Tax Implications of the Affordable Care Act

The Affordable Care Act (ACA) made many changes with respect to healthcare for individuals, employers, and insurers. It also created new taxes and related fees. In summary, the ACA expanded the types of coverage provided under group health plans, the insurance provisions under healthcare plans, and individual health insurance policies.
The main provisions of the ACA are:

  • Required coverage for adult children up to age 26
  • No pre-existing condition exclusions for children under age 19
  • Coverage for certain preventive health services with no cost sharing
    If a group health plan does not comply with the provisions of the law, excise taxes of $100 per person per day can be imposed if the failure is not corrected in 30 days. The excise tax will increase if the error is not corrected and will also be severe if the failure to provide is because of willful negligence. Grandfathered group health plans that were in effect as of March 23, 2010 are not subject to certain of these requirements.
    A summary of some of the tax provisions implemented by the ACA follows:
  • A Medicare tax for high-income earners is being imposed. Prior to the ACA, the Medicare tax rate was a flat 2.9% on all wage income, with both the employer and the employee paying exactly one-half of these amounts. As of 2013, the flat 2.9% Medicare tax continues to apply to wages under $200,000 (or under $250,000 for married couples filing a joint return). There will be an additional 0.9% Medicare tax on wages over $200,000 ($250,000 for joint filers). This additional tax is to be withheld from wages, or if not withheld, it is to be paid directly by the employee. This additional Medicare tax also affects self-employed persons paying the self-employment tax.
  • The Health Care and Education Reconciliation Act of 2010 (HR 4872) modifies the ACA to impose the expanded 3.8% Medicare tax on net investment income for people with income over $200,000 (or $250,000 for joint filers). Investment income for the purposes of the Medicare tax base would include interest, dividends, royalties, rent, passive activity income (such as income passed through from partnerships and S-corporations), and gain from the sale of property.
  • Businesses employing 25 employees or less may become eligible for tax credits of up to 35% based on employer-paid health insurance premiums. As indicated earlier, larger employers who fail to provide health insurance coverage may become liable for tax penalties.
  • A tax penalty is being imposed for individuals who fail to maintain adequate insurance coverage. Individual persons will be required to maintain adequate health insurance coverage starting in the year 2014. A new expression, “minimum essential coverage,” has been introduced. The term is defined in the newly added section 5000A of the Internal Revenue Code. Health insurance provided by employers, Medicare and Medicaid, and individually purchased insurance generally meet the definition of minimum essential coverage. Individuals will also be able to keep their existing health insurance policy as providing essential minimum coverage under a grandfathering provision. This provision is now a topic of much political debate. Individuals who do not maintain continuous health insurance coverage will become liable for tax penalties: $95 per person in 2014, $325 per person in 2015, and $695 per person in 2016, and then adjusted for inflation in the years that follow. Lower-income persons will be exempt from the requirement to maintain coverage. Also exempt are people who have a religious conscience objection to insurance coverage.
  • Tax credits will be provided to help purchase health insurance for lower-income people. Individuals and families earning between 133% and 400% of the federal poverty level will be eligible for tax credits to subsidize the cost of health insurance coverage. The credits will, in effect, cap the cost of health insurance premiums between 2% and 9.5% of total household income. Medicaid coverage would be expanded to include individuals earning less than 133% of the federal poverty level.
  • Flexible spending arrangements for health care expenses will be reduced. FSA contributions will be reduced to $2,500 maximum starting in the year 2013.
  • Health savings accounts will have increased penalties for non-medical withdrawals. The current 10% penalty is doubled to 20% for any withdrawal or distribution made for non-medical expenses. Similarly, the penalty for non-qualifying distributions on Archer medical savings accounts will rise from 15% to 20%.
  • The floor on the medical expense deduction will rise to 10%. Previously, out-of-pocket medical expenses were tax-deductible to the extent the expenses exceeded 7.5% of a person’s adjusted gross income. As of 2013, only medical expenses that exceed 10% of AGI are tax-deductible.
  • Adoption tax credit increases to $13,170 and is extended through the year 2011. Also, the adoption credit is now refundable.
  • Economic substance doctrine is codified as law. Basically, the economic substance doctrine means that a tax strategy can be disallowed as abusive if the taxpayer’s economic situation apart from the person’s tax liability does not change in any substantial way. There are automatic penalties ranging from 20% to 40% for engaging in tax strategies that do not meet this definition.
  • There will be expanded information reporting for health insurance coverage. The IRS will be in charge of monitoring whether individuals have health insurance coverage, assessing penalties for failing to maintain adequate coverage, and for paying tax credits to subsidize insurance coverage for lower-income people. There will also be information shared between the IRS and the Department of Health and Human Services, particularly to screen health care providers for tax compliance problems and to recover tax debts owed by health care providers directly from HHS payments.
  • Information reporting for income payments of $600 or more is expanded to include corporations. Currently, businesses are required to issue a Form 1099-MISC to report various types of payments, primarily issued to individuals. Starting in 2012, this requirement has been expanded to include gross payments of $600 or more to both corporate and non-corporate recipients, and is further expanded to include both payments for services and for property.
    Other tax provisions of the ACA that should be noted include the following:
  • As of 2013, employers can no longer claim a tax deduction for the portion of the cost of Medicare Part D drug benefits that is reimbursed through the government subsidy program.
  • Employers must report the cost of employer-sponsored health coverage on each employee’s Form W-2, even though the amount is not taxable to the employee. The employer can calculate the cost based on the rules for determining premiums for COBRA coverage. If this information is not reported on the W-2, the employer may be liable for penalties of up to $200 per incorrect W-2. The IRS has temporarily exempted employers filing fewer than 250 Forms W-2 for the prior year from this requirement.
  • The cost of over-the-counter (OTC) medications cannot be reimbursed through a flexible spending account (FSA) (or from a health reimbursement account (HRA) or health savings account (HSA)) unless the OTC medication is purchased with a prescription. As of 2013, the ACA limits the amount that can be withheld from an employee’s salary on a pre-tax basis for health expenses to $2,500 per plan year. Although this is not a tax on the employer, employers must monitor payroll systems to make sure the new limit is applied to FSA contributions, and employers may see a rise in payroll taxes due to decreased FSA contributions. Finally, the penalty for a non-qualifying distribution from a HSA increased from 10% to 20% of the amount of the distribution.
  • Beginning in 2018, the ACA imposes an excise tax on the provider of employer-sponsored healthcare coverage if the aggregate cost for an employee exceeds a threshold amount. The tax is 40% of the amount that the aggregate cost exceeds the threshold. For 2018, the annual threshold amount is $10,200 for self-only coverage and $27,500 for other coverage. Higher thresholds apply to retirees under age 65 and individuals in certain high-risk professions. The threshold amount is adjusted by the health cost adjustment percentage, which will increase if health care costs exceed certain predictions, and by an age and gender adjusted excess premium amount, which will increase the threshold if the employer’s workforce based on age and gender results in higher premiums than the national workforce.
    The excise tax is not deductible by the insurance company; however, the insurance premiums paid by the employer are generally deductible. For self-insured plans, the excise tax is imposed on plan administrators but is expected to be passed along to plan sponsors.

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