Posted April 20, 2010

Preeo, Silverman, Green & Egle, P.C.
Tax Library

A Review of Tax-Related Provisions of the 2010 Health Care Act
By Steven M. Weiser, J.D., LL.M. (Taxation)

The Patient Protection and Affordable Care Act (the "Health Care Act") was signed into law by President Obama on March 23, 2010. Along with the subsequently enacted Health Care and Education Reconciliation Act of 2010, which was signed into law by President Obama on March 30, 2010 (the "Reconciliation Act"), the laws were the product of health care reform efforts by the 111^th Congress. The new legislation changes much about our health care system, such as subsidizing insurance premiums, expanding Medicaid eligibility, prohibiting health insurance denial due to pre-existing conditions, and establishing health insurance exchanges. Both the Health Care Act and Reconciliation Act also contained several tax related provisions that are summarized for our friends and clients below.

Tax Changes Affecting Individuals

Individual Mandate for Health Insurance

The new laws contain a mandate that U.S. citizens and legal residents have qualifying health care coverage by 2014. Any citizen or legal resident failing to maintain such coverage is subject to a tax penalty. This penalty is equal to the greater of (a) $695/year (up to a maximum of $2,085 per family), or (b) 2.5% of household taxable income over the threshold amount of income required for tax return filing. For 2010, the threshold amount for taxpayers under age 65 is $18,700 for couples filing jointly ($9,350 for single taxpayers). However, the penalty is actually phased in each year as follows:

Exemptions will be available for financial hardship, religious objections, American Indians, those without coverage for less than three months, illegal aliens, and others.

Insurance Premium Assistance

Tax credits will be available to low and middle income individuals and families to assist them with the acquisition of health insurance. For tax years after 2013, a "premium assistance credit" is available to eligible taxpayers who purchase insurance through a health insurance exchange. The credit is payable in advance to the insurer and subsidizes the cost of insurance. Eligible individuals must enroll in a plan offered through an exchange and report his or her income to the exchange. Based upon that information the Internal Revenue Service will pay the credit directly to the insurance provider. Any additional insurance costs are paid by the individual.

Taxpayers are eligible for the credit if family income is no more than four times the federal poverty level. Based upon 2009 poverty levels an individual is eligible for credits if income is no more than $43,320, and a family of four is eligible if total income does not exceed $88,200. Furthermore, a taxpayer must be ineligible for Medicaid, employer sponsored insurance, or other acceptable coverage. The actual amount of the credit varies and is based upon the percentage of income premiums payments represent.

High Income Taxpayers Take a Hit

High income taxpayers will be faced with two tax increases as a result of the new legislation.

First, effective in 2013 married couples earning in excess of $250,000 per year ($200,000 for single taxpayers) will pay an additional 0.9% Medicare payroll tax. Currently, all taxpayers pay 1.45% of wages for this tax (employers pay another 1.45% of wages), so the total tax for the individual high-wage earner will be 2.35% over those dollar thresholds. Of course, self-employed persons pay both the employee and employer piece of the tax so their maximum tax rate will be 3.8%. Because employers will not be responsible for inquiring into a spouse's earnings, married taxpayers will have to track this tax carefully to avoid an unexpected tax bill at year-end.

Second, beginning in 2013 the Medicare payroll tax will also be applied to investment income. Under current law, the tax is only applied to wages. A new 3.8% tax will apply to investment net investment income of married taxpayers with adjusted gross incomes in excess of $250,000 ($200,000 for single taxpayers). Net investment income includes interest, dividends, royalties, rent, and net gain from the disposition of property, among other things. The tax will not apply to income paid from qualifying retirement accounts (401(k) plans, IRAs, etc.).

Itemized Deductions

Few taxpayers are able to claim medical expenses as a deductible item on their tax returns. This is because medical expenses are deductible only to the extent they exceed 7.5% of adjusted gross income. The new legislation raises that threshold to 10% of adjusted gross income, effective for tax years beginning after December 31, 2012. However, the adjusted gross income threshold will not change for individuals over age 65 through 2016.

Reimbursement for Over-the-Counter Medications

The new laws exclude the cost of over-the-counter drugs from being reimbursed through a health reimbursement account (HRA) or health flexible savings account (FSA) and from reimbursement on a tax-free basis through a health savings account (HAS) or Archer Medical Savings Account (MSA), effective for tax years beginning after December 31, 2010.

Limits on Health Flexible Spending Arrangements

A flexible spending arrangement is a tax-advantaged financial account that can be established through a cafeteria plan of an employer. A FSA allows a person to set aside a portion of earnings on a pre-tax basis to pay for qualifying medical, dependent care or other expenses as determined by the employer plan. Under current law there is no limit on the amount of contributions to a FSA; however, the new legislation limits contributions for $2,500/year, effective for tax years beginning after December 31, 2010. The dollar amount is indexed for inflation after 2013.

Dependent Coverage in Health Plans

Effective immediately, the new law extends the general exclusion for reimbursements for medical expenses paid under an employer sponsored accident or health plan to any child of an employee who has not attained age 27 as of the end of the tax year.

Indoor Tanning Gets More Expensive

Effective July 1, 2010 a new 10% excise tax is imposed on indoor tanning services. The tax is paid by the consumer, but collected by the vendor, much like a sales tax.

Adoption Credit and Assistance

For tax years beginning after December 31, 2009, the adoption tax credit is increased by $1,000 and extended through 2011. The adoption assistance exclusion is also raised by $1,000.

Tax Changes Affecting Small Businesses

Tax Credits to Employers

The new legislation offers small employers with a tax credit for nonelective contributions to purchase health insurance for their employees. To qualify, the employer must offer health insurance to its employees as part of their compensation and must pay at least half of the premium costs. A qualifying business must not have more than 25 full-time employees, and the average annual wage of those employees is no more than $50,000. However, the credit is also available to an employer with 10 or fewer full-time employees who have an average annual salary of $25,000 or less.

The credit is available beginning in 2010. For tax years beginning after 2013 the credit is only available to an employer that purchases insurance through an exchange and is only available for two years (and does not take into account years prior to 2014 when the credit was taken).

The credit is generally 35% (50% for years beginning after 2013) of the employer's nonelective contributions. The credit phases out as personnel size and average wages increase. To the extent nonelective contributions exceed the amount of the credit, the excess can be deducted as an ordinary business expense.

Tax on High-Cost Health Plans

A new excise tax applies against high-cost employer sponsored health coverage. For insurance companies, the tax rate is 40% of premiums that exceed $27,500 for married couples filing jointly ($10,200 for single taxpayers). The tax is effective for tax years beginning after December 31, 2017. Additional threshold amounts of $3,450 for married couples ($1,650 for singles) will apply for retired individuals age 55 or older, provided the employees are not in high risk professions.

Tax Changes Affecting Employers

As a result of the new legislation certain employers are required to offer and contribute to their employees' health insurance or pay a penalty. The following rules generally apply for months beginning after December 31, 2013.

Applicable Large Employers

The mandate to offer health insurance and contribute to the cost of such insurance applies only to an "applicable large employer." An "applicable large employer" is a person (individual, entity, etc.) who employed an average of at least 50 full-time employees during the preceding calendar year. A full-time employee is someone who works on average at least 30 hours each week. However, even certain employers with 50 or more full-time employees may be exempt from the mandate and will avoid the penalty if the employer does not have full-time employees that receive income sufficiently low enough to entitle them to the premium assistance credit (described above).

Penalty for Not Offering Insurance Coverage

If at least one employee has enrolled in health insurance through a state insurance exchange and such employee is eligible for the premium assistance credit or cost sharing reduction (to limit out-of-pocket costs, eligibility of which is dependent upon income levels) an applicable large employer will pay a penalty if it fails to offer its full-time employees insurance coverage. The penalty for any month is calculated by multiplying (a) the number of full-time employees that exceed an initial threshold of 30, by (b) one-twelfth (one month) of $2,000. The penalty is assessed on a monthly basis.

Penalty for Offering Coverage but Have an Employee Receiving a Credit

A penalty also exists for applicable large employers that offer health insurance coverage, but have at least one full-time employee that elects to participate in an exchange and receives a premium tax credit or cost-sharing reduction. The penalty is assessed on a monthly basis and is equal to (a) the number of full-time employees receiving the premium tax credit or cost sharing reduction, multiplied by (b) one-twelfth of $3,000. The penalty for any month is capped at an amount equal to the number of full-time employees that month in excess of 30, multiplied by one-twelfth of $2,000.

Requirement to Offer Free Vouchers

After 2013, employers offering minimum essential coverage through an employer sponsored plan and paying a portion of that coverage, are required to provide qualified employees with a voucher, the value of which can be applied towards the purchase of coverage through an insurance exchange. Qualified employees are those employees who do not participate in the employer's plan, whose required contribution for the minimum essential coverage exceeds 8% (but in no event more than 9.8%) of household income, and whose total household income does not exceed 400% of the poverty line for the family. The value of the voucher must be equal to the amount of the employer contribution to the employer sponsored plan. Minimum essential coverage includes various government-sponsored programs (e.g., Medicare and Medicaid), eligible employer-sponsored plans, plans in the individual market, grandfathered group health plans, and other coverage recognized by the Secretary of the Treasury and Secretary of Health and Human Services.