Resources

• Articles
• Legislative Updates
• Economic Recovery Services
• Newsletters
• Payroll Tax Guidelines

 

Tax Alert: Key Changes in Health Reform Legislation

 

TAX CHANGES AFFECTING INDIVIDUALS:

Topics	Effective Dates
I.     Premium assistance tax credits for purchasing          health   insurance	2014
II.     Penalties for the uninsured	2014
III.   Higher taxes on high-income taxpayers	2013
IV.   Floor on medical expenses deduction raised	2013
V.    Limit reimbursement of over-the-counter medicines from         HSAs, FSAs & MSAs	2011
VI.   Increased penalties on nonqualified distributions from          HSAs & MSAs	2011
VII.  Limit amount of contribution to FSAs	2013
VIII. Dependent coverage in employer health plans	2010
IX.   Excise tax on indoor tanning services	2010
X.     Liberalized adoption credit and adoption assistance rules	2010
XI.   State loan repayment or loan forgiveness program for          health professionals	2009
TAX CHANGES AFFECTING Businesses:
I.     Tax credits to certain small employers that provide         insurance	2010
II.    Excise tax on high-cost (Cadillac) health plans	2018
III.   Penalties for failure to provide coverage for employees	2014
IV.   Simple cafeteria plans for small businesses	2011
V.    Excise tax on medical device manufacturers	2013
VI.    Tax credit for new therapies	2009
VII.   Codification of economic substance doctrine	2010

---

 

TAX CHANGES AFFECTING INDIVIDUALS:

I.  Premium assistance tax credits for purchasing health insurance. The centerpiece of the recently enacted health care overhaul legislation is its provision of tax credits to low and middle income individuals and families for the purchase of health insurance.

No later than 1/1/2014, each state will have to establish an "American Health Benefit Exchange" (Exchange). The Exchanges will not be insurers themselves, but they will facilitate an individual's purchase of  a "qualified health plan" (QHP) and provide for the establishment of a Small Business Health Options Program (SHOP Exchange) to assist small employers in enrolling their employees in qualified health plans offered in the small group market. For tax years ending after 2013, the new law creates a refundable tax credit (the “premium assistance credit”) for eligible individuals and families who purchase health insurance through a state Exchange. The premium assistance credit, which is refundable and payable in advance directly to the insurer, subsidizes the purchase of certain health insurance plans through a state Exchange. Under the provision, an eligible individual enrolls in a QHP offered through a state Exchange and reports his or her income to the Exchange. Based on the information provided to the Exchange, the individual receives a premium assistance credit based on income and the IRS pays the premium assistance credit amount directly to the insurance plan in which the individual is enrolled. The individual then pays to the plan in which he or she is enrolled the dollar difference between the premium assistance credit amount and the total premium charged for the plan. For employed individuals who purchase health insurance through an Exchange, the premium payments are made through payroll deductions.

The premium assistance credit will be available for individuals and families with incomes up to 400% of the federal poverty level ($43,320 for an individual or $88,200 for a family of four, using 2009 poverty level figures) that are not eligible for Medicaid, employer sponsored insurance, or other acceptable coverage. The credit will reduce the amount of a taxpayer's out-of-pocket costs for QHP coverage. Thus, on an annual basis, the maximum amount that a taxpayer will have to pay out-of-pocket for a QHP in a tax year will be the applicable percentage of the taxpayer's household income for the year.  The applicable percentage will be based on the percentage of income of the Taxpayer, rising from 2% of income for those at 100% of the federal poverty level for the family size involved to 9.5% of income for those at 400% of the federal poverty level for the family size involved. 

For example: Assume that the "Adjusted Monthly Premium" is $4,500 for single coverage (family size of 1), the applicable "federal poverty line" (FPL), which refers to the guidelines issued each year by the Department of Health and Human Services (HHS), for the purpose of determining financial eligibility for certain federal programs, is $10,830. The taxpayer, a single individual enrolled in a QHP, has income just under $43,320, which is 400% of the applicable FPL. Taxpayer's final premium percentage is 9.5% based upon a Table of premium percentages for the specified FPL tiers. The “affordable premium amount” for Taxpayer is equal to $4,115.40 (9.5% × $43,320). The amount allowed to Taxpayer as a premium assistance credit will be $387.60 (i.e., $4,500 premium − $4,115.40 affordable premium amount). Taxpayer won't get any premium assistance credit if the premium is less than $4,115.40.

 Table of Contents

II.  Penalties for the uninsured. Generally, beginning in 2014, the new law contains an “individual mandate”—a requirement that U.S. citizens and legal residents have qualifying health coverage or be subject to a tax penalty. Under the new law, those without qualifying health coverage will pay a tax penalty of the greater of: (a) $695 per year, up to a maximum of three times that amount ($2,085) per family, or (b) 2.5% of household income over the threshold amount of income required for income tax return filing. The penalty will be phased in according to the following schedule: $95 in 2014, $325 in 2015, and $695 in 2016 or the flat fee on 1.0% of taxable income in 2014, 2.0% of taxable income in 2015, and 2.5% of taxable income in 2016. Beginning after 2016, the penalty will be increased annually by a cost-of-living adjustment. There are number of exemptions granted in certain situations.

Table of Contents

III.  Higher taxes on high-income taxpayers.  High-income taxpayers will be hit with two big tax hikes under the recently enacted health overhaul legislation: a tax increase on wages and a new tax on income from investments.  To help offset the cost of providing health insurance to millions of Americans, the new law imposes an additional 0.9% Medicare tax on wages above $200,000 for individuals and $250,000 for married couples filing jointly. In addition, for higher-income households, the new law adds a 3.8% tax on unearned income, including interest, dividends, capital gains and other investment income.

Higher Medicare payroll tax on wages. The Medicare payroll tax is the primary source of financing for Medicare's hospital insurance trust fund, which pays hospital bills for beneficiaries, who are 65 and older or disabled. 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 (but are allowed to deduct half of this amount for income tax purposes). 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 takes effect 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.  This change does not affect the employer's portion of the Medicare hospital insurance tax. 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 will not 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 their 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 net investment income of individuals, estates and trusts. 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 for individuals, trusts and estates. 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 (un-indexed). 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 deductions properly allocable to such income. However, the new tax won't apply to qualified retirement plan distributions, such as pension, profit sharing and 401(k) plans, as well as IRAs (both regular and Roth). 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. The Medicare tax on investment income is in addition to the .09% increase in Medicare tax on employee's wages and self-employment income.  Therefore, taxpayers who have both high wages or self-employment income and high investment income may be hit with both taxes.

For estates and trusts, the tax is 3.8% of the lesser of (a) undistributed net investment income or (b) the excess of AGI over the dollar amount at which the highest estate and trust income tax bracket begins.

Table of Contents


IV.  Floor on medical expenses deduction raised.  Under current law, taxpayers can take an itemized deduction for un-reimbursed medical expenses for regular income tax purposes only to the extent that those expenses exceed 7.5% of the taxpayer's AGI. The new law raises the floor beneath itemized medical expense deductions from 7.5% of AGI to 10%, effective for tax years beginning after Dec. 31, 2012. If either the taxpayer or the taxpayer's spouse turns 65 before the end of the taxable year, the increased threshold does not apply and the threshold remains at 7.5 percent of AGI through 2016.

Table of Contents

V.  Limit reimbursement of over-the-counter medicines from HSAs, FSAs & MSAs.  The new law excludes the costs for over-the-counter drugs not prescribed by a doctor from being reimbursed through a health reimbursement account (HRA) or health flexible savings accounts (FSAs) and from being reimbursed on a tax-free basis through a health savings account (HSA) or Archer Medical Savings Account (MSA), effective for tax years beginning after Dec. 31, 2010.

Table of Contents

VI.  Increased penalties on nonqualified distributions from HSAs & MSAs.  The new law increases the tax on distributions from HSAs or MSAs that are not used for qualified medical expenses to 20% (from 10% for HSAs and from 15% for MSAs) of the disbursed amount, effective for distributions made after Dec. 31, 2010.

Table of Contents

VII.  Limit amount of contribution to FSAs.  An FSA is one of a number of tax-advantaged financial accounts that can be set up through a cafeteria plan of an employer. An FSA allows an employee to set aside a portion of his or her earnings to pay for qualified expenses as established in the cafeteria plan (most commonly for medical expenses, but often for dependent care or other expenses). Under current law, there is no limit on the amount of contributions to an FSA. Under the new law, however, allowable contributions to health FSAs will capped at $2,500 per year, effective for tax years beginning after Dec. 31, 2012. The dollar amount will be indexed for inflation after 2013.

Table of Contents

VIII.  Dependent coverage in employer health plans.  Effective immediately, the new law extends the general exclusion for reimbursements for medical care expenses under an employer-provided accident or health plan to any child of an employee who has not attained age 27 as of the end of the tax year. This change is also intended to apply to the exclusion for employer-provided coverage under an accident or health plan for injuries or sickness for such a child. A parallel change is made for VEBAs and 401(h) accounts. Also, self-employed individuals are permitted to take a deduction for the health insurance costs of any child of the taxpayer who has not attained age 27 as of the end of the tax year.

  Table of Contents

IX.  Excise tax on indoor tanning services. The new law imposes a 10% excise tax on indoor tanning services performed on or after July 1, 2010. The tax, which will be paid by the individual on whom the tanning services are performed, but collected and remitted by the person receiving payment for the tanning services. Phototherapy services performed by a licensed  medical professional are exempt from the excise tax.

Table of Contents

X.  Liberalized adoption credit and adoption assistance rules.  The maximum adoption tax credit is increased by $1,000 to $13,170, made refundable, and extended through 2011. The exclusion from an employee's income for employer-provided adoption assistant is also increased to $13,170.  The adoption credit is phased out ratably for taxpayers with modified adjusted gross income between $182,520 and $222,520 for taxable years beginning in 2010, which under the new law will be adjusted for inflation.

Table of Contents

XI.  State loan repayment or loan forgiveness program for health professionals.  The new law provides that an individual's gross income doesn't include amounts received under any state loan repayment program or loan forgiveness program.  These state programs are intended to increase the availability of health care services in areas that a state determines are underserved or have a shortage of health professionals. It is effective for amounts received by an individual in tax years beginning after December. 31, 2008. This is in addition to the specific exclusions for state loan repayment programs described in Sec. 338I of the Public Health Service Act and the National Health Service Corps loan repayment program.

Table of Contents

 

TAX CHANGES AFFECTING BUSINESSES

For owners of small businesses and their workers, there are some key provisions in which to pay attention. The major ones include: tax credits; excise taxes; and penalties. But whether a business will be affected by them depends on a variety of factors, such as the number of its employees and the amount of their wages.

I.     Tax credits to certain small employers that provide insurance. The new law provides small employers with a tax credit (i.e., a dollar-for-dollar reduction in tax) for "nonelective contributions" (an employer contribution other than an employer contribution under a salary reduction arrangement) 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 full-time equivalent wages that average no more than $50,000. The credit is reduced for employers with more than 10 FTEs but not more than 25 FTEs and the credit is also reduced for an employer to whom the average wages per employee is between $25,000 and $50,000.  Consequently, the full amount of the credit is available only to an employer with 10 or fewer FTEs and whose employees have average annual full-time equivalent wages from the employer of less than $25,000.

Years the credit is available. The credit is initially available for any tax year beginning in 2010, 2011, 2012, or 2013. Qualifying health insurance for claiming the credit for this first phase of the credit is health insurance coverage purchased from an insurance company licensed under state law. For tax years beginning after 2013, the credit is only available to an eligible small employer that purchases health insurance coverage for its employees through a state Exchange and is only available for two years. The maximum two-year coverage period does not take into account any tax years beginning before 2014. Thus, an eligible small employer could potentially qualify for this credit for six tax years, four years under the first phase and two years under the second phase.

Calculating the amount of the credit. For tax years beginning in 2010, 2011, 2012, or 2013, the credit is generally 35% (50% for tax years beginning after 2013) of the employer's non-elective contributions toward the employees' health insurance premiums. As mentioned previously, the credit phases out as firm-size and average wages increase. Tax-exempt small businesses meeting these requirements are eligible for payroll tax credits of up to 25% for tax years beginning in 2010, 2011, 2012, or 2013 (35% in tax years beginning after 2013) of the employer's "nonelective" contributions toward the employees' health insurance premiums.

Special rules. The employer is entitled to an ordinary and necessary business expense deduction equal to the amount of the employer contribution minus the dollar amount of the credit. For example, if an eligible small employer pays 100% of the cost of its employees' health insurance coverage and the amount of the tax credit is 50% of that cost (i.e., in tax years beginning after 2013), the employer can claim a deduction for the other 50% of the premium cost.

Self-employed individuals, 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. Any employee with respect to a self-employed individual is not an employee of the employer for purposes of this credit if the employee is not performing services in the trade or business of the employer. Thus, the credit is not available for a household employee of a sole proprietor of a business. There is also a special rule to prevent sole proprietorships from receiving the credit for the owner and their family members. Thus, no credit is available for any contribution to the purchase of health insurance for these individuals and the individual is not taken into account in determining the number of full-time equivalent employees or average full-time equivalent wages.

Table of Contents

II.    Excise tax on high-cost (Cadillac) health plans.  The new law places an excise tax on high-cost employer-sponsored health coverage (often referred to as “Cadillac” health plans). This is a 40% excise tax on insurance companies, based on premiums that exceed certain amounts. The tax is not on employers themselves unless they are self-funded (this typically occurs at larger firms). However, it is expected that employers and workers will ultimately bear this tax in the form of higher premiums passed on by insurers.

The new tax, which applies for tax years beginning after Dec. 31, 2017, places a 40% nondeductible excise tax on insurance companies and plan administrators for any health coverage plan to the extent that the annual premium exceeds $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. The tax will apply to self-insured plans and plans sold in the group market, but not to plans sold in the individual market (except for coverage eligible for the deduction for self-employed individuals). Stand-alone dental and vision plans will be disregarded in applying the tax. The dollar amount thresholds will be automatically increased if the inflation rate for group medical premiums between 2010 and 2018 is higher than the Congressional Budget Office (CBO) estimates in 2010. Employers with age and gender demographics that result in higher premiums could value the coverage provided to employees using the rates that would apply using a national risk pool. The excise tax will be levied at the insurer level. Employers will be required to aggregate the coverage subject to the limit and issue information returns for insurers indicating the amount subject to the excise tax.

Table of Contents

III.   Penalties for failure to provide coverage for employees.  Under the new law, effective for months beginning after December 31, 2013, a large employer that does not offer coverage for all its full-time employees, offers minimum essential coverage that is unaffordable, or 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%, is required to 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.

Who is subject to the employer mandate? Only an “applicable large employer,” defined as someone who employed an average of at least 50 full-time employees during the preceding calendar year, is subject to the requirement to offer coverage. Most small businesses, since they have fewer than 50 employees, are thus exempt from the employer requirement. In counting the number of employees for purposes of determining whether an employer is an applicable large employer, a full-time employee (meaning, for any month, an employee working an average of at least 30 hours or more each week) is counted as one employee and all other employees are counted on a pro-rated basis. However, even an employer with 50 or more employees isn't subject to the penalty for not offering coverage if the employer doesn't have any full-time employees who have a lower income that might qualify him or her to receive a subsidy when purchasing a health plan in the proposed state Exchange.

Penalty for employers not offering coverage. An applicable large employer who fails to offer its full-time employees and their dependents the opportunity to enroll in minimum essential coverage under an employer-sponsored plan for any month is subject to a penalty if at least one of its full-time employees is certified to the employer as having enrolled in health insurance coverage purchased through a state Exchange with respect to which a premium tax credit or cost-sharing reduction is allowed or paid to the employee. The penalty for any month is an excise tax equal to the number of full-time employees over a 30-employee threshold during the applicable month (regardless of how many employees are receiving a premium tax credit or cost-sharing reduction) multiplied by one-twelfth of $2,000. For example, if an employer fails to offer minimum essential coverage and has 60 full-time employees, ten of whom receive a tax credit for the year for enrolling in a state exchange-offered plan, the employer will owe $2,000 for each employee over the 30-employee threshold, for a total penalty of $60,000 ($2,000 multiplied by 30 (60 minus 30)). This penalty is assessed on a monthly basis.

Penalty for employers that offer coverage but have at least one employee receiving a premium tax credit. An applicable large employer who offers coverage but has at least one full-time employee receiving a premium tax credit or cost-sharing reduction is subject to a penalty. The penalty is an excise tax that is imposed for each employee who receives a premium tax credit or cost-sharing reduction for health insurance purchased through a state Exchange. For each full-time employee receiving a premium tax credit or cost-sharing subsidy through a state Exchange for any month, the employer is required to pay an amount equal to one-twelfth of $3,000. The penalty for each employer for any month is capped at an amount equal to the number of full-time employees during the month (regardless of how many employees are receiving a premium tax credit or cost-sharing reduction) in excess of 30, multiplied by one-twelfth of $2,000. For example, if an employer offers health coverage and has 60 full-time employees, 15 of whom receive a tax credit for the year for enrolling in a state Exchange-offered plan, the employer will owe a penalty of $3,000 for each employee receiving a tax credit, for a total penalty of $45,000. The maximum penalty for this employer is capped at the amount of the penalty that it would have been assessed for a failure to provide coverage, or $60,000 ($2,000 multiplied by 30 (60 minus 30)). Since the calculated penalty of $45,000 is less than the maximum amount, the employer pays the $45,000 calculated penalty. This penalty is assessed on a monthly basis.  However, the penalty won't be imposed for any month with respect to any employee to whom the employer provides a free choice voucher as explained below.

Requirement to offer “free choice vouchers.” After 2013, employers offering minimum essential coverage through an eligible employer-sponsored plan and paying a portion of that coverage will have to provide qualified employees with a voucher whose value could be applied to purchase of a health plan through the state Exchange. Qualified employees would be those employees: who do not participate in the employer's health plan; whose required contribution for employer sponsored minimum essential coverage exceeds 8%, but does not exceed 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 would be equal to the dollar value of the employer contribution to the employer offered health plan. Employers providing free choice vouchers will not be subject to penalties for employees that receive a voucher.

Table of Contents

IV.   Simple cafeteria plans for small businesses. For tax years beginning after 2010, a new employee benefit cafeteria plan known as a Simple Cafeteria Plan will be available to any employer that employed an average of 100 or fewer employees on business days during either of the two preceding years. Under such a plan, an eligible small employer is provided with a safe harbor from the nondiscrimination requirements for cafeteria plans as well as from the nondiscrimination requirements for specified qualified benefits offered under a cafeteria plan, including group term life insurance, benefits under a self insured medical expense reimbursement plan, and benefits under a dependent care assistance program.

Table of Contents

V.   Excise tax on medical device manufacturers. For sales after December 31, 2012, the sale of a taxable medical device by the manufacturer, producer, or importer will be subject to a tax equal to 2.3% of the price for which it is sold.  For purposes of this tax, a taxable medical device is generally any device intended for humans, except for eyeglasses, contact lenses, hearing aids and any other medical device determined by IRS to be of a type that is generally purchased by the public at retail for individual use. If the excise tax is paid on specified or listed uses or resales of articles it will be deemed to be an overpayment of tax for which a credit or refund may be claimed.

Table of Contents


VI.  Tax credit for new therapies.  For expenses paid or incurred after December 31, 2008, in tax years beginning after that date, a two-year temporary qualifying therapeutic discovery project (QTDP) credit applies, subject to an overall cap of $1 billion, to encourage investments in new therapies to prevent, diagnose, and treat acute and chronic diseases (''qualifying therapeutic discovery project").  Generally, the QTDP credit is an amount equal to 50% of the aggregate amount of the costs paid or incurred in the tax year for expenses necessary for and directly related to the conduct of a "qualifying therapeutic discovery project." The QTDP credit as a component of the investment credit and, thus, of the general business credit, is subject to the rules that, generally, do not allow the general business credit against the alternative minimum tax, and limit the general business credit's allowance against the regular income tax.

Table of Contents

VII.  Codification of economic substance doctrine.  The economic substance doctrine is a judicial doctrine that has been used by the courts to deny tax benefits when the transaction generating these tax benefits lacks economic substance. The courts have not applied the economic substance doctrine uniformly. For transactions entered into after March 30, 2010, and to underpayments, understatements, and refunds and credits attributable to transactions entered into after March 30, 2010, the manner in which the economic substance doctrine should be applied by the courts is clarified and a penalty is imposed on understatements attributable to a transaction lacking economic substance.

Table of Contents


I hope this information is helpful. If you would like more details about these provisions or any other aspect of the new law, please do not hesitate to call.

Very truly yours,
Alpern Rosenthal