By Laura L. House, CPA
On June 28, 2012, the U.S. Supreme Court (the Court) made a historic decision on the Patient Protection and Affordable Care Act (PPACA) and its companion law, the Health Care and Education Reconciliation Act (HCERA). In a 5 to 4 decision, the nation's highest court upheld all of the tax provisions and health insurance reforms that were part of the overall health care reform legislation passed in 2010 except for a certain Medicaid provision involving state funding. Critical to the Court's approval of President Obama's signature health care law was its finding that the new law’s mandatory penalty for certain individuals who fail to obtain “minimum essential health insurance coverage” was constitutional based upon Congress' power to tax.
In the coming months, we expect to see more commentary on the Court's highly controversial decision and further examination of the new law and its practical implementation. In the interim, individuals and businesses alike are left wondering what this all means and what steps they need to be taking now to comply with these new laws.
The Supreme Court's decision allows the numerous tax provisions within the original health care legislation passed in 2010 to move forward on schedule. Most of these tax provisions are scheduled to take effect starting in 2013 and 2014. One provision, the excise tax on high-cost employer-sponsored coverage, will not take effect until 2018.
Significant Tax Provisions and Their Effective Dates
The PPACA and HCERA include numerous tax changes which will take effect over the next several years. Some of the more widespread provisions are discussed below:
Tax provisions taking effect for tax years ending after December 31, 2012:
Medicare tax rate increase for highly compensated individuals – The Medicare tax rate will increase from 1.45% to 2.35% on the wages and self-employment income earned by higher-income individuals. The additional 0.9% tax will be levied on the excess wages earned above the following thresholds: single - above $200,000; married filing jointly - above $250,000; married filing separately - above $125,000.
- 3.8% Medicare tax on unearned income - A new 3.8% Medicare tax will be imposed on unearned income for higher-income individuals with adjusted gross income above the following thresholds: single - $200,000; married filing jointly - $250,000; married filing separately - $125,000. The 3.8% tax is imposed on the lesser of (a) net investment income (gross investment income properly reduced by allocable investment expenses) or (b) the excess of the taxpayer’s adjusted gross income over the applicable threshold amounts noted. Unearned income includes interest, dividends, annuities, royalties, rents and net gain (to the extent taken into account in computing taxable income) on the disposition of property other than property held in a trade or business. The new tax does not apply to income in tax-deferred retirement accounts such as 401(k) plans, tax-exempt bond interest or excluded capital gain from the sale of a principal residence.
Tax provisions taking effect for tax years beginning after December 31, 2012
Floor on medical expenses deduction increased to 10% of AGI - The threshold for deducting medical expenses as an itemized deduction will be raised from 7.5% to 10% of adjusted gross income.
- Health flexible spending arrangements (FSAs) are limited to $2,500 - Flexible spending accounts established under an employer’s cafeteria plan allow employees to set aside pre-tax earnings to pay for qualified expenses such as medical or dependent care expenses. The new law limits an employee’s contributions made by salary reduction to health FSAs maintained under a cafeteria plan to $2,500 per year. The dollar amount will be indexed for inflation after 2013.
Tax provisions taking effect for tax years ending after December 31, 2013:
Individual mandate - The new law requires all non-exempt U.S. citizens and legal residents to have minimum essential health insurance coverage. 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 between the 2014 and 2016 tax years. Exempt individuals include taxpayers with annual gross income below the income tax return filing threshold.
- Low income refundable tax credits - The “Premium Assistance Credit” is a refundable credit that will be provided to eligible low- and middle-income individuals and families for the purchase of health insurance through an “Exchange”. The IRS pays the premium assistance credit amount directly to the insurance plan in which the individual is enrolled. The individual then pays the dollar difference between the premium assistance credit amount and the total premium charged for the plan. For employed individuals, the premium payments are made through payroll deductions.
Tax provisions taking effect for tax years beginning after December 31, 2013:
- Large employer mandate – The new law imposes a tax penalty on large employers (generally, those who employed 50 individuals or more, on average, during the preceding calendar year) if any full-time employee has certified to the employer as having purchased health insurance through a state insurance “Exchange” with respect to which a tax credit or cost-sharing reduction is allowed or paid to the employee because the employer:
- did not offer health care coverage for all of its full-time employees,
- did not offer affordable minimum essential coverage,
- offered minimum essential coverage that consists of a plan under which the plan's share of the total allowed cost of benefits was less than 60%.
The penalty amount for any one month will be the product of the total number of full-time employees in excess of 30 during the applicable month multiplied by one-twelfth of $2,000.
- Small employer tax credits - For tax years beginning in 2010 through 2013, qualifying small employers (generally, less than 25 full time employees with average annual wages less than $50,000) are eligible to receive a 35% tax credit for non-elective contributions made to purchase health insurance for their employees. Starting in 2014, qualifying small employers will be eligible for a tax credit up to 50% of their non-elective contributions if the employee health insurance was purchased through the “Insurance Exchange” program (Internal Revenue Code Section 45R).
Tax provision taking effect in 2018:
- Excise tax on high-dollar insurance - Effective for tax years beginning after December 31, 2017, a 40% nondeductible excise tax will be imposed on insurance companies and plan administrators for employer-sponsored health coverage plans that have annual premium costs in excess of $10,200 for single coverage and $27,500 for family coverage.
The Court's upholding of the PPACA paves the way for full implementation of the new law. At this point in time, it is not foreseeable that the Act will be repealed. Therefore, taxpayers and employers must navigate their way through the many provisions of the PPACA and understand the business and personal tax implications of these new laws. BlumShapiro will continue to provide you with updates on the Health Care Act. We are committed to making sure you understand and comply with the new tax laws while ensuring that proper tax planning is done in preparation for the provisions taking effect in 2012 and the years that follow.