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Supreme Court Upholds PPACA; Refresher on Healthcare Law's Tax Provisions
(Parker's Federal Tax Bulletin: June 06, 2012)
SUMMARY: The Supreme Court ruled that the Patient Protection and Affordable Care Act is constitutional because the individual mandate penalty functions more like a tax than a penalty; Parker gives a refresher on the law's tax provisions
Last week, in a 5-4 decision, the Supreme Court upheld the Patient Protection and Affordable Care Act (PPACA) passed in 2010. In National Federation of Independent Business et al. v. Sebelius, Secretary of Health and Human Services, et al, 2012 PTC 167 (S. Ct. 6/28/12), the Court concluded that the penalty imposed by PPACA on individuals who do not buy health insurance (i.e., the individual mandate) functions more like a tax than a penalty. Thus, because Congress has the authority to tax, the Court held the law was constitutional.
According to Chief Justice Roberts, the most straightforward reading of the individual mandate is that it commands individuals to buy insurance. The Court rejected the government's main argument that the Commerce Clause gave Congress the power to force individuals to buy health insurance. The individual mandate, the Court noted, does not regulate existing commercial activity. It instead compels individuals to become active in commerce by purchasing a product on the ground that their failure to do so affects interstate commerce. Construing the Commerce Clause to permit Congress to regulate individuals precisely because they are doing nothing, the Court stated, would open a new and potentially vast domain to congressional authority. According to the Court, allowing Congress to justify federal regulation by pointing to the effect of inaction on commerce would bring countless decisions an individual could potentially make within the scope of federal regulation and empower Congress to make those decisions for him. Thus, the Court concluded that the Commerce Clause does not give Congress the power to command individuals to buy insurance.
With respect to the government's alternative argument that the mandate could be upheld as within Congress's power to tax the Court said that the penalty imposed by PPACA on those without health insurance looks like a tax in many respects. First, it is paid into the Treasury by taxpayers when they file their tax returns. Second, for taxpayers who do owe the payment, its amount is determined by such factors as taxable income, number of dependents, and joint filing status. Third, the requirement to pay is found in the Internal Revenue Code and enforced by the IRS, which must assess and collect it in the same manner as taxes. This process, the Court stated, yields the essential feature of any tax: It produces at least some revenue for the government. Indeed, the Court noted, the payment is projected to raise about $4 billion per year by 2017. The Court stated that, while PPACA describes the payment as a penalty, not a tax, such labels are not controlling. In the end, the Court found that the penalty functions as a tax, and thus it is within Congress's power to assess such a tax.
Refresher on PPACA's Key Tax Provisions
In the wake of the Supreme Court's decision and expected media attention to the healthcare law throughout the election season, practitioners should be ready for increased inquiries from clients on the law's tax provisions. The following recap provides answers to the most frequently asked PPACA tax questions.
PRACTICE AIDS: For client letters explaining healthcare-related taxes and credits, go to the "Affordable Care Act" folder in the "Sample Client Letters" database.
With respect to individuals, the more significant provisions are:
(1) a penalty, assessed on tax returns, for not maintaining essential heathcare coverage;
(2) a premium assistance tax credit;
(3) additional hospital insurance tax for high income individuals;
(4) unearned income Medicare contribution tax;
(5) an increase in the threshold over which medical expenses are deductible; and
(6) a limitation on health FSAs.
With respect to employers, some of the more significant provisions are:
(1) a penalty on large employers not offering adequate health coverage;
(2) a small business tax credit; and
(3) an excise tax on high-cost employer-sponsored health coverage.
Individual Mandate (Penalty for Not Maintaining Minimum Essential Coverage)
The crux of PPACA is the requirement for almost all individuals to maintain minimum essential healthcare coverage (i.e., the individual mandate). Beginning in January 2014, nonexempt U.S. citizens and legal residents must maintain such coverage or be subject to a penalty. Minimum essential coverage includes coverage under government-sponsored programs, eligible employer-sponsored plans, plans in the individual market, grandfathered group health plans, and other coverage as recognized by the Secretary of Health and Human Services (HHS) in coordination with the Secretary of the Treasury.
Government-sponsored programs include Medicare, Medicaid, Children's Health Insurance Program, coverage for members of the U.S. military, veterans health care, and health care for Peace Corps volunteers. Eligible employer-sponsored plans include: governmental plans, church plans, grandfathered plans, and other group health plans offered in the small or large group market within a state. Minimum essential coverage does not include coverage that consists of certain HIPAA-excepted benefits (e.g., coverage only for accident, or disability income insurance; coverage issued as a supplement to liability insurance; workers' compensation or similar insurance, etc.). Other HIPAA-excepted benefits that do not constitute minimum essential coverage if offered under a separate policy, certificate, or contract of insurance include long-term care, limited scope dental and vision benefits, coverage for a disease or specified illness, hospital indemnity or other fixed indemnity insurance, or Medicare supplemental health insurance.
Once the penalty is fully phased in, individuals who fail to maintain minimum essential coverage are subject to a penalty equal to the greater of:
(1) 2.5 percent of household income in excess of the taxpayer's household income for the tax year over the threshold amount of income required for income tax return filing for that taxpayer under Code Sec. 6012(a)(1); or
(2) $695 per uninsured adult in the household.
The per-adult annual penalty is phased in as follows: $95 for 2014; $325 for 2015; and $695 for 2016. For years after 2016, the $695 amount is indexed to CPI-U, rounded to the next lowest $50. The percentage of income is phased in as follows: 1 percent for 2014; 2 percent in 2015; and 2.5 percent beginning after 2015. If a taxpayer files a joint return, the individual and spouse are jointly liable for any penalty payment.
The fee for an uninsured individual under age 18 is one-half of the adult fee for an adult. The total household penalty may not exceed 300 percent of the adult penalty ($2,085).
The penalty applies to any period the individual does not maintain minimum essential coverage and is determined monthly. The penalty is assessed through the Code and accounted for as an additional amount of federal tax owed. However, it is not subject to the enforcement provisions of the Code.
Individuals are exempt from the requirement to maintain minimum essential coverage for months they:
(1) are incarcerated;
(2) are not legally present in the United States; or
(3) maintain religious exemptions.
Those who are exempt from the requirement due to religious reasons must be members of a recognized religious sect exempting them from self employment taxes and adhere to tenets of the sect. Individuals living outside of the United States are deemed to maintain minimum essential coverage. If an individual is a dependent of another taxpayer, the other taxpayer is liable for any penalty payment with respect to the individual.
Premium Assistance Tax Credit
PPACA enacted Code Sec. 36B. This provision, which is effective for tax years ending after December 31, 2013, creates a refundable tax credit, called the premium assistance credit, for eligible individuals and families who buy health insurance through an insurance exchange. The premium assistance credit, which is refundable and payable in advance directly to the insurer, subsidizes the purchase of certain health insurance plans through an exchange. The premium assistance credit is generally available for individuals (single or joint filers) with household incomes between 100 and 400 percent of the federal poverty level (FPL) for the family size involved.
Additional Hospital Insurance Tax
Beginning in 2013, the employee portion of the hospital insurance (HI) portion of FICA taxes is increased by an additional tax of 0.9 percent on wages received in excess of the threshold amount. However, unlike the general 1.45 percent HI tax on wages, this additional tax is on the combined wages of the employee and the employee's spouse, in the case of a joint return. The threshold amount is $250,000 in the case of a joint return or surviving spouse, $125,000 in the case of a married individual filing a separate return, and $200,000 in any other case.
As under present law, the employer is required to withhold the additional HI tax on wages. However, in determining the employer's requirement to withhold and liability for the tax, only wages the employee receives from the employer in excess of $200,000 for a year are taken into account, and the employer must disregard the amount of wages received by the employee's spouse. Thus, the employer is only required to withhold on wages in excess of $200,000 for the year, even though the tax may apply to a portion of the employee's wages at or below $200,000, if the employee's spouse also has wages for the year, they are filing a joint return, and their total combined wages for the year exceed $250,000.
For example, if a taxpayer's spouse has wages in excess of $250,000 and the taxpayer has wages of $100,000, the employer of the taxpayer is not required to withhold any portion of the additional tax, even though the combined wages of the taxpayer and the taxpayer's spouse are over the $250,000 threshold. In this instance, the employer of the taxpayer's spouse is obligated to withhold the additional 0.9-percent HI tax with respect to the $50,000 above the threshold with respect to the wages of $250,000 for the taxpayer's spouse.
Expanded Medicare Contribution Tax (3.8% Tax on Unearned Income)
For tax years beginning after 2012, in the case of an individual, estate, or trust, an additional tax is imposed on income over a certain level. The Joint Committee on Taxation's Technical Explanation of PPACA refers to this tax as the unearned income Medicare contribution tax. Others have referred to it as a tax on investment income, although it can apply to individuals, estates, and trusts that do not have investment income.
In the case of an individual, this tax is 3.8 percent of the lesser of:
(1) net investment income; or
(2) the excess of modified adjusted gross income over the threshold amount.
The threshold amount is $250,000 in the case of taxpayers filing a joint return or a surviving spouse, $125,000 in the case of a married individual filing a separate return, and $200,000 in any other case. Modified adjusted gross income is adjusted gross income increased by the amount excluded from income as foreign earned income under Code Sec. 911(a)(1) (net of the deductions and exclusions disallowed with respect to the foreign earned income).
For purposes of the unearned income Medicare contribution tax, net investment income is investment income reduced by the deductions properly allocable to such income. Investment income is the sum of:
(1) gross income from interest, dividends, annuities, royalties, and rents (other than income derived in the ordinary course of any trade or business to which the tax does not apply);
(2) other gross income derived from any trade or business to which the tax applies; and
(3) net gain (to the extent taken into account in computing taxable income) attributable to the disposition of property other than property held in a trade or business to which the tax does not apply.
Investment income does not include distributions from a qualified retirement plan or amounts subject to self-employment tax.
OBSERVATION: Investment income does not include items that are excludible from gross income under the tax rules, such as interest on tax-exempt bonds, veterans' benefits, and any gain excludible from income upon the sale of a principal residence.
In the case of a trade or business, the tax applies if the trade or business is a passive activity with respect to the taxpayer, or the trade or business consists of trading financial instruments or commodities. The tax does not apply to other trades or businesses. Income, gain, or loss on working capital is not treated as derived from a trade or business.
In the case of an estate or trust, the tax is 3.8 percent of the lesser of:
(1) undistributed net investment income or
(2) the excess of adjusted gross income over the dollar amount at which the highest income tax bracket applicable to an estate or trust begins.
OBSERVATION: There is no provision for the indexing of the threshold amounts that apply to individuals. However, there is a provision for indexing the tax calculation for estates and trusts, since their tax brackets are indexed annually for inflation. However, the highest tax bracket that applies to estates and trusts is so low that the indexing provision won't provide much benefit.
The tax is subject to the individual estimated tax provisions and is not deductible in computing any income tax. Thus, for example, there is no deduction allowed for this tax under Code Sec. 164(f) (relating to the deduction for one-half of self-employment taxes).
Increase in Medical Expense Deduction Threshold
A taxpayer can deduct on Schedule A (Form 1040), Itemized Deductions, only the amount of the taxpayer's medical and dental expenses that is more than 7.5 percent of the taxpayer's adjusted gross income (AGI) for the year. Thus, in effect, a taxpayer must subtract 7.5 percent of the taxpayer's AGI from his or her medical expenses to figure the medical expense deduction.
Under PPACA, for 2013 and later years, the deduction floor is increased to 10 percent. However, for any tax year ending before January 1, 2017, the floor will be 7.5 percent if the taxpayer or the taxpayer's spouse has attained age 65 before the end of that year.
FSA Limitation
Under PPACA, for a health flexible spending arrangement (FSA) to be a qualified benefit under a cafeteria plan, the maximum amount available for reimbursement of incurred medical expenses of an employee, the employee's dependents, and any other eligible beneficiaries with respect to the employee, under the health FSA for a plan year (or other 12-month coverage period) must not exceed $2,500. This provision is effective for tax years beginning after 2012. The $2,500 limitation is adjusted for inflation, with any increase that is not a multiple of $50 rounded to the next lowest multiple of $50 for years beginning after December 31, 2013.
A cafeteria plan that does not include this limitation on the maximum amount available for reimbursement under any FSA is not a cafeteria plan within the meaning of Code Sec. 125. Thus, when an employee is given the option under a cafeteria plan maintained by an employer to reduce his or her current cash compensation and instead have the amount of the salary reduction be made available for use in reimbursing the employee for his or her medical expenses under a health FSA, the amount of the reduction in cash compensation pursuant to a salary-reduction election must be limited to $2,500 for a plan year.
Shared Responsibility for Employers
Under PPACA, certain employers have a responsibility to supply their workers with health care or be subject to a penalty. An applicable large employer that does not offer coverage for all its full-time employees, offers minimum essential coverage that is unaffordable, or offers minimum essential coverage that consists of a plan under which the plan's share of the total allowed cost of benefits is less than 60 percent, is required to pay a penalty if any full-time employee is certified to the employer as having purchased health insurance through a state exchange with respect to which a tax credit or cost-sharing reduction is allowed or paid to the employee.
An employer is an applicable large employer with respect to any calendar year if it employed an average of at least 50 full-time employees during the preceding calendar year. For purposes of this rule, the term employer includes any predecessor employer. An employer is not treated as employing more than 50 full-time employees if the employer's workforce exceeds 50 full-time employees for 120 days or fewer during the calendar year and the employees that cause the employer's workforce to exceed 50 full-time employees are seasonal workers. A seasonal worker is a worker who performs labor or services on a seasonal basis, including retail workers employed exclusively during the holiday season and workers whose employment is, ordinarily, the kind exclusively performed at certain seasons or periods of the year and that, from its nature, may not be continuous or carried on throughout the year.
Small Business Tax Credit
PPACA enacted Code Sec. 45R, which provides a tax credit for a qualified small employer for nonelective contributions to buy health insurance for its employees. While the credit took effect in 2011, the amount of the credit increases from 35 percent of eligible premium payments to 50 percent in 2014. A qualified small business employer for this purpose generally is an employer with no more than 25 full-time equivalent employees (FTEs) employed during the employer's tax year, and whose employees have annual full-time equivalent wages that average no more than $50,000. The credit phases out gradually (but not below zero) for eligible small employers if the number of FTEs exceeds 10 or if the average annual wages exceed $25,000. These wage limits are indexed for inflation for years beginning in 2014.
Excise Tax on High-Cost Employer-Sponsored Health Coverage
Beginning after December 31, 2017, an excise tax is imposed on certain health insurance providers for any excess benefit provided by an employer to an employee with respect to employer-sponsored health coverage. An excess benefit is the amount, if any, by which the aggregate cost of such coverage exceeds a threshold amount. The excess benefit is determined on a monthly basis and the amount of the excise tax is equal to 40 percent of the sum of the monthly excess benefits for the tax year. For 2018, the threshold amount is $10,200 for individual coverage and $27,500 for family coverage, multiplied by a health cost adjustment percentage increased by an age and gender adjusted excess premium amount.
The excise tax is imposed pro rata on the issuers of the insurance. In the case of a self-insured group health plan, a health FSA or a health reimbursement arrangement (HRA), the excise tax is paid by the entity that administers benefits under the plan or arrangement (plan administrator). Where the employer acts as plan administrator to a self-insured group health plan, a health FSA or an HRA, the excise tax is paid by the employer. Where an employer contributes to a health savings account (HSA) or an Archer MSA, the employer is responsible for payment of the excise tax, as the insurer.
Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.
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