…and the tax laws hidden within
It is official. The Patient Protection and Affordable Health Care Act passed Congress and was signed by the President on March 23, 2010. The law changes the entire paradigm behind health care and even changes some tax rules.
— Changes in Healthcare –—
Rules on Preexisting Conditions
Starting in 2014, insurance companies will no longer be able to deny coverage for preexisting conditions to adults. Children under the age of 27 whose parents are purchasing insurance for them will no longer be denied health coverage within the next six months. Those with health considerations or who have children with ailments such as epilepsy, cystic fibrosis and a whole range of genetic and age-related disease will gain the right to be covered.
Health Care Exchanges
Currently, health care insurers and consumers are limited as to where and how they can buy and sell health insurance. Under the new law, “health care exchanges” will be created to allow more flexibility as to how, who and the means by which health care insurance can be purchased. While the exact mechanics of the health care exchanges remain to be seen, they are predicted to increase competition in the insurance marketplace and make health insurance more affordable to consumers.
— Changes in the Tax Laws –—
With the new law comes an obligation for all individuals to be insured. Those individuals who refuse to get coverage will face a fine of up to $695 per year to a maximum of $2,085 per family per year, or 2.5 percent of the household income over the amount subject to income tax, whichever is greater. The penalty is being phased in as follows:
• 2014: $95 or 1 percent
• 2015: $325 or 2 percent
• 2016: $695 or 2.5 percent.
The penalty then increases after 2016 based on a cost-of-living adjustment. For some, it may be less expensive to pay the fine than to purchase health insurance. However, be aware that the $695 penalty is a penalty by means of the Internal Revenue Code. In other words, the penalty must be paid or such individuals will face the IRS.
Government Tax Credits
In order to pay for the individual mandate for insurance, the federal government is offering tax credits to individuals who are not eligible for Medicare or Medicaid, or are not covered by their employers for health insurance. The tax credits do not become effective until 2014 and are available for individuals and families making between 100 percent and 400 percent of the federal poverty guidelines. The current federal poverty level for a family of four is $22,050, thus resulting in $88,200 as the top qualifying income for a family of four.
This credit works as follows:
1. The individual purchases insurance from an insurance exchange.
2. The individual tells the insurance exchange what their income is.
3. The IRS issues a credit and pays the insurance exchange a fee.
4. The individual pays the insurance exchange the difference.
Employers with 50 or More Employees
In the new law, there is no mandate or requirement that employers provide insurance to employees. There is, however, a dichotomy between those employing 50 employees or more and those employing 49 employees or fewer. Those employing 50 or more face penalties if their employees elect the government credits for their health insurance purchases. The penalty is $2,000 per employee who elects the government credits; however, the first 30 employees who do so do not count against the company. Small businesses employing 49 employees or fewer are under no such penalties.
A special penalty applies to insurance companies and self-insured companies if the premiums they charge exceed $10,200 per person or $27,500 per family. The penalty is an excise tax of 40 percent of the excess premium charged.
Taxpayers earning in excess of $250,000 (for families) or $200,000 (for individuals) will pay an additional 0.9 percent in Medicare taxes on their excess income. The law goes into effect in 2013.
In addition to the above, a Medicare tax of 3.8 percent will be applied to any net investment income that exceeds the $200,000 and $250,000 thresholds. This includes income from the sale of a business.
Income from dividends has seen its share of changes in the past ten years. Once again, the dividend rate has been altered by means of the legislation. For those families making above $250,000, dividends will be subject to an additional 3.8 percent tax. This tax begins in 2012. To those who own closely held C Corporations, a review of their tax strategy is appropriate, especially if unpaid retained earnings are present. The current dividend tax rate is 15 percent.
While interest is taxable as ordinary income, there will be a 3.8 percent surcharge assessed to interest earnings for those families making over $250,000 per year starting in 2012.
Capital gains income has enjoyed favorable treatment for quite some time. Currently, capital gains are taxed at zero percent for low-income-bracket payers and 15 percent for high-tax-bracket payers. For those making above $250,000, the tax rate will increase by an additional 3.8 percent starting in 2012.
Credit for Small Businesses
Employers who (1) have 25 or fewer full-time employees, (2) provide average compensation of $50,000 or less and (3) pay at least half of the health insurance coverage are eligible for a tax credit.
During tax years 2010, 2011, 2012 and 2013, employers will receive a 35 percent tax credit (in addition to a tax deduction for the premiums paid less the tax credit). In 2014 and 2015, the tax credit increases to 50 percent. After 2013, the credit is only available for two more years and only if the insurance is purchased from an insurance exchange.
On the other hand, if the employer has ten or fewer employees, their average compensation must be less than $25,000 in order for the employer to qualify for the credit. Furthermore, their credit is 25 percent for 2010, 2011, 2012 and 2013. For 2014 and 2015, the credit increases to 35 percent.
Under the old law, individuals—if they itemized—could only deduct medical expenses in excess of 7.5 percent of their adjusted gross income. Effective January 1, 2013, the floor raises to 10 percent for all individuals, except those 65 years of age and older. This is expected to result in a decrease of the deduction for medical expenses, thus raising taxes.
Health Reimbursement Plans
Effective 2011, reimbursements will no longer be allowed for any over-the-counter drugs. Anyone with a flexible savings account plan, a health savings account, etc., will not be able to use tax-deductible dollars to pay for over-the-counter drugs or medications. Only prescription items from a doctor will be allowed to be paid from such plans.
In addition, a penalty of 20 percent will be imposed on all health reimbursement plans for any funds not used for qualified medical expenses. The new penalty is effective January 1, 2011.
Individuals will now only be allowed to put a maximum of $2,500 per year into health savings plans. This limit goes into effect January 1, 2013. After 2013, the maximum amount will be indexed per inflation. Effective March 2010, children under the age of 27 can be included in such health care savings plans.
In a surprise move, the new law creates an excise tax on all indoor tanning services. The individual who receives the service must pay the tax to the operator, who will collect the tax and remit it to the federal government. The tax is 10 percent.
Presently, there exists a credit for adoption costs incurred by families. The new law increases the current credit of $12,150 by $1,000. This law is retroactive to January 1, 2010, and extends only until December 31, 2011.
The health care bill has now become law. Not only are there incentives for small businesses to cover employees and new opportunities for individuals to obtain health insurance, a whole host of tax issues have surfaced. Just to name a few, business succession and exit planning will be affected because of the new capital gains rates. C Corporations with retained earnings should at least consider accelerating their payouts to avoid the increased taxes on dividends (2012). Along with these issues, many others exist in the tax world as a result of this law.
|Meet the Authors
Bart A. Basi, CPA, Esq., (left) is senior advisor at The Center for Financial, Legal, and Tax Planning, Inc. Marcus S. Renwick, Esq., is director of research. The Center is located in Marion, Illinois, and on the Web at www.taxplanning.com.