qualified expenses minus 7.5% of your AGI.  The new law will increase the threshold from 7.5% to 10%.  However, if the taxpayer or spouse turned 65 before the end of 2013, 2014, 2015, or 2016, the rate remains 7.5%.  For those seniors, the 10% rate won’t apply until 2017.

3)      Beginning 2013, Federal subsidies received by sponsors of qualified retiree prescription drug plans will be effectively taxable.  The employer’s deduction for its contributions to the retiree plan will be offset by the subsidies received.

4)      Employers won’t be able to deduct Medicare Part D drug plan subsidies for Part D eligible employees.

2014

Penalty for individual who doesn’t have a qualified health plan by 2014

Non-exempt U.S citizens and legal residents will be required to maintain “minimum essential coverage.” Otherwise, they will have to pay a penalty. 

The penalty for any tax year will be equal to the greater of:

•          the annual penalty amount, or

•          the “specified percentage” of household income in excess of the amount required to file an income tax return.

The full penalty would be imposed on each adult.  A half-penalty (50% of the adult penalty) would be imposed on an uninsured individual under age 18.

The annual penalty amount (for adults) and the specified percentage of household income are phased in as follows:

In no event will the total penalty for the household exceed the lesser of:

•          300% of the annual penalty amount (e.g., $695 x 3 = $2,085 in 2016), or

•          The national average premium for the Insurance Exchange’s “bronze level” health plan for that household size.

For this purpose, the household includes all members for whom the taxpayer is allowed a personal exemption deduction.

Minimum Essential Coverage means any of the following:

·         These government plans:  Medicare, Medicaid, CHIP, TRICARE for Life, Veteran’s Healthcare and a Peace Corps Title 22 plan.

·         An eligible employer plan

·         A health plan offered in an individual market within a state

·         Certain grandfathered plans

·         Other health plan recognized by the Health and Human Services (HHS) as such.

There are some individuals who are exempt from the requirement to maintain minimum essential coverage.  These people are:

•          Individuals who can’t afford coverage (where the required contribution for sponsored coverage or the “bronze plan” of the Insurance Exchange exceeds 8% of the individual household income).

•          Individuals with income less than the threshold amount required to file an income tax return. 

•          Individuals who have suffered a hardship with respect to the ability to obtain coverage under a qualified health plan.

•          Those with religious exemptions.

•          Members of Indian tribes.

•          Individuals who experience short coverage gaps (gaps with a continuous period of less than three months).

Free Choice Voucher

After 2013, an employer that offers minimum essential coverage and pays for a portion of the coverage must provide a voucher to qualified employees who can instead use it to purchase a health insurance plan through the Insurance Exchange. 

Qualified employees are employees whose required contribution to an employer-sponsored minimum essential coverage plan exceeds 8%, but does not exceed 9.8%, of the household income for the taxable year, and household income does not exceed 400% of the poverty line for the family.  The employee must not participate in the employer’s health plan.

The value of the voucher is equivalent to what the employer would have paid to the employer plan.

Employers will treat the amount of a free choice voucher as an amount for compensation, which is deductible as a business expense.   If the value of the voucher is the same or less than the premium cost of health insurance chosen by the employee, then it is tax-free.  If the value is greater, however, then the excess value over the premium cost of the chosen policy is taxable compensation.

”Pay or Play” – Employers with at least 50 employees

An applicable large employer (one with an average of at least 50 full-time employees on business days during the preceding calendar year) must offer affordable minimum coverage to its employees in a plan that pays at least 60% of the total allowed cost of benefits, beginning 2014.

If it fails to do so, and any full-time employee is certified that he/she has purchased health insurance through a state Exchange (and thus is eligible for the Premium Assistance Tax credit or a Cost-Sharing Reduction), then the employer will have to pay a penalty.

Note: The Premium Assistance Tax Credit and Cost-Sharing Reduction are discussed below.

1.      For employers that do not offer a minimum essential coverage insurance plan to full-time employees and their dependents - The monthly penalty is equal to the product of (1) the total number of its full-time employees for the month, minus 30, and (2) an amount equal to 1/12 of $2,000, or $166.67.  (The monthly amount in (2) will be adjusted for inflation after 2014.)

For example, in 2014, Employer X does not offer health coverage and has 100 full-time employees.  One full-time employee receives a Premium Assistance Tax Credit for the year after enrolling in a state exchange offered plan. X will be considered a large employer for this purpose.  Furthermore, since at least one full-time employee received the premium credit, then X will have to pay a penalty.  The excise tax will be $11,667 per month, [(100 employees – 30) x $166.67], or $140,000 for the year.

2.       For employers that offer minimum essential coverage to full-time employees and their dependents - The monthly penalty is equal to the product of (1) the number of its full-time employees for the month who receive a Premium Assistance Tax Credit or Cost-Sharing Reduction, and (2) an amount equal to 1/12 of $3,000, or $250.00.  (The monthly amount in (2) will be adjusted for inflation after 2014.)   However this is subject to an overall limitation.  It can be no more than the penalty that would apply if no coverage were offered (see A. above).

Suppose Employer Y offers health coverage and has 100 full-time employees.  One full-time employee receives a Premium Assistance Tax Credit for the year after enrolling in a state exchange offered plan. Y will also be considered a large employer for this purpose.  Since at least one full-time employee received the premium credit, then Y will also have to pay a penalty.  However, for Y, the excise tax will be $250 per month (1 employee x $250), or $3,000 for the year.

No penalty will be assessed if a Free Choice Voucher is provided by an employer that offers a plan as described in B. above.

Refundable Premium Assistance Credit

Beginning in 2014, the credit is available for individuals whose income is at least 100% but not more than 400% of the Federal Poverty, and who do not receive minimum essential coverage through an employer-sponsored plan.

The Federal Poverty Line (FPL) amounts are determined by HHS each year.   For purposes of illustration only, the 2009 amounts are shown below:

** - A higher FPL applies to residents of Alaska and Hawaii.

As a result, lower income individuals will be able to afford health plans. In order to claim the credit, the qualified health plans must be purchased through an American Health Benefit Exchange. Taxpayers can use the credit to offset income tax and alternative minimum tax (AMT).

Note:  The credit will generally be payable to the insurer (not the insured).   The insurer will then reduce premiums by the credit received.   However, if the insured elects to pay for the entire premium out-of-pocket, then the credit can be claimed on the insured’s personal tax return.  This credit is refundable, which means that it can be used even if the net tax is zero.

For an alien individual who is lawfully present in the US, there’s a flexible eligibility rule if that individual is not eligible for Medicaid.  A qualifying alien individual will be treated as eligible for the credit even if household income is less than 100% of the Federal Poverty Line. Taxpayers who are married can claim the credit only if they file jointly (i.e., if the file separately, neither spouse can claim the credit). Individuals who can be claimed as dependents by another taxpayer do not qualify.

The amount of credit is the lesser of

•      The annual premiums paid by the taxpayer for the qualified health plan covering the taxpayer, spouse and/or dependents, OR

•        The amount by which the cost of the annual premiums for an applicable “second lowest cost silver plan” exceeds an amount based on the “applicable percentage” of the household income.  (Note: The applicable percentage is derived by using a sliding scale between the Initial Premium Percentage and the Final Premium Percentage that corresponds to the level of household income relative to the FPL.  Accordingly, the following table sets the ranges of applicable percentages.)

                                                Applicable % Table

Examples:

1.      Assume that the premium charged in an area for a “second lowest cost silver plan” is $4,000 for single coverage, that the taxpayer pays $5,000 to a qualified Exchange plan, that the FPL for his family size is $10,830, and that the taxpayer has income equal to 150% of the FPL (150% x $10,830 = $16,245).  The applicable percentage is 4.00%.  The taxpayer’s affordable premium for the household income is $649.80 ($16,245 x 4.00%), and the taxpayer will receive a premium assistance credit of $3,350.20 ($4,000.00 - $649.80), since it is less than the actual premiums paid ($5,000.00).

2.       Assume the same facts as A. above, except that the household income is $17,328, which is 160% of the FPL for his family size.  The applicable percentage is 4.46% (since 160% is 10% higher than 150%, and 10% is one-fifth of the 50% difference between 150% and 200%, then it follows that 0.46% is one-fifth of the 2.30% difference between 4.00% and 6.30%, so 4.46% is used.)  The taxpayer’s affordable premium would then be $772.83 ($17,328 x 4.46%), and the taxpayer will receive a premium assistance credit of $3,227.17 ($4,000.00 - $772.83).

Note: The computations are actually made on a monthly basis, using the premiums and income of each month.  For purposes of simplifying the illustrations, I am presenting the figures on an annual basis.

Cost-Sharing Reduction

 This will also help lower income individuals with their health insurance costs.  An individual whose household income exceeds 100% but does not exceed 400% of the Federal Poverty Line for the family size, who enrolls in qualified health plan in the silver level of coverage will qualify for this subsidy.  That individual can use it to reduce annual out-of-pocket cost-sharing such as co-payments, coinsurance etc. instead of taking a tax credit. 

For an eligible insured whose household income is more than 100% but not more than 200% of FPL, the out-of-pocket limit will be reduced by two-thirds (2/3).

For an eligible insured whose household income is more than 200% but not more than 300% of federal poverty line, the out-of-pocket limit will be reduced by one-half (1/2).

For an eligible insured whose household income is more than 300% but not more than 400% of federal poverty line, the out-of-pocket limit will be reduced by one-third (1/3).

An issuer of a qualified health plan will notify the HHS Secretary when it makes the cost-share deduction available to a qualified person. Then the HHS secretary will make periodic and timely payments to the issuer equal to the value of the reductions.

Estimated taxes increase for large corporations

Beginning in July 2014, corporations with $1 billion or more assets that pay any estimated tax payments will need to increase those payments from 157.75% of the estimated tax to 173.50%.

Example: A multi-billion dollar corporation estimates its taxes to be $100,000,000 on September 2014 and December 2014.  Instead of paying $157,750,000 each on September and December, the corporation now has to pay $173,500,000 on those due dates.

2018

Excise tax on “Cadillac Plans”

Beginning in 2018, there will be an excise tax on “high-cost’ employer sponsored health care coverage (“Cadillac Plans”).

Coverage providers will pay a nondeductible 40% excise tax on the “excess benefit” if an employee is covered under any “applicable employer-sponsored coverage.”

Excess benefit is the aggregate premium cost of the applicable employer-sponsored coverage of the employee over an annual limit (initially, $10,200 for individual coverage or $27,500 for family coverage) multiplied by a factor used to measure the inflation of health care costs.  Gender-based factors will also affect the computation by increasing the health cost adjustment.

For example, if the health cost adjustment for an individual is 102% and the gender adjustment amount is $900, then the annual limit amount will be $11,304 ($10,200 x 102% + 900). If in 2018, this individual is under a medical insurance plan with a premium cost of $15,000, then the amount subject to excise tax will be $3,696 ($15,000 - $11,304).  The employer will report it to the insurer who then will calculate and remit the excise tax to IRS.  In this case, the nondeductible excise tax will be $1,478.40 (40% of $3,696.)

Note: The employer is responsible for reporting to the coverage provider the latter’s share of the amount subject to excise tax.  A coverage provider is:

·         In the case of an employer-sponsored fully insured medical plan – the insurance company;

·         In the case of a plan for which the employer makes contributions (e.g., HSA or MSA) – the employer;

·         In the case of a plan administered by a third party (e.g., a payroll service) – the third party administrator.