New Health Care Reform Law Includes Several Significant Tax Changes

The recent enactment of the Patient Protection and Affordable Care Act of 2010, in combination with the Health Care and Education Tax Credits Reconciliation Act of 2010 (collectively known as the “Health Care Act” or the “Act”), significantly changes the nation’s health care landscape, and many of these changes will be carried out through substantial additions and alterations to the U.S. tax code.

Given the scope of this landmark legislation, this short summary is by no means a comprehensive review of the new law. As your tax professionals at CB&H continue to study the legislation, we will continue to keep you informed and up-to-date regarding the health care reform’s tax implications for you and your business.

BRIEF OVERVIEW

The Health Care Act requires all individuals not covered by Medicaid or Medicare to obtain minimum essential coverage or pay a penalty (unless they are exempt from the individual responsibility mandate). Low-income individuals and some middle-income families are eligible for credits or vouchers to aid in the cost of obtaining coverage.

The Act also encourages employers to provide qualifying coverage by both penalizing large businesses that lack qualifying coverage and promoting contributions from small businesses to employee premiums. Employers that currently offer qualified coverage can continue to offer that same coverage under a grandfather provision.

The Health Care Act is offset chiefly by three measures:

• An increase in Medicare payroll taxes for individuals with earned income over $200,000, $250,000 for families (effective 2013)
• A 40-percent nondeductible excise tax on coverage plans above a high-dollar threshold (effective 2018)
• New fees and taxes on several health care-related industries (some effective starting in 2010)

The IRS will have oversight responsibility for these measures, in addition to several smaller revenue-raising efforts. To allow ample time for both taxpayers and the IRS to prepare for these sweeping changes, many measures include delayed start dates and/or phase-in provisions over the next four years. Click here to download a quick reference timeline that outlines the start dates related to these provisions.

EMPLOYERS

Mid-Market and Large-Scale Businesses

Since the Health Care Act requires individuals to obtain health care insurance coverage, the new law does not contain an employer mandate. However, starting in 2014, the Act does levy an additional tax on those businesses that do not offer minimum essential coverage.

Under the new law, a full-time employee of a large or midsize business may be eligible to enroll in a subsidized plan using tax credit assistance or cost sharing measures. Should that same business not offer minimum essential coverage, then that business will be liable for an additional tax for each month in which it does not offer qualified coverage.

The annual tax amount payable is equal to the number of full-time employees minus 30, multiplied by up to $2,000 per employee. An additional tax would also apply should an employer with eligible employees impose waiting-period restrictions or extend enrollment periods beyond 90 days.

Employers with fewer than 50 employees are exempt from this additional tax. An employer insurance plan that exceeds 9.5 percent of an employee’s income, or with an actuarial value of less than 60 percent would not qualify as minimum essential coverage.

The Act also requires employers that provide minimum essential coverage to file returns with the IRS that include detailed information about the employer, waiting period, employees, coverage plans selected, and premium amount information. Failure to comply with these informational returns will result in additional penalties.

Small Businesses

The Health Care Act defines a small business as one with 25 or fewer employees and average annual wages of $50,000 or less. Small businesses that meet these qualifications are eligible for a tax credit designed to offset some of the cost of the employer contribution toward the employee’s health insurance premium.

From 2010 to 2013, prior to the availability of state-run insurance exchanges, this credit will apply for up to 35 percent of the employer contribution to premiums. After the exchanges come into effect, that credit will equal up to 50 percent of the contribution for two years. Employers with 10 or fewer employees and average annual wages of less than $25,000 (indexed for inflation) will be eligible for the full credit.

Small businesses with 100 or fewer employees will be able to pool funds and distribute risk through state-based web portals. These Small Business Health Options Program (SHOP) Exchanges should give small businesses greater leverage when negotiating with insurance providers.

INDIVIDUALS

Beginning in 2014, individuals not otherwise qualified for Medicare or Medicaid will be required to obtain minimum essential health coverage. Individuals not minimally covered will be required to pay a penalty. The amount of the penalty will vary based on income level.

The Health Care Act phases in this penalty, which will not reach its full amount until 2016. After 2016, the penalty base will be indexed for inflation, with an upper penalty limit set at three times the minimum penalty amount.

The Health Care Act also provides assistance to individuals and families at certain income levels. On a sliding scale related to the federal poverty level (FPL), tax credits and cost sharing measures will be available to qualifying individuals so that their insurance premium payments do not exceed a specific percentage of their income. The scale ranges based on family size from 133 percent to 400 percent of the FPL.

As with businesses, the Health Care Act also grandfathers individuals who already maintain qualified coverage as compliant under the new requirements. The Act also considers individuals with Medicare, Medicaid or other government-sponsored plans to be in compliance with the new coverage requirements. Individuals not required to file an income tax return are not required to meet the minimum essential coverage standards.

In addition, the Health Care Act provides a program for employer-sponsored early retiree reinsurance. Payments made to the reinsurance program are excludable from gross income calculations. Individuals can also purchase community living assistance services through a voluntary program under the new law, paying premiums through payroll deductions.

The Health Care Act also includes provisions that outline exceptions for religious conscience, an exclusion of undocumented residents from coverage, and several provisions for various specific situations, such as hardship and incarceration.

HIGH-INCOME MEDICARE PAYROLL TAX

The Health Care Act imposes an additional Medicare payroll tax on high-income individuals. This consists of both a 0.9 percent additional tax on earned income above $200,000 for individuals and $250,000 for families, and an unearned income Medicare contribution of 3.8 percent if modified adjusted gross income (MAGI) is over $200,000 for individuals or $250,000 for families.

Net investment income subject to the new tax includes dividends, interest, rents, royalties, gains from the disposition of property, and certain passive activity income. Estates, trusts and self-employed individuals are all liable for the new tax. Income from certain retirement accounts, such as pensions, IRAs, 401(a), 403(b), and 457(b) plans, is exempt. The IRS has not yet provided guidance as to how the new tax will reconcile with deferred compensation scenarios.

The 3.8 percent Medicare contribution is effective starting 2013, and only applies to the employee’s portion of Medicare contributions. Combined with the added 0.9 percent earned income tax, the Congressional Budget Office calculates that these measures will raise an estimated $210 billion from 2013 to 2019.

EXCISE TAX ON HIGH-COST INSURANCE

Beginning in 2018, group insurers with annual premium payments in excess of $10,200 for individual coverage and $27,500 for families will be subject to a 40-percent excise tax (amounts will be indexed for inflation). These premium levels increase to $11,850 for individuals and $30,950 for families for retirees age 55 and over, and high professional risk employees.

The taxable amount is any amount greater than the given threshold. Should an individual hold a plan in 2018 with annual premium payments equal to $15,200, the taxable amount for the individual’s insurer will be $5,000 (i.e., $15,200 less $10,200). The Act calculates the threshold amounts for 2018 and 2019 using the Consumer Price Index for All Urban Consumers (CPI-U) plus one percent. Thereafter, the threshold amount will be calculated using the base CPI-U.

HEALTH CARE INDUSTRY FEES

Under the Health Care Act, health insurance providers, pharmaceutical companies, and other health care-related businesses are liable for new, nondeductible annual fees according to market share. Certain delays exist in some instances, such as a 2011 onset date for brand name pharmaceuticals and a 2014 start date for health insurance providers.

Medical device companies. The Health Care Act adds a 2.3-percent excise tax on medical device sales starting in 2013. Frequently purchased items, such as eyeglasses and hearing aids, are exempt from the new tax.

Tax-exempt hospitals. 501(c)(3) insurance providers that serve certain targeted and low-income groups are exempt from the new fees. However, qualified nonprofit hospitals are subject to enhanced assessment requirements. Such hospitals will need to adopt written financial assistance policies and review community benefit activities at least once every three years. They will need to bill individuals that qualify for financial assistance at the same rates as insured individuals.

The Act also adds consumer protection provisions that relate to debt collection procedures. To further enforce compliance and prevent Medicare fraud, the new law authorizes the IRS to share return information with the Department of Health and Human Services.

Health insurance executive compensation. The Health Care Act restricts high-level executive pay for health insurance providers should such providers not meet minimum acceptable coverage requirements. If at least 25 percent of premium income does not meet these requirements, the insurer could not claim a Code §162(m) deduction to the extent remuneration exceeds $500,000. The Act contains special provisions to address deferred compensation.

Indoor tanning services. Starting July 1, 2010, the Health Care Act levies a 10-percent tax on indoor tanning services.

New health care therapies. The Act also provides a two-year temporary tax credit for investments in therapeutic discovery projects. This credit is effective for tax years beginning in 2009 and 2010.

MEDICAL-RELATED EXPENSES

Health-related accounts. The Health Care Act amends several provisions related to flexible spending accounts (FSAs), health savings accounts (HSAs), and medical savings accounts (MSAs). The Act alters the definitions for qualified medical expenses as they relate to FSAs, HSAs, and Archer MSAs. Beginning in 2011, the definition will match that of the medical expense itemized deduction.

For tax years beginning 2013 and later, FSA contributions are limited to $2,500 per year, indexed for inflation thereafter. The Act also provides cafeteria plan provisions to prevent an end-run around new FSA restrictions. The tax on nonqualified distributions increases beginning in 2011 for HSAs from 10 to 20 percent, and for Archer MSAs from 15 to 20 percent.

Medical expense itemized deduction. The Act also increases the itemized medical expense deduction threshold from 7.5 percent to 10 percent of AGI effective for tax years beginning after December 31, 2012. Individuals age 65 and over will receive a temporary exemption from the increase for any tax year beginning after December 31, 2012 and ending before January 1, 2017 if the individual or the individual’s spouse turns 65 in that tax year.

Coverage of adult children. The Act extends the gross income exclusion for employer-provided health coverage to adult children through age 26 who can be claimed as dependents for tax purposes.

Adoption credit enhancements. In addition, the Act increases the adoption credit to $13,170, extends the credit through 2011, and makes the credit refundable. The new law contains provisions that further enhance the credit in special needs adoption cases.

Medicare Part D. Effective 2013, the Act eliminates employer subsidy deductions for retiree prescription drug coverage under Medicare Part D.

ADDITIONAL REVENUE PROVISIONS

The Act includes additional provisions that are projected to raise $28.1 billion through 2020:

Biofuel credit. As of January 1, 2010, cellulosic biofuel sales of the “black liquor” by-product no longer qualify for the biofuel tax credit. Intended to reward taxpayers for the use of alternative fuels, some legislators have targeted abuse of this particular credit category. Though unrelated to health care matters, this measure is expected to raise $23.6 billion of the $28.1 billion cited above.

Information reporting. Businesses that pay $600 or more annually to property and service providers (including corporations) must file an informational return with each provider and the IRS.

Economic substance doctrine. The basis for a transaction’s economic substance now exists only if a taxpayer both changed their economic position in a meaningful way and had substantial non-federal income tax purpose for engaging in the transaction. This change in definition is immediate and could lead to penalties of 20 or 40 percent depending on the transaction and disclosure requirements.

Corporate estimated tax payments. Corporations with assets of at least $1 billion must now increase the required corporate estimated tax payments factor for payments due in July, August and September 2014 by 15.75 percentage points.

CONCLUSION

Look for more details in the months ahead about how these and other provisions of the Health Care Act will affect you and your business. Until then, please do not hesitate to contact your local CB&H tax professional today with any questions.