Understanding the Affordable Care Act

In its landmark 5 to 4 decision handed down on June 28, 2012, the U.S. Supreme Court cleared the path for President Obama’s signature health care law, the Patient Protection and Affordable Care Act (PPACA) and the Health Care and Education Reconciliation Act (HCERA), to move forward on schedule.  This decision brings a sense of urgency to employers, individuals and other stakeholders that time is now growing short both to prepare for those major changes soon to take place in 2013 and 2014 and also to implement provisions or benefits that are already effective and available.  The PPACA and HCERA add to or amend numerous sections of the Internal Revenue Code, resulting in the largest set of tax law changes in more than 20 years.  The IRS has been working on many fronts to issue guidance on these provisions, to flesh out certain benefits and requirements, and to set up procedures necessary for compliance.  Below highlights several of the major individual and business tax provisions of PPACA and HCERA:

Individual Mandate:

  • The PPACA requires applicable individuals to carry minimum essential health coverage for themselves and their dependents or otherwise pay a shared responsibility penalty for each month of noncompliance.  The individual mandate provision is scheduled to be effective beginning in calendar year 2014.  Also beginning in 2014, eligible lower-income individuals who obtain coverage under a qualified health plan through an insurance exchange may qualify for a premium assistance tax credit.

Medical Deduction Threshold:

  • The PPACA increases the threshold to claim an itemized deduction for unreimbursed medical expenses from 7.5 percent of adjusted gross income (AGI) to 10 percent of AGI for tax years beginning after December 31, 2012.  However, individuals (or their spouses) age 65 and older before the close of the tax year are exempt from the increased threshold, and the 7.5 percent threshold continues to apply until after 2016.  The PPACA did not change the alternative minimum tax (AMT) treatment of the itemized deduction for medical expenses.

Additional Tax on HSA/MSA Distributions:

  • Distributions from health savings account (HSA) or Archer medical savings account (Archer MSA) not used for the beneficiary’s qualified medical expenses are generally included in the beneficiary’s gross income and subject to an additional tax.  Effective for distributions made after December 31, 2010, the additional tax on HSAs and Archer MSAs increases from 10 percent to 20 percent, in the case of HSAs, and from 15 percent to 20 percent, in the case of Archer MSAs, of the amount included in gross income.

Additional Medicare Tax:

  • For tax years beginning after December 31, 2012, an additional 0.9 percent Medicare tax is imposed on wages and self-employment income of higher-income individuals.  The additional Medicare tax applies to individuals with remuneration in excess of $200,000; married couples filing a joint return with incomes in excess of $250,000; and married couples filing separate returns with incomes in excess of $125,000.

Medicare Tax on Investment Income:

  • The PPACA imposes a 3.8 percent Medicare contribution tax on unearned income effective for tax years beginning after December 31, 2012.  The tax is imposed on the lesser of an individual’s net investment income for the tax year or modified AGI in excess of $200,000 ($250,000 for married couples filing a joint return and $125,000 for married couples filing a separate return).  Investment income includes income from interest, dividends, annuities, royalties, certain rents, and certain other passive business income as well as the amount of capital gain on a home sale that exceeds the amount that can be excluded from taxation.
  • A home sale may result in a capital gain that increases net investment income.  Under current tax law, single individuals may exclude up to $250,000 in capital gain, and married couples may exclude up to $500,000 in capital gain.  A gain in excess of these excludable amounts could increase a taxpayers modified AGI above the general threshold for the 3.8 percent tax.
  • This 3.8 percent tax would be on top of any increase in the dividends/capital gains/ordinary income tax rates that were established by the Bush-era and are set to expire at the end of 2012.  Considering the possibility of the expiration of the Bush tax rates and the addition of this Medicare tax on investment income, we strongly encourage a thorough review of your asset allocation and investment strategy with your financial advisor to address these tax impacts on your portfolio.

Health FSAs Offered in Cafeteria Plans:

  • Effective for tax years beginning after December 31, 2012, the PPACA limits contributions to health flexible spending arrangements (health FSAs) to $2,500, down from an overall $5,000 FSA limit.  The $2,500 limitation is adjusted annually for inflation for tax years beginning after December 31, 2013.

Form W-2 Reporting:

  • The PPACA generally requires employers to disclose the aggregate cost of applicable employer-sponsored coverage on an employee’s Form W-2 for tax years beginning on or after January 1, 2011.  Reporting is for informational purposes only.   Certain types of coverage, such as major medical, must be reported while other types of coverage are optional.  The IRS has provided some transitional relief for small employers in this area.

2.3 Percent Excise Tax on Medical Device Manufacturers beginning after December 31, 2012

40 Percent Excise Tax on High-Cost Health Coverage starting after December 31, 2017

As mentioned above, these are only a few of the major tax provisions embedded in the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act.  We will continue to keep you updated as further legislative developments occur or as the IRS issues additional guidance on these provisions.

In preparation of these pending tax law changes and the possible expiration of the Bush-era tax rates, we would encourage you to keep the below planning opportunities in mind:

  • Recognizing capital gains from the sale of stock, a primary or secondary home or from the sale of a business this year before the 3.8 percent tax is scheduled to take effect.
  • Consider accelerating income from stock options or bonuses this year to avoid the additional 0.9 percent tax on wages exceeding thresholds scheduled for 2013.
  • Consider purchasing municipal bonds as income from these investments are exempt from the 3.8 percent tax.
  • Review your current asset allocation, investment strategy and portfolio income needs considering the 3.8 percent tax and possible expiration of Bush-era tax rates.
  • Seek ways to manage your adjusted gross income below the $200,000 or $250,000 thresholds by staggering the income you receive over several years if possible.
  • Review your current estate and implement planning strategies to shift current and future income and appreciation to others.

For a complete analysis or to discuss how this recent legislation may impact your business or individual tax situation please contact us directly.

The KatzAbosch Tax Department

Sources:  CCH Tax Briefing and the Journal of Accountancy

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