The Supreme Court has upheld most of The Patient Protection and Affordable Care Act of 2010 (the Act). The Act includes multiple tax-related provisions; some of which are outlined below. In a 5-4 decision, the Court ruled that the individual mandate, which requires most Americans to obtain health insurance beginning in 2014 or pay a penalty, is constitutional and within Congress’s taxing authority. Consequently, the following provisions remain intact.
3.8 percent Medicare tax. The most significant provision is the additional 3.8 percent Medicare tax beginning in 2013. The tax applies to net investment income or the excess of a taxpayer’s adjusted gross income (AGI) above certain thresholds ($200,000 for individuals and $250,000 for joint filers), whichever is less. For this purpose, net investment income includes interest, dividends, royalties, rents, capital gains, and passive income from trade or business activities. As a result, the effective tax rate on passive activities will actually be higher than if an individual was active in the business but not subject to self-employment tax on the same income, because passive income will be subject to the additional 3.8 percent unearned income tax.
We recommend preparing for the potential impact of this tax and evaluate the following important planning considerations.
- Examine your passive activities to see if you can establish material or active participation in any income-generating activities. If you also have passive losses, keep in mind that shifting passive income to active income could mean that those losses become suspended.
- If your company offers nonqualified deferred compensation plans, consider what income could be recognized (for FICA purposes) in 2012 before the 3.8 percent tax goes into effect. The regulations for these plans provide some latitude as to when the value of an employee’s deferred compensation is recognized for FICA purposes.
- Since tax-exempt bonds and other similar tax-exempt investments are not subject to the new tax, compare the yields on such investments against the effective return on taxable investments after factoring in this additional tax.
Small Business Health Care Tax Credit. For tax years 2010 through 2013, there is a maximum 35 percent refundable tax credit for small business employers that offer healthcare to their employees. Beginning January 1, 2014, the credit is expected to increase to 50 percent. A qualifying employer has fewer than 25 full-time equivalent employees, with less than $50,000 in average wages. A qualifying employer must also cover at least 50 percent of the cost of a single healthcare coverage cost for each employee. Form 8941 is used to claim the credit.
2.3 percent medical device tax. Manufacturers and importers of taxable medical devices will be subject to the 2.3 percent medical device excise tax beginning in 2013. The tax is based on the sales price of the device by the manufacturer or importer and is calculated and paid on the quarterly Form 720, Quarterly Federal Excise Tax Return.
Health insurance premium tax credit. Beginning in 2014, individuals and families can receive a refundable tax credit for coverage purchased through an Affordable Insurance Exchange. These exchanges will be offered by each state and the District of Columbia and will offer a choice of health plans and coverage.
Health coverage for older children. Children can remain on their parent’s health insurance plan through the age of 26.
Limited compensation deduction for health insurance providers. Section 162(m) has been amended to limit the compensation deduction allowed to health insurance providers. Limited to $500,000, directors, officers, and employee compensation in excess of this amount is nondeductible for tax purposes. "Health care insurance provider" is also defined within the published guidance of Notice 2011-02.
Annual fee on branded prescription pharmaceutical manufacturers and importers. Effective in 2012, Form 8947, Report of Branded Prescription Drug Information, is required to be filed in order to report and pay the annual branded prescription drug fee. The IRS will send each covered entity its fee calculation by August 31 of each fee year, and it must be paid by September 30 of the fee year. Notice 2011-92 provides additional guidance.
Excise tax on indoor tanning services. Effective July 1, 2010, indoor UV tanning services are now subject to a 10 percent excise tax. Payments are calculated on and paid with Form 720, Quarterly Excise Tax Return.
Adoption credit. For 2011, the adoption credit increases to $13,360 per child and becomes refundable. The credit is based on reasonable and necessary expenses associated with legal adoptions. Form 8839, Qualified Adoption Expenses, as well as one or more adoption-related documents must be attached to the 2011 return.
Employer penalties. If an employer has fewer than 50 full-time equivalent employees (FTE), they are not subject to employer penalties related to healthcare coverage offerings but could qualify for a health insurance tax credit. Large employers that do not offer coverage to their workforce are subject to an annual penalty of $2,000 per FTE minus 30. So, the penalty for an employer with 100 FTEs would pay a $140,000 penalty if they do not offer health insurance to their employees.
Large employers that do not pay at least 60 percent of covered healthcare expenses and require employees to contribute more than 9.5 percent of family household income for coverage are subject to a $3,000 penalty per FTE minus 30. Penalty payments are indexed by the premium adjustment percentage for each calendar year.