Tax & Estate Preservation Legal Update

Health Reform Act and Reconciliation Act

On March 23, President Obama signed into law the Patient Protection and Affordable Care Act (the “Health Reform Act”), and a week later signed the Health Care and Education Reconciliation Act of 2010 (the “Reconciliation Act”), which amends certain provisions of the Health Reform Act.  We have summarized important tax provisions in the combined Acts for both individuals and businesses.

Changes Affecting Individuals

Individual Mandate.  The Health Reform Act requires U.S. citizens and legal residents to have qualifying health coverage or be subject to an excise tax starting in 2014.  Those without qualifying health coverage will pay an excise tax of the greater of: (a) for 2014, $95 or 1.0% of taxable income; (b) for 2015, $325 or 2.0% of taxable income; and (c) in 2016, $695 or 2.5% of taxable income.  After 2016, the excise tax will be increased annually by a cost-of-living adjustment.  Certain exemptions will be allowed, including financial hardship, religious objections, American Indians, those without coverage for less than 3 months, aliens not lawfully present in the U.S., incarcerated individuals, those with incomes below the tax filing threshold, and those residing outside the U.S.

Tax Credits.  Low and middle income individuals and families will be eligible to claim a tax credit for the cost of purchasing health insurance.  For tax years beginning in 2014, the credit will be available for eligible individuals and families who purchase health insurance through a newly established insurance exchange.  The tax credit is available on a sliding scale basis, meaning that individuals and families at the federal poverty level will receive 100% of the credit, and individuals and families earning income up to 400% of the federal poverty level can claim a smaller percentage of the credit.  If the income is above 400% of the federal poverty level, the individual or family cannot receive the tax credit.  In addition to an income limitation, an individual or family cannot be eligible for Medicaid, participate in employer-sponsored insurance, or be covered under any other acceptable policy.

Increased Medicare Payroll Taxes.  Individuals earning over $200,000 and married couples earning more than $250,000 (high-income taxpayers) will be taxed at a higher rate on the Medicare portion of their payroll taxes.  Currently, the Medicare tax is 2.9% of an employee’s wages, and the employee and the employer each pay 1.45% of the tax.  Beginning in 2013, high-income taxpayers must pay an additional 0.9% tax on the wages exceeding $200,000 or $250,000, respectively.  The employee must pay the additional Medicare tax, but the employer has the burden of collecting the tax.  For individuals, collection of the additional tax is straightforward for the employer, but accounting for the additional Medicare tax for a married couple could be more burdensome, especially when neither spouse makes above the individual threshold but have a combined income over $250,000.  Another important note is that the high-income amounts are not indexed for inflation.

Medicare Tax on Investments.  The Medicare tax currently applies only to wages, but the Health Reform Act extends the Medicare tax so that it will apply to investment income beginning in 2013.  For high-income taxpayers (described above), a new 3.8% tax will be imposed on net investment income, which includes interest, dividends, royalties, rents, passive activity income, and net gain from disposition of non-business property.  Taxpayers will be able to take deductions that are allocable to their net investment income.  Also, the new Medicare tax will not apply to income from qualified retirement plans (e.g., IRAs, 401(k)s, etc.).  As with the increased Medicare payroll tax, the high-income amounts are not indexed for inflation.

Medical Expenses Deduction.  Beginning in 2013, the adjusted gross income (AGI) threshold for claiming the itemized deduction for medical expenses will be raised from 7.5% to 10%.  However, the AGI threshold for individuals age 65 and older (and their spouses) will remain unchanged at 7.5% through 2016.

Over-the-Counter Drugs Purchased with an HRA, FSA, HSA, or MSA.  Beginning in 2011, the costs of over-the-counter medicine (other than insulin or doctor-prescribed medicine) cannot be reimbursed through an employer-sponsored flexible savings account (FSA) or health reimbursement account (HRA).  Additionally, these same limitations will apply to an employer-sponsored health savings account (HSA) or Archer medical savings account (MSA) so that disbursements or withdrawals for these medicines will not be on a tax-free basis.

Increased Penalties on Nonqualifying HSA or MSA Distributions.  Beginning in 2011, the penalty for distributions or withdrawals from HSAs before age 65 for purposes other than qualified medical expenses will be increased from 10% to 20%.  Similarly, the penalty for distributions or withdraws from MSAs before age 65 for purposes other than qualified medical expenses will be increased from 15% to 20% beginning in 2011.

FSA Limitation.  Currently, there is no limit on the amount of contributions to an employer-sponsored FSA.  However, beginning in 2013, allowable contributions to qualified FSAs will be capped at $2,500 per year.  This limitation will be indexed for inflation.

Dependent Coverage in Employer Health Plans.  The Health Reform Act extends the general exclusion for reimbursements for medical care expenses under an employer-provided accident or health plan to any child of an employee who is under age 27.  This change is effective as of the enactment date of the Act, which was March 23, 2010.  This change also applies to self-employed individuals who are allowed to deduct the costs of health insurance for a dependent child who has not attained age 27 by the end of the tax year.

Excise Tax on Indoor Tanning Services.  Starting July 1, 2010, individuals using indoor tanning services must pay a 10% excise tax on the value of the services.  The tax will be collected and remitted by the operator of the indoor tanning facility.

Adoption Credit.  Starting in 2010, the adoption tax credit is increased by $1,000, made refundable, and extended through 2011.  The adoption assistance exclusion is also increased by $1,000.

Changes Affecting Businesses

Employer Mandate.  The Health Reform Act requires “applicable large employers” to offer and contribute to their employees’ health insurance beginning in 2014.  An applicable large employer is any employer who employed an average of at least 50 full-time employees during the preceding calendar year.  In counting the number of employees, a full-time employee (averaging at least 30 hours per week) is counted as one employee and all other employees are counted on a pro-rated basis.  However, an applicable large employer is not subject to a penalty if none of its employees qualify for a subsidy when purchasing a health plan in the exchange (i.e., the employer does not have any low-income employees).  The applicable monthly penalty for not providing health coverage equals the number of full-time employees over a 30-employee threshold during the applicable month multiplied by $166.66.  An additional penalty applies if a full-time employee receives a premium tax credit or cost-sharing reduction for actually purchasing coverage on an exchange.  This monthly penalty is $250.00 per full-time employee receiving a credit or cost-sharing reduction.

Tax Credit for Small Employers that Provide Insurance.  If an employer is not an applicable large employer but provides for nonelective contributions to purchase health insurance for its employees, it may be eligible for a tax credit to offset its regular tax or its alternative minimum tax.  To qualify, a business must offer health insurance to its employees as part of their compensation and contribute at least half of the total premium cost. The employer must have no more than 25 full-time equivalent employees, and the employees cannot have annual full-time equivalent wages that average more than $50,000.  The credit is available from 2010-2013 for health insurance coverage purchased from an insurance company licensed under state law.  However, beginning in 2014, the credit is only available for health insurance purchased through a state exchange and is only available to each employer for 2 years.  The tax credit is generally 35% (50% for tax years beginning in 2014) of the employer’s contributions toward the employees’ health insurance premiums, but the credit is phased out as employer size and average wages increase above 10 full-time equivalent employees and $25,000.  Note that the wage limits are indexed for inflation after 2014.

The “Cadillac Tax” on High-Cost Health Plans.  Beginning in 2018, a 40% nondeductible excise tax will apply to high-cost employer-sponsored health coverage plans (a.k.a. “Cadillac” health plans).  The insurance companies will be responsible for the tax, rather than the employers, unless the policies are self-funded.  The tax will be levied on any health coverage plan to the extent that the annual premium exceeds $10,200 for single coverage and $27,500 for family coverage.  An additional threshold amount of $1,650 for single coverage and $3,450 for family coverage will apply for retired individuals age 55 and older and for plans that cover employees engaged in high risk professions.  The tax will only be imposed on self-insured plans and plans sold in the group market.  Stand-alone dental and vision plans will be disregarded.

Free Choice Vouchers.  Beginning in 2014, employers offering minimum essential coverage through an eligible employer-sponsored plan and paying a portion of that coverage will have to provide qualified employees with a voucher to purchase a health plan through the insurance exchange.  Qualified employees include those: (1) who do not participate in the employer’s health plan; (2) whose required contribution for employer-sponsored minimum essential coverage exceeds 8% but does not exceed 9.5% of household income; and (3) whose total household income does not exceed 400% of the poverty line for the family.  The value of the voucher will equal the dollar value of the employer contribution to the employer offered health plan.  Employers providing free choice vouchers will not be subject to penalties for employees that receive a voucher.

Elimination of Deduction for Employer Part D.  The deduction for the subsidy for employers who maintain prescription drug plans for their Medicare Part D eligible retirees will be eliminated beginning in 2013.

Reporting Responsibilities.  Beginning in 2011, employers must disclose the value of the benefit provided for each employee’s health insurance coverage on the employee’s annual Form W-2.  In 2012, businesses that pay more than $600 during the year to corporations providing property and services will have to file an information report (presumably a Form 1099) with each corporation and with the IRS.

Increased Estimated Tax Payments.  The required corporate estimated tax payments factor for corporations with assets of at least $1 billion will be increased by 15.75 percentage points for payments due in July, August, and September of 2014.

Simple Cafeteria Plans.  Beginning in 2011, a new employee benefit cafeteria plan, called a Simple Cafeteria Plan, will be allowed for eligible small businesses.  This plan will be subject to eased participation restrictions so that the small business can provide tax-free benefits to their employees.

If you have any questions about the tax provisions in the new Health Reform Act or the Reconciliation Act, please do not hesitate contact one of our Taxation and Estate Preservation attorneys.

Hiring Incentives to Restore Employment Act

On March 18, 2010, President Obama signed into law the Hiring Incentives to Restore Employment ("HIRE") Act. This update explains several of the important tax provisions of the HIRE Act.

Payroll Tax Holiday for Hiring Unemployed Workers

During 2010, the HIRE Act provides private employers with temporary Social Security payroll tax forgiveness for newly hired workers that meet the following requirements.  A qualifying employee must:

• Have begun work after February 3, 2010, and before January 1, 2011
• Have worked 40-hours or less during the 60-day period immediately prior to beginning employment and certified such requirement by a signed affidavit
• Not be employed to replace another employee unless the other employee separated from service voluntarily or for cause
• Not be a related party to the employer.

For workers meeting these requirements, the HIRE Act waives the employer’s 6.2% share of Social Security payroll taxes for such employees.  The relief applies to wages earned after March 18, 2010, and on or before December 31, 2010.  For wages that qualify, the tax relief for the first quarter of 2010 is received through a credit toward the general second quarter 2010 Social Security tax liability.  After the first quarter, the employer does not pay the 6.2% tax as wages are paid.

The maximum savings per employee is $6,621.60, as the Social Security wage base is capped at $106,800 per employee. This “payroll tax holiday” does not apply to the 1.45% Medicare portion of the payroll tax.

Unless the qualified employer elects out of the payroll tax holiday, wages paid to a qualified individual won't be eligible for the Work Opportunity Tax Credit during the one-year period beginning on the date that the qualified employer hired the individual. The Committee Report to the HIRE Act indicates that the election can be made on an employee-by-employee basis.

New Credit for Each Retained Worker

The HIRE Act also provides an up-to-$1,000 credit for “retained workers.” A retained worker is any qualified individual who, as defined for purposes of the payroll tax holiday:  (1) was employed by the employer on any date during the tax year, (2) was employed for a period of not less than 52 consecutive weeks, and (3) was paid wages for that employment during the last 26 weeks of the 52-week period equaling at least 80% of the wages for the first 26 weeks of that period.

The credit is calculated during the current year by increasing the general business credit for each retained worker by the lesser of (1) $1,000 or (2) 6.2% of the wages paid by the employer to the retained worker during the 52-consecutive week period. If the increase in the general business credit results in a net operating loss during a tax year, the loss attributable to this credit cannot be carried back to a tax year beginning before the enactment date of the HIRE Act.

Expensing Limits Increased For 2010

Essentially, the 2008 and 2009 Section 179 expensing provisions are extended through the 2010 year.  For the 2010 tax year only, the HIRE Act increases the amount a taxpayer can expense under Internal Revenue Code Section 179. The maximum amount a taxpayer can expense for a tax year beginning in 2010 is $250,000 of the cost of qualifying property placed in service for that tax year. The $250,000 amount is reduced (but not below zero) by the amount equaling the excess of the cost of qualifying property placed in service during 2010 over $800,000.

Foreign Compliance

The HIRE Act added several new reporting and withholding obligations with respect to foreign investments and interests in foreign entities and trusts.  Please do not hesitate to contact a member of our Taxation and Estate Preservation Section for a more detailed explanation of the new provisions.