—   Embracing the Past while Building for the Future   —

The Patient Protection and

Affordable Care Act

Signed into law March 23, 2010

The Health Care and Education Reconciliation Act of 2010

Signed into law March 30, 2010

The recently enacted health care legislation includes provisions which will impact businesses and individuals alike over many years.  Many of the key provisions in the health care package take effect in 2010 including:

·         Small business tax credit;

·        Temporary high-risk pool for individuals who are uninsured because of a pre-existing condition;

·         Temporary reinsurance program for early retirees;

·         No discrimination against children with pre-existing conditions;

·         No lifetime limits on coverage;

·        Coverage for young persons until age 26 through parents’ insurance; and

·         A $250 rebate to Medicare beneficiaries who are affected by the “Donut Hole.”

The following is a brief overview of the tax changes in this health care legislation:

Penalty for remaining uninsured

For tax years ending after December 31, 2013, non-exempt U.S. citizens and legal residents will have to maintain minimum essential coverage or pay a penalty.

Those failing to maintain minimum essential coverage in 2016 will be subject to a penalty equal to the greater of:  (1) 2.5% of household income over the threshold amount of income required for income tax return filing, or (2) $695 per uninsured adult in the household.  The fee for an uninsured individual under age 18 will be one-half of the fee for an adult.  The total household penalty will not exceed 300% of the per adult penalty ($2,085), nor exceed the national average annual premium for the “bronze level” health plan offered through the Insurance Exchange that year for the household size.

The per adult annual penalty will be phased in as follows:  $95 for 2014; $325 for 2015; and $695 in 2016.  For years after 2016, the $695 amount will be indexed to CPI-U, rounded to the next lowest $50.  The percentage of income will be phased in as follows:  1% for 2014; 2% in 2015; and 2.5% beginning after 2015.  If a taxpayer files a joint return, the individual and spouse will be jointly liable for any penalty payment.  The penalty, which will apply to any period the individual does not maintain minimum essential coverage (determined monthly) will be assessed through the Code.

Among those individuals who will be exempted from the penalty:  Individuals who cannot afford coverage because their required contribution for employer sponsored coverage or the lowest cost “bronze plan” in the local Insurance Exchange exceeds 8% of household income; those who are exempted for religious reasons; and those residing outside of the U.S.

Low-income tax credits for participating in health exchanges

For tax years ending after 2013, tax credits 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) that are not eligible for Medicaid, employer sponsored insurance, or other acceptable coverage.  These individuals and families will have to obtain health care coverage in newly established Insurance Exchanges in order to obtain credits.

Employer responsibilities

For months beginning after December 31, 2013, an “applicable large employer” (generally, one that employed an average of at least 50 full-time employees during the preceding calendar year) not offering coverage for all its full-time employees, offering minimum essential coverage that is unaffordable, or offering 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%, will have 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.  The penalty for any month will be 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 (adjusted for inflation after 2014).

Also, an applicable large employer that offers, for any month, its full-time employees and their dependents the opportunity to enroll in minimum essential coverage under an employer sponsored plan will be subject to a penalty if any full-time employee 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 such employee or employees.

Free choice vouchers

After December 31, 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 can be applied to purchase of a health plan through the Insurance Exchange.  Qualified employees are those employees:

·         who do not participate in the employer’s health plan;

·        whose required contribution for employer sponsored minimum essential coverage (if they did participate in the plan) 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.

After 2014, the 8% and 9.8% will be indexed for premium growth.  The value of the voucher is equal to the dollar value of the employer contribution to the employer offered health plan and is not includable in income to the extent it is used for the purchase of health plan coverage.  If the value of the voucher exceeds the premium of the health plan chosen by the employee, the employee is paid the excess value of the voucher.  The excess amount received by the employee is includible in gross income.  If an individual receives a voucher, he is disqualified from receiving any tax credit or cost sharing credit for the purchase of a plan in the Insurance Exchange.  Similarly, if any employee receives a free choice voucher, the employer is not assessed a shared responsibility payment on behalf of that employee.

Tax credits for small employers offering health coverage

For tax years beginning after December 31, 2009, an eligible small employer will be given a tax credit for non-elective contributions to purchase health insurance for its employees.  An eligible small employer generally is an employer with no more than 25 full-time equivalent employees (FTEs) employed during the employer’s tax year, and whose employees have annual full-time equivalent 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 full-time equivalent wages from the employer of less than $25,000.  These wage limits will be indexed to the Consumer Price Index for Urban Consumers (“CPI-U”) for years beginning in 2014.

For tax years beginning in 2010 through 2013, the credit will be 35% (25% for certain tax-exempts) for small employers with fewer than 25 employees and average annual wages of less than $50,000 who offer health insurance coverage to their employees.  In 2014 and later, eligible small employers who purchase coverage through the Insurance Exchange will be eligible for a tax credit for two years of up to 50% (35% for certain tax exempts) of their contribution.

Dependent coverage in employer health plans

Effective on the enactment date of the 2010 Reconciliation Act, 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 has not attained age 27 as of the end of the tax year.  The Committee Report says 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.  Also, self-employed individuals may take a deduction for any child of the taxpayer who has not attained age 27 as of the end of the tax year.

Excise tax on high-cost employer-sponsored health coverage

For tax years beginning after December 31, 2017, a 40% nondeductible excise tax will be levied 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 singe 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 will 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.

Cost of employer sponsored health coverage included on Form W-2

For tax years beginning after December 31, 2010, employers must disclose the value of the benefit provided by them for each employee’s health insurance coverage on the employee’s annual Form W-2.

Other new employer reporting responsibilities for health coverage

For periods beginning after 2013, insurers (including employers who self-insure) that provide minimum essential coverage to any individual during a calendar year must report the following to both the covered individual and to any individual during a calendar year must report the following to both the covered individual and to IRS:  (1) name, address, and tax payer identification number (TIN) of the primary insured, and name and TIN of each other individual obtaining coverage under the policy; (2) the dates during which the individual was covered under the policy during the calendar year; (3) whether the coverage is a qualified health plan offered through an exchange; (4) the amount of any premium tax credit or cost-sharing reduction received by the individual with respect to such coverage; and (5) such other information as IRS may require.  To the extent coverage is through an employer-provided group health plan, the insurer is also required to report the name, address and employer identification number of the employer, the portion of the premium, if any, required to be paid by the employer, and any other information IRS may require to administer the new tax credit for eligible small employers (see discussion above).

Additional Hospital Insurance Tax (HI) for high wage workers

For tax years beginning after December 31, 2012, the HI tax rate is increased by 0.9 percentage points on an individual taxpayer earning over $200,000 ($250,000 for married couples filing jointly); these figures are not indexed.

Surtax on unearned income

For tax years beginning after December 31, 2012, a 3.8% surtax (called the Unearned Income Medicare Contribution) will apply to net investment income of higher income taxpayers.  The surtax for individuals is 3.8% of the lesser of (1) net investment income or (2) the excess of modified adjusted gross income (AGI) over the threshold amount.  The threshold amount is $250,000 for a joint return or surviving spouse, $125,000 for a married individual filing a separate return, and $200,000 in any other case.

For an estate or trust, the surtax is 3.8% of the lesser of :  (1) undistributed net investment income or (2) the excess of AGI (as defined in Code Sec. 67(e)) over the dollar amount at which the highest income tax bracket applicable to an estate or trust begins.
 

The tax does not apply to a nonresident alien or to a trust all the unexpired interests in which are devoted to charitable purposes, a trust that is exempt from tax under Code Sec. 501, or a charitable remainder trust exempt from tax under Code Sec. 664.

The surtax is subject to the individual estimated tax provisions and is not deductible in computing any tax imposed by subtitle A of the Code (relating to income taxes).

Net investment income for surtax purposes 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).  Investment income is reduced by properly allocable deductions to such income to arrive at net investment income.

New limit on health FSA contributions

For tax years beginning after December 31, 2012, the amount of contributions to health flexible spending accounts (FSAs) under cafeteria plans will be limited to $2,500 per year.  The dollar amount will be inflation indexed after 2013.

Restricted definition of medical expenses for employer provided coverage

For purposes of employer provided health coverage (including health reimbursement accounts (HRAs) and health flexible savings accounts (FSAs), health savings accounts (HSAs), and Archer medical savings accounts (MSAs)), the definition of medicine expenses deductible as a medical expense is generally conformed to the definition for purposes of the itemized deduction for medical expenses.  But this change does not apply to doctor prescribed over-the-counter medicine.  Thus, the cost of over-the-counter medicine (other than insulin or doctor prescribed medicine) cannot be reimbursed through a health FSA or HRA.  In addition, the cost of over-the-counter medicines (other than insulin or doctor prescribed medicine) cannot be reimbursed on a tax-free basis through an HSA or Archer MSA.  These changes for HSAs and Archer MSAs apply for amounts paid out with respect to tax years beginning after December 31, 2010.  The changes for health FSAs and HRAs apply for reimbursement of expenses incurred with respect to tax years beginning after December 31, 2010.

Increased tax on nonqualifying HSA or Archer MSA distributions

For distributions made after December 31, 2010, the additional tax for HSA withdrawals before age 65 that are used for purposes other than qualified medical expenses is increased from 10% to 20%, and the additional tax for Archer MSA withdrawals that are used for purposes other than qualified medical expenses is increased from 15% to 20%.

Modified threshold for claiming medical expense deductions

For tax years beginning after December 31, 2012, the adjusted gross income (AGI) threshold for claiming the itemized deduction for medical expenses will be increased from 7.5% to 10%.  However, the 7.5%-of-AGI threshold will continue to apply through 2016 to individuals age 65 and older (and their spouses).

Deduction for employer Part D is eliminated

For tax years beginning after December 31, 2012, the deduction for the subsidy for employers who maintain prescription drug plans for their Medicare Part D eligible retirees will be eliminated.

Industry-specific revenue raisers

The following revenue raising changes will be imposed on health related industries:

·     A new deduction limit on executive compensation applies to insurance providers.  If at lease 25% of the insurance provider’s gross premium income is derived from health insurance plans that meet the minimum essential coverage requirements in the new health reform law (“covered health insurance provider”), an annual $500,000 per tax year compensation deduction limit will apply for all officers, employees, directors, and other workers or service providers performing services for or on behalf of a covered health insurance provider.  The limit applies to remuneration paid in tax years beginning after 2012 for services performed after 2009.

·       Pharmaceutical manufacturers and importers will have to pay an annual flat fee beginning in 2011 allocated across the industry according to market share.  The annual flat fee beginning in 2011 is allocated across the industry according to market share.  The schedule for the flat fee is:  2011, $2.5 billion; 2012 to 2013, $2.8 billion; 2014 to 2016, $3 billion; 2017, $4 billion; 2018, $4.1 billion; 2019 and later, $2.8 billion.  The fee will not apply to companies with sales of branded pharmaceuticals of $5 million or less.

·       For sales after December 31, 2012, manufacturers or importers of medical devices will have to pay a 2.3% of the sale price is imposed on the sale of any taxable medical device by the manufacturer, producer, or importer of the device.  A taxable medical device is any device, defined in section 201(h) of the Federal Food, Drug, and Cosmetic Act, intended for humans.  The excise tax will not apply to eyeglasses, contact lenses, hearing aids, and any other medical device determined by IRS to be of a type that is generally purchased by the general public at retail for individual use.

·      Health insurance providers will face an annual flat fee on the health insurance sector effective for calendar years beginning after December 31, 2013.  The fee will be allocated based on market share of net premiums written for a U.S. health risk for calendar years beginning after December 31, 2012.  The aggregate annual flat fee for the industry will be:  $8 billion for 2014; $11.3 billion for 2015 and 2016; $13.9 billion for 2017; and $14.3 billion for 2018.  The fee will be indexed to the rate of premium growth for later years.  The fee will not apply to companies whose net premiums written are $25 million or less.

·       For services provided on or after July 1, 2010, the indoor tanning industry will be hit with a 10% excise tax on indoor tanning services.

·       For tax years beginning after December 31, 2009, nonprofit Blue Cross Blue Shield organizations must maintain a medical loss ratio of 85% or higher in order to take advantage of the special tax benefits provided to them, including the deduction for 25% of claims and expenses and the 100% deduction for unearned premium reserves.

Corporate information reporting

For payments made after December 31, 2011, businesses that pay any amount greater than $600 during the year to corporate providers of property and services will have to file an information report with each provider and with IRS.

Codification of economic substance doctrine and imposition of penalties

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 the enactment date of the 2010 Reconciliation Act, and to underpayments, understatements, and refunds and credits attributable to transactions entered into after the enactment date of the 2010 Reconciliation Act, 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.

Elimination of credit for black liquor

A $1.01 per gallon tax credit applies for the production of biofuel from cellulosic feedstocks in order to encourage the development of new production capacity for biofuels that are not derived from food source materials.  Congress is aware that some taxpayers are seeking to claim the cellulosic biofuel tax credit for unprocessed fuels, such as “black liquor.”  For fuel sold or used after December 31, 2009, eligibility for the tax credit under the 2010 Reconciliation Act will be limited to processed fuels (i.e. fuels that could be used in a car engine or in a home heating application).

Estimated taxes for large corporations

The required corporate estimated tax payments factor for corporations with assets of at least $1 billion will be increased by 15.75 percentage points for payments due in July, August, and September of 2014.

Simple cafeteria plans for small businesses

For years beginning after 2010, a new employee benefit cafeteria plan known as a Simple Cafeteria Plan will be available.  This plan will be subject to eased participation restrictions so that small businesses could provide tax-free benefits to their employees; it will include self-employed individuals as qualified employees.

Liberalized adoption credit and adoption assistance rules

For tax years beginning after December 31, 2009 the adoption tax credit will be increased by $1,000, and made refundable.  The adoption assistance exclusion also will be increased by $1,000.  Both credit exclusion are extended through 2011.

New credit for new therapies

For expenses paid or incurred after December 31, 2008, in tax years beginning after that date, a two-year temporary credit applies, subject to an overall cap of $1 billion, to encourage investments in new therapies to prevent, diagnose, and treat acute chronic diseases.

New exclusion for certain health professionals

Payments made under any State loan repayment or loan forgiveness program that is intended to provide for the increased availability of health care services in underserved or health professional shortage areas are excluded from gross income, effective for amounts received by an individual in tax years beginning after December 31, 2008.

Health Insurance Exchanges and enrollment periods – after 2013

Not later than January 1, 2014, each state will have to establish an American Health Benefit Exchange (an “Exchange”) for that state that : (a) facilitates the purchase of “qualified health plans”(QHPs); (b) provides for the establishment of a Small Business Health Options Program (i.e., a “SHOP Exchange”) designed to assist qualified employers in the state who are small employers in facilitating enrollment of their employees in qualified health plans offered in the small group market in the state; and (c) meets the organizational and operational requirements of 2010 Health Care Act.  An Exchange will have to be a governmental agency or nonprofit entity that is established by a state.

A state will be allowed to elect to provide only one Exchange in that state for providing both Exchange and SHOP Exchange services to both qualified individuals and qualified small employers, but only if the Exchange has adequate resources to assist those individuals and employers in obtaining coverage.

Although the Act does not include an express definition of what is a health insurance “Exchange,” it appears that the Exchange would be a federally supervised marketplace for health insurance policies meeting specific eligibility and benefit criteria, to be made available to qualifying individuals and employer groups of graduated sizes.

Although each state has the responsibility of managing the Exchanges in its state, Health and Human Services will be required by regulation to establish criteria for the certification of health plans as QHPs.

The Act expressly provides that none of its provisions will prohibit a health insurance issuer from offering outside of an Exchange a health plan to a qualified individual or qualified employer.  Nor does the Act prevent a qualified individual from enrolling in, or a qualified employer from selecting for its employees, a health plan offered outside of an Exchange.

An Exchange will be required to make QHPs available to “qualified individuals” and “qualified employers”, but will not be allowed to make available any health plan that is not a QHP.  An Exchange will be required to allow an issuer of a plan that provides only limited scope dental benefits to offer the plan through the Exchange.

For purposes of Exchange participation, a “qualified individual” will be an individual who is seeking to enroll in a QHP health plan in the individual market offered through the Exchange, and who resides in the state that established the Exchange.

Certain employers will have to provide free choice vouchers to qualified employees after 2013

The 2010 Health Care Act requires individuals to maintain minimum essential health insurance coverage after 2013.  Also, an “offering employer” will have to provide “free choice vouchers” to each of its “qualified employees” after 2013.  The value of these vouchers can be applied by employees to purchase of a health plan through and “Exchange.”

Under the Act, an “offering employer” will be any employer who:

 (1) offers “minimum essential coverage” to its employees consisting of coverage through an “eligible employer-sponsored plan;” and

(2) pays any portion of the costs of the plan

 A “qualified employee” will be, with respect to any plan year of an offering employer, any employee:

 (1) whose “required contribution” for minimum essential coverage through an eligible employer-sponsored plan:

(i) exceeds 8% of the employee’s “household income” for the tax year which ends with or within the plan year; and

(ii) does not exceed 9.8% of the employee’s household income for the tax year;

(2) whose household income for the tax year is not greater than 400% of the poverty line for a family of the size involved; and

(3) who does not participate in a health plan offered by the offering employer.

In the case of any calendar years after 2014, the 8% and 9.8% figures are to be indexed. HHS must adjust the percentages to reflect the rate of premium growth over the rate of income growth between the preceding calendar year and 2013.

The amount of any free choice voucher provided will have to be equal to the monthly portion of the cost of the eligible employer-sponsored plan that would have been paid by the employer if the employee were covered under the plan with respect to which the employer pays the largest portion of the employee’s premium.  The amount will have to be equal to the amount the employer would pay for an employee with self-only coverage unless the employee elects family coverage, in which case the amount will have to be the amount the employer would pay for family coverage.

If an employer offering the same plans for $200 and $300 offers a flat $180 contribution for all plans, a contribution of 90% for the $200 plan and a contribution of 60% for the $300 plan, the value of the voucher would equal the value of the contribution to the $200 since it received a 90% contribution, a value of $180.  However, if the firm offers a $150 contribution to the $200 plan (75%) and a $200 contribution to the $300 plan (67%), the value of the voucher is based on the plan receiving the greater percentage paid by the employer and would be $150.  If a firm offers health plans with monthly premiums of $200 and $300 and provides a payment of 60% of any plan purchased, the value of the voucher will be 60% of the higher premium plan, in this case, 60% of $300 or $180.

An Exchange will have to credit the amount of any free choice voucher to the monthly premium of any qualified health plan in the Exchange in which the qualified employee is enrolled, and the offering employer will have to pay any amounts so credited to the Exchange.

If the amount of the free choice voucher exceeds the amount of the premium of the qualified health plan in which the qualified employee is enrolled for the month, that excess will have to be paid to the employee.

If an individual receives a voucher the individual is disqualified from receiving any tax credit or cost sharing credit for the purchase of a plan in the Exchange.  Similarly, if any employee receives a free choice voucher, the employer is not to be assessed a shared responsibility payment on behalf of that employee.

Gross income will not include the amount of any free choice voucher provided by an employer to the extent that the amount of the voucher does not exceed the amount paid for a qualified health plan by the taxpayer.

However, any excess amount received by the employee is includible in the employee’s gross income.

Effective for vouchers provided after December 31 2013.

Additional 0.9% Medicare Tax Will be Imposed After 2012 on Wages and Self-Employment Income over Threshold Amounts

FICA taxes

The Federal Insurance Contributions Act (FICA) imposes two taxes on employees on wages received with respect to employment.  Similar taxes are imposed on wages paid by employers.

The Old Age, Survivors and Disability Insurance (OASDI) tax is imposed at a 6.2% rate, on wages up to an annually-adjusted “wage base” ($106,800 for 2010).

Under pre-2010 Health Care Act law, the Medicare Hospital Insurance (HI) tax was imposed at a 1.45% rate on all wages, regardless of amount.

Employers must collect the employee FICA tax by withholding it from the employee’s wages when paid.

The 2010 Health Care Act increases the employee portion of the HI tax after 2012 by an additional tax of 0.9% on wages received in excess of the applicable threshold amount (see below).  Unlike the general 1.45% HI tax on wages, the additional tax on a joint return is on the combined wages of the employee and the employee’s spouse.

The same additional HI tax applies to the HI portion of SECA tax on self-employment income.  Thus, an additional tax of 0.9% is imposed on every self-employed individual on self-employment income in ecess of the applicable threshold amount.  The threshold amount is reduced (but not below zero) by the amount of wages taken into account in determining the taxpayer’s FICA tax.

For tax years beginning after December 31, 2012, an additional 0.9% HI tax will be imposed on taxpayers (other than corporations, estates, or trusts) on wages received with respect to employment in excess of:

·         $250,000 for joint returns (Code Sec. 3101(b)(2)(A)),

·         $125,000 for married taxpayers filing a separate return, and

·         $200,000 in all other cases.

These threshold amounts are not indexed for inflation.  Thus, as time goes on, more taxpayers will become subject to these taxes.

This tax will be in addition to the regular HI rate of 1.45% of wages received by employees with respect to employment.

Thus, the HI tax rate will be:

·         1.45% on the first $200,000 of wages ($125,000 on a separate return, $250,000 of combined wages on a joint return); and

·         2.35% (1.45% + 0.9%) on wages in excess of $200,000 ($125,000 on a separate return, $250,000 of combined wages on a joint return).

This change does not affect the HI tax imposed on employers.

A single taxpayer earns wages of $500,000 for 2013.  Taxpayer pays HI tax of $2,900 on the first $200,000 of wages ($200,000 x 1.45%) and $7,050 on the excess of his wages over $200,000 ($300,000 x 2.35%), for a total HI tax of $9,950.

For 2013, H and W file a joint return.  H earns wages of $125,000 and W earns wages of $175,000.  H and W pay HI tax of $3,625 ($250,000 x 1.45%) on their first $250,000 of wages and $1,175 on the excess of their combined wages over $250,000 ($50,000 x 2.35%), for a total HI tax of $4,800.

Employer’s obligation to withhold

The employer is required to withhold the additional 0.9% HI tax on wages.  The employer is liable for the tax that it fails to withhold from wages or to collect from the employee (where the employer fails to withhold).

However, an employer’s obligation to withhold the additional 0.9% HI tax applies only to wages in excess of $200,000 that the employee receives from the employer.  The employer may disregard the amount of wages received by the employee’s spouse.  The Committee Report adds that the employer must disregard the spouse’s wages.

Thus, the employer is only required to withhold the additional 0.9% HI tax on wages in excess of $200,000 for the year, even though the tax may apply to a portion of the employee’s wages at or below $200.000, if the employee’s spouse also has wages for the year, they are filing a joint return, and their total combined wages for the year exceed $250,000.

For 2013, H has wages of $250,000, and W has wages of $100,000.  H’s employer must withhold the additional 0.9% HI tax on the $50,000 of H’s wages in excess of $200,000.  W’s employer is not required to withhold any portion of the additional 0.9% HI tax, even though H and W’s combined wages are over the $250,000 threshold.

Couples in this situation may have to make estimated tax payments to cover the additional 0.9% HI tax, because the amounts withheld by their employers will not be sufficient.

The employer will not be liable for any additional 0.9% HI tax that it fails to withhold and that the employee later pays, but will be liable for any penalties resulting from its failure to withhold.

The employee will be liable for the additional 0.9% HI tax to the extent it is not deducted by the employer.  In contrast, employees generally have no direct liability for the employee portion of the general 1.45% HI tax.

The amount of the additional 0.9% HI tax not withheld by an employer must be taken into account in determining a taxpayer’s estimated tax liability.

The above is effective for tax years beginning after December 31, 2012.

New 3.8% Medicare Contribution Tax Will be Imposed after 2012 on Net Investment Income of Individuals, Estates, and Trusts

The 2010 Reconciliation Act imposes an unearned income Medicare contribution tax on individuals, estates, and trusts.

The tax is generally levied on income from interest, dividends, annuities, royalties, rents, and capital gains.

For individuals, the tax is 3.8% of the lesser of (a) net investment income or (b) the excess of modified adjusted gross income (MAGI) over the applicable threshold amount.

Net investment income is investment income reduced by the deductions properly allocable to such income.

MAGI is adjusted gross income (AGI) increased by the amount excluded from income as foreign earned income, net of the deductions and exclusions disallowed with respect to the foreign earned income.

The threshold amount is $250,000 for joint returns or surviving spouses, $125,000 for separate returns, and $200,000 in other cases.

Only individuals with MAGI above the applicable threshold amount will be subject to the tax.

For 2013, a single taxpayer has net investment income of $50,000 and MAGI of $180,000.  The taxpayer will not be liable for the Medicare contribution tax, because his MAGI ($180,000) does not exceed his threshold amount ($200,000).

For 2013, a single taxpayer has net investment income of $100,000 and MAGI of $220,000.  The taxpayer would pay a Medicare contribution tax only on the $20,000 amount by which his MAGI exceed his threshold amount of $200,000, because that is less than his net investment income of $100,000.  Thus, taxpayer’s Medicare contribution tax would be $760 ($20,000 x 3.8%).

An individual will pay the 3.8% tax on the full amount of his net investment income if his MAGI exceeds his threshold amount by at least the amount of the net investment income.

Assume that the taxpayer in illustration (2) had MAGI of $300,000.  Because taxpayer’s MAGI exceeds his threshold amount by $100,000, he would pay a Medicare contribution tax on his full $100,000 of net investment income.  Thus, taxpayer’s Medicare contribution tax would be $3,800 ($100,000 x 3.8%).
 

The Medicare contribution tax is in addition to the 0.9% HI tax on wages and on self-employment income in excess of threshold amounts.  Taxpayers who have both high wages or self-employment income and high investment income may be hit with both taxes.

For 2013, a single taxpayer has net investment income of $100,000, wages of $300,000, and MAGI of $375,000.

In addition to paying a Medicare contribution tax of $3,800, as explained in illustration (3), the taxpayer would also pay an additional HI (Medicare) tax of $900 ($100,000 x 0.9%) on his wages in excess of $200,000.

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.

“Net Investment income” defined

For purposes of the Medicare contribution tax, “net investment income” means the excess, if any, of:

 (1) The sum of:

…gross income from interest, dividends, annuities, royalties, and rents, unless those items are derived in the ordinary course of a trade or business to which the Medicare contribution tax does not apply (see below),

…other gross income derived from a trade or business to which the Medicare contribution tax applies (below),

…net gain (to the extent taken into account in computing taxable income) attributable to the disposition of property other than property held in a trade or business to which the Medicare contribution tax does not apply, over

(2) The allowable deductions that are properly allocable to that gross income or net gain.

Gross income does not include items, such as tax-exempt bond interest, veterans’ benefits, and excluded gain from the sale of a principal residence, that are excluded from gross income for income tax purposes.

Trades and businesses to which tax applies

The Medicare contribution tax applies to a trade or business if it is:

·         a passive activity of the taxpayer, within the meaning of Code Sec. 469, or

·         a trade or business of trading in financial instruments or commodities as defined in Code Sec.475(e)(2)

The Medicare contribution tax does not apply to other trades or businesses conducted by a sole proprietor, partnership, or S corporation.

Thus, for a taxpayer that does not engage in a passive activity or a financial instrument or commodities trading business, “net investment income” will include non-business income from interest, dividends, annuities, royalties, rents, and capital gains, minus the allocable deductions.  Business income will not be included.

For a taxpayer that does engage in a passive activity or a financial instrument or commodities trading business, “net investment income” will include the above items, plus the gross income (minus allocable deductions) from the passive activity or trading business.

Income on investment of working capital subject to tax.

For purposes of the definition of “net investment income,” a rule applies that is similar to the rule of Code Sec. 469(e)(1)(B), which treats income, gain, or loss attributable to an investment of working capital as not derived in the ordinary course of a trade or business.

Thus, income, gain, or loss on working capital is not treated as derived from a trade or business.

As a result, those items will be subject to the Medicare contribution tax.

Exception for certain active interests in partnerships and S corporations.

Gain from a disposition of an interest in a partnership or S corporation is taken into account as net investment income only to the extent of the net gain that the transferor would take into account if the partnership or S corporation had sold all its property for fair market value immediately before the disposition.

A similar rule applies to a loss from a disposition of an interest in a partnership or S corporation.

Thus, only net gain or loss attributable to property held by the entity that is not properly attributable to an active trade or business is taken into account.  For this purpose, a business of trading financial instruments or commodities is not treated as an active trade or business.

Qualified plan distributions.

Qualified retirement plan distributions are not included in investment income.  Specifically, net investment income does not include any distribution from a plan or arrangement described in:  (Code Sec. 1411 (c)(5))

·         Code Sec. 401(a) (qualified pension, profit-sharing, and stock bonus plans);

·         Code Sec. 403(a) (qualified annuity plans);

·         Code Sec. 403(b) (annuities for employees of tax-exempt organizations or public schools);

·         Code Sec. 408 (individual retirement accounts-IRAs)

·         Code Sec. 408A (Roth IRAs);

·         Code Sec. 457(b) (deferred compensation plans of state and local governments and tax exempt organizations).

Investment income does not include amounts subject to SECA taxes.  Specifically, net investment income does not include any item taken into account in determining self employment income for the tax year, if that item is subject to the HI portion of SECA taxes under Code Sec. 1401(b).

Estates and trusts are subject to a Medicare contribution tax for each tax year equal to 3.8% of the lesser of:

(1) The estate’s or trust’s undistributed net investment income for the tax year, or

(2) The excess (if any) of:

…the estate’s or trust’s AGI for the tax year, over

…the dollar amount at which the highest tax bracket in Code Sec. 1(e) begins for the tax year.

For 2010, the highest estate and trust income tax bracket begins at $11,200.  These brackets are indexed for inflation.  Presumably, by the time the Medicare contribution tax takes effect in 2013, the dollar amount will be higher.

The Medicare contribution tax does not apply to a trust all of the unexpired interests in which are devoted to one or more of the charitable purposes described in Code Sec. 170(c)(2)(B).

The tax also does not apply to a trust that is tax-exempt under Code Sec. 501 or a charitable remainder trust exempt from tax under Code Sec. 664.

In addition, the Medicare contribution tax probably will not apply to simple trusts and grantor trusts.  A simple trust is a trust that makes no distribution other than of current income and whose terms require all of its income to be distributed currently and do not provide for charitable contributions.  Thus, it would not have any undistributed net investment income that would be subject to the Medicare contribution tax.

Under the grantor trust rules, a grantor or other person, such as a beneficiary, may be treated as “owner” of all or part of the trust and taxed directly, to that extent, on the trust income.  To the extent that the grantor trust rules apply, the regular rules for taxing trusts and their beneficiaries do not apply.

The Medicare contribution tax is subject to the individual estimated tax provisions.  The Medicare contribution tax is treated as “tax” for purposes of computing the penalty for underpayment of estimated tax.

Employers With at Least 50 Full-Time Employees May be Subject to Monthly Health Coverage Excise Taxes After 2013

After 2013, a large employer (generally, an employer with at least 50 full-time employees, see below) that does not offer health care 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.

The 2010 Health Care Act collectively refers to the rules imposing these excise taxes as “shared responsibility for employers regarding health coverage.”

After 2013, under the 2010 Health Care Act, an “applicable large employer” (see below) will have to pay an assessable payment equal to the product of (a) the “applicable payment amount” (see below), and (b) the number of individuals employed by the employer (less the 30-employees reduction described below) as “full-time employees” (see below) during any month, if:

 (1) The employer fails to offer to its full-time employees (and their dependents) the opportunity to enroll in “minimum essential coverage” under an “eligible employer-sponsored plan” for that month; and

(2) At least one full-time employee has been certified to the employer as having enrolled for that month in a qualified health plan for which an “applicable premium tax credit or cost-sharing reduction” (collectively referred to as “health coverage assistance,” see below) is allowed or paid with respect to the employee.

The “applicable payment amount” will be $166.67 with respect to any month, i.e., 1/12 of $2,000 (adjusted for inflation after 2014, see below).

The term “applicable premium tax credit and cost-sharing reduction” (sometimes referred to collectively as “health coverage assistance” will mean:

·         any premium tax credit allowed under Code Sec. 36B

·         any cost-sharing reduction; and

·         any advance payment of the premium tax credit or cost-sharing reduction

In 2014, Employer A fails to offer minimum essential coverage and has 100 full-time employees, ten of whom receive a tax credit for the year for enrolling in a state exchange-offered plan.  For each employee over the 30-employee threshold, the employer owes $2,000, for a total penalty of $140,000 ($2,000 multiplied by 70 ((100-30)).  This penalty is assessed on a monthly basis.

Generally, if an employee is offered affordable minimum essential coverage under an employer-sponsored plan, then the individual is ineligible for a premium tax credit and cost sharing reductions for health insurance purchased through a state exchange.  However, if an employee is offered minimum essential coverage by their employer that is either “unaffordable” (see below), or that consists of a plan under which the plan’s share of the total allowed cost of benefits is less than 60% then the employee is eligible of a premium tax credit and cost sharing reductions, but only if the employee declines to enroll in the coverage, and purchases coverage through the exchange instead.

“Unaffordable” is defined as 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 the premium tax credits).  This percentage of the employee’s income is indexed to the per capita growth in premiums for the insured market as determined by the Secretary of Health and Human Services.  The employee must seek an affordability waiver from the state exchange and provide information as to family income and the lowest cost employer option offered to them.  The state exchange then provides the waiver to the employee.  The employer penalty applies for any employees receiving an affordability waiver.

For purposes of determining if coverage is unaffordable, required salary reduction contributions are treated as payments required to be made by the employee.  However, if an employee is reimbursed by the employer for any portion of the premium for health insurance coverage purchased through the exchange, including any reimbursement through salary reduction contributions under a cafeteria plan, the coverage is employer-provided and the employee is not eligible for premium tax credits or cost-sharing reductions.  Thus, an individual is not permitted to purchase coverage through the exchange, apply for the premium tax credit, and pay for the individual’s portion of the premium using salary reduction contributions under the cafeteria plan of the individual’s employer.

An employer must be notified if one of its employees is determined to be eligible for a premium assistance credit or a cost-sharing reduction because the employer does not provide minimal essential coverage through an employer-sponsored plan, or the employer does offer such coverage but it is not affordable or the plan’s share of the total allowed cost of benefits is less than 60%.  The notice must include information about the employer’s potential liability for payments under Code Sec. 4980H.

An employer is generally not entitled to information about its employees who qualify for the premium assistance credit or cost-sharing reductions; however the appeals process must provide an employer the opportunity to access the data used to make the determination of an employee’s eligibility for a premium assistance credit or cost-sharing reduction, to the extent allowable by law.

Applicable large employer

For a calendar year, an “applicable large employer” will be an employer who employed an average of at least 50 “full-time employees” (see below) on business days during the preceding calendar year.

However, an employer will not be considered to employ more than 50 full-time employees if:

(1) The employer’s workforce exceeds 50 full-time employees for 120 days, or fewer, during the calendar year; and

(2) The employees in excess of 50 employed during that 120-day (or fewer) period were seasonal workers (see below).

Solely for purposes of determining whether an employer is an applicable large employer, in addition to including the number of full-time employees for any month otherwise determined, an employer will also have to include for that month the number of full-time employees determined by dividing (1) the aggregate number of hours of service of employees who are not full-time employees for the month, by (2) 120.

In April 2014, Employer B employs 48 full-time employees, as well as five employees who are not full-time employees, who work an aggregate of 360 hours of service during that month.  For April 2014, Employer B is considered to employ 51 full-time employees (48 plus (360 divided by 120)).

For purposes of determining an applicable large employer, all persons treated as a single employer in accordance with the employer aggregation rules that follow, will be treated as one employer:

·         Code Sec. 414(b) (relating to employees of a controlled group of corporations);

·         Code Sec 414(c) (relating to employees of partnerships, proprietorships, etc., under common control);

·         Code Sec. 414(m) (relating to employees of an affiliated service group); and

·         Code Sec. 414(o) (relating to separate organizations, employee leasing, or other arrangements treated by IRS as involving a single employer).

For an employer that was not in existence throughout the preceding calendar year, the determination of whether that employer is an applicable large employer will be based on the average number of employees reasonably expected to be employed on business days in the current calendar year.

For purposes of the excise tax rules described above, any reference to an “employer” includes a reference to any predecessor of that employer.

For any month, a “full-time employee” will be an employee who is employed on average at least 30 hours of service per week.

A “seasonal worker” will be a worker who performs labor or services on a seasonal basis as defined by the Department of Labor (DOL), including workers covered by section 500.20(s)(1) of title 29, Code of Federal Regulations (CFR), and retail workers employed exclusively during holiday seasons.

Under 29 CFR 500.20(s)(1), labor is performed on a seasonal basis where, ordinarily, the employment pertains to, or is of the kind exclusively performed at, certain seasons or periods of the year and which, from its nature, may not be continuous or carried on throughout the year.  A worker who moves from one seasonal activity to another, while employed in agriculture or performing agricultural labor, is employed on a seasonal basis even thought he may continue to be employed during a major portion of the year.

The above is effective for months beginning after December 31, 2013.

Small Employer Health Insurance Credit is Allowed for Tax Years Beginning After December 31, 2009

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 full-time equivalent 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 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 in years 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 nonelective contributions toward the employees’ health insurance premiums.  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 domestic 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.
 

Economic Substance Doctrine Clarified

Under pre-2010 Reconciliation Act law, courts denied claimed tax benefits under two closely related nonstatutory doctrines that evolved in judicial decisions.  Under the “economic substance” doctrine, courts generally denied claimed tax benefits if the transaction that gave rise to those benefits lacked economic substance independent of tax considerations – even though the purported activity actually occurred.  A common law doctrine that often was considered together with the economic substance doctrine was the business purpose doctrine.  The business purpose doctrine involved a subjective inquiry into the taxpayer’s motives, i.e., whether the taxpayer intended the transaction to serve some useful non-tax purpose.

There was a lack of uniformity as to the proper application of the economic substance doctrine.  Some courts applied a conjunctive test that required a taxpayer to establish the presence of both economic substance (i.e. the objective component) and business purpose (i.e. the subjective component) for the transaction to be given effect.  Under a narrower approach used by some courts either a business purpose or economic substance was sufficient to have the transaction respected.  Under a third approach economic substance and business purpose were viewed as simply more precise factors to consider in determining if a transaction had any practical economic effects other than the creation of tax benefits.  In 2006, the Federal Circuit Court stated that while the economic substance doctrine could well apply if the taxpayer’s sole subjective motivation was tax avoidance, even if the transaction had economic substance, a lack of economic substance was sufficient to disqualify the transaction without proof that the taxpayer’s sole motive was tax avoidance.  In 2009, the 5^th Circuit also adopted the view that a lack of economic substance alone was sufficient to disqualify the transaction without regard to the taxpayer’s motive.

The 2010 Reconciliation Act provides statutory rules for applying the economic substance doctrine.

The 2010 Reconciliation Act also defines the economic substance doctrine as the common law doctrine under which the Federal income tax benefits of a transaction are not allowable if the transaction does not have economic substance or lacks a business purpose.

Testing a transaction under the codified economic substance doctrine

Under the 2010 Reconciliation Act, a transaction to which the economic substance doctrine is relevant (see below) has economic substance only if:

 (1) The transaction changes in a meaningful way (apart from Federal income tax effects) the taxpayer’s economic position, and

(2) The taxpayer has a substantial purpose (apart from Federal income tax effects) for entering into the transaction.  (This list is referred to as the economic substance test list.)

The determination of whether the economic substance doctrine is relevant to a transaction is made as if this provision was never enacted.  Thus, the provision does not change current law standards in determining when to utilize an economic substance analysis.

Information Reporting Added for a Trade or Business Payor of $600 or More in Gross Proceeds to a Payee After 2011

Every person engaged in a trade or business has to file with IRS an information return for “payments” (described below) made to another person (other than certain payments with respect to which information returns are required under Code Sections other than Code Sec. 6041) in the course of the payor’s trade or business that constitute fixed or determinable income aggregating $600 or more in any tax year.  The “payments” subject to this information-return requirement are those for:

 (1) salaries, wages, commissions, fees, and other forms of compensation for services rendered amounting to $600 or more in a tax year; and

(2) interest, rents, royalties, annuities, pensions, and other gains, profits, and income amounting to $600 or more in a tax year.

The 2010 Health Care Act adds “amounts in consideration for property” and “gross proceeds” to the pre-2010 Health Care Act categories of payments for which an information return to IRS will be required if the $600 aggregate payment threshold (described above) is met in a tax year for any one payee.

Thus, Congress says that for payments made after 2011, the term “payments” includes gross proceeds paid in consideration for property or services.

The information return will have to set forth the amount of the gross proceeds described in Code Sec. 6041(a)

Congress presumable intended to ensure that payments made by persons engaged in a trade or business, made in consideration of property, in excess of $600 in the aggregate to a payee in one tax year, will be reported to IRS if made in 2012 or thereafter.  This would flag the payment for IRS, to help determine if it was properly reported by the payee.

X Corp., a calendar-year taxpayer, is engaged in the trade or business of manufacturing.  X purchases a used automobile from Y, an individual, for $1,000 in 2010.  The $1,000 is an amount paid in consideration of property.  X is not required to file an information reporting return with IRS for the $1,000 payment made to Y.

The facts are the same as in the previous paragraph, except that X buys the automobile from Y in 2012.  Y’s adjusted basis in the automobile is $500.  X will be required to file an information return with IRS for the $1,000 payment of gross proceeds, setting forth the amount paid ($1,000), regardless of the fact that Y’s gain on the sale is only $500.

The 2010 Health Care Act provides that, notwithstanding any IRS reg issued before March 23, 2010, for information reporting purposes, “person” includes any corporation that is not exempt from tax under Code Sec. 501(a).

Thus, a business is required to file an information return for all payments aggregating $600 or more in a calendar year to a single payee (other than a payee that is a tax-exempt corporation), notwithstanding any reg promulgated before March 23, 2010.

Congress apparently wants to ensure that payments made by persons engaged in a trade or business, to a corporation other than a tax-exempt corporation, of $600 or more in the aggregate in one tax year, will be reported to IRS if made in 2012 or thereafter.  This will flag the payment for IRS, to help determine if it was properly reported by the corporate payee.

R, a calendar-year taxpayer, is engaged in the trade or business of being a florist.  In 2011, R pays D Corp., a calendar-year taxpayer, $12,000 to rent a storefront to conduct the florist business.  R is not required to file an information reporting return with IRS for the $12,000 payment made to D.

The facts are the same as in the previous paragraph, except that R pays the $12,000 rent to D in 2013.  R will be required to file an information reporting return with IRS for the $12,000 payment, setting forth the amount paid ($12,000) and D’s name and address.  R will also be required to provide D with a statement showing the $12,000 payment and include R’s contact information.  IRS will thus be on notice that R paid D $12,000 in 2013, and can check D’s 2013 return to see if D properly reported the rent payment as income.

This information-reporting provision will increase the paperwork burden on businesses that routinely make payments each year totaling $600 or more per corporation.  Effective for payments made after December 31, 2011.

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