How Will the Health Care Bill Affect Your Taxes?

On March 23, 2010, President Obama signed into law the new health care legislation.  The legislation will affect virtually every individual in one way or another and will significantly impact tax returns in the future.  The following overview of the tax-related provisions of the legislation is based upon the House of Representatives’ version and the one signed by President Obama on March 24, 2010.  The provisions take effect over a number of years (2018).

Excludable Medical Reimbursements for Older Children

Effective on Mar. 30, 2010, the general exclusion for reimbursements for medical care expenses under an employer-provided accident or health plans is extended to any child of an employee who hasn't attained age 27 as of the end of the tax year.

Big Break for Self-Employed Health Insurance Deduction

Generally, a self-employed individual (or a partner or a more-than-2%-shareholder of an S corporation) can deduct as an above-the-line expense 100% of the amount paid during the tax year for medical insurance on behalf of himself, his spouse and his dependents subject to certain requirements, commonly referred to as the self-employed health insurance deduction.  Effective on March 30, 2010, this above-the-line deduction can include medical insurance on behalf of the self-employed individual’s child under the age of 27 as of the end of the year.

Tax Credits for Small Employers Offering Health Coverage

For tax years 2010 through 2013, qualified small employers, generally those with no more than 25 full-time employees with an average annual full-time equivalent wage of no more than $50,000, will be eligible for a tax credit of up to 35% of the cost of non-elective contributions to purchase health insurance for its employees.  The maximum credit is available to employers with no more than 10 full-time equivalent employees with an annual full-time equivalent wage from the employer of less than $25,000.

2014 and Later - In 2014 and later, eligible small employers who purchase coverage through the Insurance Exchange would be eligible for a tax credit for two years of up to 50% of their contribution.

Adoption Credit Limit Raised, Made Refundable and Extended

One of the non-health care related items included in the new law is an increase in the dollar limitation for the adoption credit to $13,170 (adjusted for inflation after 2010) and an extension of the credit through 2011. The credit also is changed from being nonrefundable to a refundable credit.

Tanning Services Excise Tax

For indoor tanning services performed on or after July 1, 2010, a new 10% excise tax is imposed on the amount paid for any indoor tanning service, whether paid for by insurance or otherwise. The tax is imposed on tanning service recipients, although the service provider is liable for the collection and payment of the tax; thus, service providers are liable if they fail to collect the tax.

Over-the-Counter Medication Restriction for Employer-Provided Plans

Beginning in 2011, over-the-counter medications, except for doctor prescribed over-the-counter medication and insulin will no longer qualify for reimbursement.  This restriction applies to health reimbursement accounts (HRAs), health flexible savings accounts (FSAs), health savings accounts (HSAs), and Archer medical savings accounts (MSAs).

Small Employer Simple Cafeteria Plans

For years beginning after Dec. 31, 2010, small employers (average of 100 or fewer employees on business days during either of the two preceding years) may provide employees with a “simple cafeteria plan.”  Under such a plan, the employer is provided with a safe harbor from the nondiscrimination requirements for cafeteria plans as well as from the nondiscrimination requirements for specified qualified benefits offered under a cafeteria plan–

• including group term life insurance,
• benefits under a self-insured medical expense reimbursement plan, and
• benefits under a dependent care assistance program.

Increased Tax on Nonqualifying HSA or Archer MSA Distributions

Beginning in 2011, the additional tax for HSA withdrawals for other than qualified medical expenses before age 65 are increased from 10% to 20%, and the additional tax for Archer MSA withdrawals for other than qualified medical expenses is increased from 15% to 20%. Distributions after age 65 are not subject to the penalty.

Expansion of Information Return Reporting

Currently a business paying more than $600 per year to a noncorporate service provider who isn’t an employee is required to file an information return (Form 1099-MISC). The new law expands the return filing requirement to include both corporate and noncorporate providers of property and services, beginning with tax years beginning in 2011.

Employer Flexible Health Spending Plan Contributions Limited

Beginning in 2013, the maximum that can be contributed to an employer’s health flexible spending accounts (FSAs) would be limited to $2,500 per year.  The amount will be indexed for inflation after 2013.

Medical Itemized Deductions Limited – Beginning in 2013, the itemized deduction for medical expenses will be limited in the following manner:

• AGI Threshold - The AGI threshold for claiming medical expenses on a taxpayer’s Schedule A is increased from 7.5% to 10%, which is the same as the current alternative minimum tax (AMT) rate.  Individuals (and their spouses) age 65 and older will continue to use the 7.5% rate through 2016.
  
  
• Deduction for Employer Part D would be Eliminated - The deduction for the subsidy for employers who maintain prescription drug plans for their Medicare Part D eligible retirees is eliminated.

Taxpayers Earning Over $200,000

Beginning in 2013, higher-income taxpayers will be subject to the following additional taxes:

• Additional Hospital Insurance Tax - The Hospital Insurance (HI) tax rate (currently at 1.45%) would be increased by 0.9 percentage points on an individual taxpayer earning over $200,000 ($250,000 for married couples filing jointly).
  
  
• Surtax on Unearned Income – A 3.8% surtax, called the Unearned Income Medicare Contribution, would be placed on the net investment income of a taxpayer earning over $200,000 ($250,000 for a joint return).  Net investment income includes 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).  “Net” investment income is investment income reduced by allowable investment expenses. Distributions from qualified retirement plans and IRAs will not be subject to the surtax.

Penalty For Not Being Insured

Beginning in 2014, taxpayers will be penalized for failing to maintain the minimum essential coverage.  The penalty will be phased in beginning in 2014 and the fully-implemented penalty in 2016 will be the greater of:

• 2.5% of household income over the threshold amount of income required for income tax filing, or
  
  
• $695 (indexed for inflation after 2016) per uninsured adult in the household ($348 if under age 18).

Maximum Penalty – The total household penalty cannot exceed 300% of the per-adult penalty ($2,085) or national annual premium for the “bronze level” health plan offered through the Insurance Exchange that year for the household size.  Penalties are based upon the months that the required insurance is not in force.

Penalty Phase-In – The maximum penalty will not be imposed until 2016.  The phase-in rates are:   
                                             
                                                             2014           2015
Per-adult annual penalty                  $95            $325
% of income penalty                           1%               2%
Family maximum                              $285           $975 

Taxpayers Exempt from the Penalty – Individuals are exempt from the penalty if either their employer’s sponsored coverage or the lowest cost “bronze” coverage exceeds 8% of household income.  Also exempt are individuals residing outside of the U.S., those exempted for religious purposes, and those whose income is below the threshold for having to file a return.

Low-Income Health Exchange Participation Credits

Beginning in 2014, tax credits will be available for low-income individuals and families with incomes up to 400% of the federal poverty level that are not available for Medicaid, employer-sponsored insurance, or other acceptable coverage.  To qualify for the credits, these individuals and families would have to obtain coverage in the newly-established insurance exchange.  Based upon the current poverty levels, the credit would phase-out at $42,420 for individuals and $88,200 for a family of four.  Additionally, a cost-sharing subsidy will be provided for low-income individuals to help pay for their coverage.

Large Employer Responsibilities

Beginning in 2014, large employers, generally those with 50 or more full-time employees in the prior calendar year, that:

• Do not offer coverage for all its full-time employees,
  
  
• Offer minimum essential coverage that is unaffordable, or
  
  
• Offer minimum essential coverage where the plan's share of the total allowed cost of benefits is less than 60%,

Would be required to pay a penalty if any of its full-time employees were certified to the employer as having purchased health insurance through a state exchange and qualified for either tax credits or a cost-sharing subsidy discussed previously.

Penalty – The excise tax penalty for any month would be $167 times the number of full-time employees in excess of 30.

Free Choice Vouchers

Beginning in 2014, employers who offer minimum essential coverage through an eligible employer-sponsored plan and pay a portion of that coverage will be required to offer an equivalent value voucher, allowing a qualified employee the option of purchasing coverage through the Insurance Exchange.  An employee qualified to make this choice is an individual with a required contribution to the employer plan that exceeds 8%, but does not exceed 9.5% of the household income and has income that does not exceed 400% of the poverty line for the family.

Excise Tax on High-Cost Employer-Sponsored Health Coverage

Beginning in tax year 2018, there will be a 40% non-deductible excise tax on insurance companies and plan administrators for any health coverage plan where the premiums exceed the following amounts:

Single Coverage:                                                                                             $10,200
Single Coverage, high-risk employment or retired age 55 and older:  $11,850
Family Coverage:                                                                                             $27,500
Family Coverage, high-risk employment or retired age 55 and older:  $30,950

The tax would 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 would be disregarded in applying the tax.  The dollar amount thresholds may be later adjusted for inflation.

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