What you need to know:
The health reform legislation recently signed into law imposes new and higher taxes, penalties and tax reporting requirements on businesses, high-income individuals and families.
What you need to do:
Businesses and individuals should understand how the tax provisions in the new health care law may affect their federal tax liability. Some of these provisions take effect in 2010. Therefore, employers should begin immediately to develop strategies for implementing the new law. Individuals should begin to plan for the tax impact, but will necessarily be affected by employer decisions that have not yet been implemented.
Now that the well publicized health reform legislation has become law, businesses and individuals have more certainty as to how the new law will impact their federal tax liabilities. As expected, the law will impose higher taxes, new penalties and reporting requirements. Health insurers, pharmaceutical companies and medical device manufacturers will have to contend with industry-specific tax increases and penalties. Below is a summary of the key tax provisions contained in the health care legislation. For a summary of the employee benefits implications for employers, please see our client notice titled Employee benefit plan implications of health care reform.
Tax provisions affecting individuals
High income individuals and families (and in some cases, any individual or family) may also be subject to a number of tax increases and penalties under the new health care law.
Penalty for failure to maintain coverage: By 2016, any uninsured adult will have to pay a penalty equal to 2.5% of household income over a threshold (the minimum amount of income that triggers a federal income tax return filing) but not less than $695. Individuals under age 18 will be subject to a penalty equal to half of the adult penalty. Total household penalties are capped at 300% of the per adult penalty. The law exempts certain persons from these penalties, including those who cannot afford coverage because the cost exceeds 8% of household income. The penalties will be phased-in beginning in 2014.
Increased FICA tax for high-income employees: Beginning in 2013, the employee’s share of the hospital insurance component of the FICA payroll tax will increase from 1.45% to 2.35% for individuals earning over $200,000 and joint filers earning over $250,000. The employer portion of the hospital insurance tax remains 1.45% for a combined rate of 3.8%.
Surtax on investment income: Beginning in 2013, a 3.8% surtax will be imposed on net investment income including “carried interests” earned by high-income taxpayers. The 3.8% tax is imposed on the lesser of either the individual’s net investment income or the excess of the taxpayer’s “modified adjusted gross income” over a set threshold amount. The threshold amount is $200,000 for an individual taxpayer and $250,000 for joint filers. Thus, this new tax will apply only to income in excess of the threshold amounts. For example, an individual with $150,000 of wages and $100,000 of capital gain income will pay 3.8% tax only on $50,000. Beginning in 2011, the tax on capital gain will rise from 15% to 20% as the Bush tax cuts sunset. Once the 3.8% surtax becomes effective in 2013, the tax on capital gain will be as high as 23.8%. Similarly, beginning in 2011, the tax on dividends will rise from 15% to 39.6%. Once the 3.8% surtax becomes effective, the combined rate will reach 43.4%.
Penalty tax on non-qualifying distributions from health savings accounts increased to 20%: In general, distributions from health savings accounts that are used for qualified medical expenses are not taxable to the recipient. However, if such distributions are not used for qualified medical expenses, such distributions are not only subject to ordinary income tax rates, but the recipient is also currently subject to a 10% penalty on the disbursed amount. Employees participating in an Archer medical savings account face similar tax consequences for taking distributions that are not used for medical expenses, though the penalty is currently 15%.
Beginning in 2011, any disbursements from a health savings account (or an Archer medical savings account) that are not used for qualified medical expenses will be subject to a 20% penalty, in addition to ordinary income tax, on the distributed amount.
Increased threshold for claiming medical expense deductions: Previously, a taxpayer could deduct medical expenses only to the extent that they exceeded 7.5% of the taxpayer’s adjusted gross income. For most taxpayers (other than persons aged 65 or older), medical expenses will have to exceed 10% of adjusted gross income in order for the taxpayer to claim such expenses as an itemized deduction.
Tax provisions affecting businesses
The tax provisions contained in the law that affect businesses fall into three general categories: tax provisions arising from universal health coverage; tax provisions that are otherwise health care related; and other tax provisions.
Penalties on employers relating to universal health coverage: Beginning in 2014, employers with an average of 50 or more employees during a calendar year may face penalties for not offering health coverage to all full-time employees or for offering coverage deemed unaffordable. Please see our client notice titled Employee benefit plan implications of health care reform for additional details regarding these employer penalties.
“Cadillac” health plans: Beginning in 2018, the new law imposes a new 40% nondeductible excise tax on insurance companies and plan administrators for any health coverage (excluding dental and vision) to the extent that the yearly premium on such coverage exceeds $10,200 for a single person and $27,500 for a family, with such thresholds subject to yearly adjustment for inflation. Slightly higher thresholds apply for retirees and certain employees (such as those engaged in high-risk professions). The excise tax applies to both self-insured and insured group health plans.
Employer reporting responsibilities relating to coverage benefits: Beginning in 2012 with respect to the 2011 calendar year, employers must begin disclosing on each employee’s yearly Form W-2 the “aggregate cost” of the health insurance coverage benefit provided to such employee. In addition, beginning in 2014, insurers (as well as employers who self-insure) that provide coverage to any person during the calendar year must report information about the coverage to both the covered person and the IRS.
Elimination of deduction for expenses allocable to Medicare Part D subsidy: Employers that maintain drug plans for their retirees who are eligible for Medicare Part D subsidies will no longer be able to deduct expenses that are allocable to Part D subsidies. The deduction will be eliminated for tax years beginning in 2013.
Small employer tax credit: For tax years beginning in 2010, certain “qualified small employers” may receive a tax credit for nonelective contributions to purchase health insurance coverage for their employees. A qualified small employer is one that has 25 or fewer full-time equivalent employees for the tax year, the average annual wages of which do not exceed $50,000 for each year between 2010 and 2013 (subject to inflation adjustment for years beginning in 2014). In addition, the employer has to contribute at least 50% of the premiums toward coverage for the employee under a qualified health plan.
The amount of the credit is 50% of the lesser of the amount of actual contributions made by the small employer on behalf of employees for the coverage under the qualified health plan, and an aggregate “benchmark” premium, as computed by the Department of Health and Human Services, that the employer would pay for all of its employees if they were enrolled in a hypothetical group health plan.
Industry-specific tax provisions: Businesses in certain industries are subject to special taxes and fees.
- Pharmaceutical industry fee. Beginning in 2011, an annual fee will be imposed on companies engaged in the business of manufacturing or importing branded pharmaceuticals with the total fee allocated among such businesses according to market share. The aggregate fee for 2011 is $2.3 billion, and will increase annually until 2018 when it reaches a high of $4.1 billion, before falling back to $2.8 billion for 2019 and thereafter.
- Health insurance industry fee and compensation deduction cap. A similar industry-wide annual fee will be imposed on health insurance providers. Beginning in 2014, the annual fee for health insurance providers will be $8 billion, rising to $14.3 billion in 2018. As is the case with the fee imposed on pharmaceutical manufacturers and importers, the fee is allocated based on market share (computed by reference to net premiums written in the US in 2013 and thereafter). For 2019 and beyond, the industry-wide fee increases according to the rate of “premium growth” in the industry.
In addition, for tax years beginning in 2013, a health insurance provider may also be subject to a $500,000 per tax year compensation deduction limit for each of its employees (officers, directors or employees) if 25% or more of the provider’s gross premium income is generated from “minimum essential coverage” health plans. Although the provision does not take effect until 2013, it can apply to compensation for services performed after January 1, 2010.
- Medical device manufacturer sales tax. Finally, beginning in 2013, makers and importers of medical devices will be subject to a 2.3% sales tax on the sale of any “taxable medical device.” In general, a “taxable medical device” is any device intended for humans that is used to diagnose or treat disease, among other things. Taxable medical devices do not include items of a type that are generally available for purchase by individuals at retail, such as eyeglasses, hearing aids, contact lenses, etc.
Other tax provisions affecting businesses: The health care law attempts to standardize the application of the long-standing judicial principle known as “the economic substance doctrine.” Under this doctrine, a court could disallow tax benefits on the grounds that the transaction giving rise to the tax benefits lacks economic substance. The health care law clarifies for the courts how the economic substance doctrine should be applied and increases penalties for underpayments of tax attributable to, and inadequate disclosure of, transactions lacking economic substance. This provision applies to transactions entered into on or after March 30, 2010.
The new law expands information reporting requirements to include payments of more than $600 during the year by businesses to corporate providers of property and services. Such payments will have to be reported on a Form 1099 beginning in 2012. Previously, payments made by businesses to a corporation for property or services were not required to be reported on a Form 1099.
Effect of health care reform on state taxes
One issue generating significant controversy is that the health care legislation imposes an “unfunded mandate” on the states to expand Medicaid. With many states already experiencing significant financial struggles, there is the possibility that taxes at the state level will have to increase in order to fund such programs. It is unclear at this time exactly how, or even if, state taxes will be increased. As of the time of this writing, a lawsuit filed by 13 states challenging this mandate is pending.
The discussion above is merely a summary of the key tax provisions in the health reform legislation. Many of the provisions are complex and contain numerous qualifications.