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A Few Tips on the Affordable Care Act

By Louis F. Lobenhofer
Professor of Law

            ImageThe Affordable Care Act of 2010, popularly called Obamacare, brings substantial changes to health care for employers, individuals, and health care providers. Even summarizing all of the provisions of this legislation that can come up in a tax preparation practice is too much to expect from a newsletter article. Here are a few examples of the variety of Affordable Care Act issues that may come up as clients seek advice from their accountants in tax season 2014.

            One of the most controversial provisions is section 5000A, the penalty or “shared responsibility payment” for failing to have minimum essential health coverage.[i] While this penalty does not go into effect until 2014, tax advisors must be prepared to advise clients on this financial downside of not having medical coverage. Any individual who does not have “minimum essential coverage,” even children, may be subject to the penalty.[ii] Married individuals filing jointly are jointly liable for the penalty, and a taxpayer bears the responsibility for the penalty for her dependents, as that term is normally defined for tax purposes.[iii] There are several avenues for obtaining the necessary coverage, including employer-provided coverage, Medicare, Medicaid, or coverage obtained through an insurance exchange.[iv] The statute exempts from penalty those individuals who are uncovered for a continuous period of less than three months, but if the individual remains uncovered at the end of the three-month period, the penalty applies to all months for which the individual lacked coverage.[v] Individuals with hardships may obtain relief from the penalty by obtaining approval from the Department of HHS. To ease the transition to mandatory insurance coverage, the annual penalty for most individuals for 2014 is only $95, but it rises to $325 for 2015 before reaching its normal level, $695 in 2016.[vi] The penalty for children under 18 is only half of the amount of the penalty for an adult.[vii] Taxpayers subject to the penalty will remit it with their income tax returns.[viii]

            Congress also has expanded the Medicare tax as a part of the Affordable Care Act. The Medicare tax is a familiar component of Social Security taxes. For most employees, the employer and the employee, through withholding, both pay 6.2 percent of wages as OASDI (old age, survivors, and disability) and 1.45 percent of wages for hospital or Medicare tax.[ix] Self-employed taxpayers pay 12.4 percent OASDI and 2.9 percent for hospital tax.[x] The OASDI portion of the tax for both employees and self-employed taxpayers is capped at $113,700, but the Medicare tax continues to apply to earnings above the OASDI cap.[xi] Beginning in 2013, both employees and self-employed taxpayers owe an additional .9 percent Medicare tax for wages that exceed $200,000 for single taxpayers and heads of household, $250,000 for married couples filing jointly, and $125,000 for married couples filing separately.[xii] In figuring FICA withholding, employers must withhold the employee’s additional Medicare tax for employees whose wages exceed $200,000 but do not need to take into account the wages of the employee’s spouse.[xiii] This could leave an unpaid Medicare tax liability for some employees. For example, if Wilma earns $175,000 and her husband, Herbert, earns $125,000, the couple would owe Medicare tax on $50,000 of wages on their joint return, but neither employer would have withheld the additional Medicare tax. Nevertheless, Wilma and Herbert would still owe $450 of additional Medicare tax.[xiv]

            In addition, the 3.8 percent Medicare tax has expanded to apply to the net investment income of taxpayers with modified adjusted gross income above $200,000 for single taxpayers and heads of household, $250,000 for married taxpayers filing jointly, and $125,000 for married taxpayers filing separately.[xv] For estates and trusts, the tax applies to the “undistributed net investment income” of a trust or estate whose income has reached the threshold for the 39.6 percent tax rate, $11,950 in 2013.[xvi] The term “net investment income” covers a wide range of items, including “interest, dividends, annuities, royalties, and rents” if such income is not “derived in the ordinary course of a trade or business.[xvii] Net gains from dispositions of property not held in a trade or business, like investment securities, also constitute investment income.[xviii] Fortunately, tax-exempt income, such as interest from municipal bonds and distributions from qualified retirement plans, avoid the net investment income classification.[xix] Unfortunately, net investment income also includes trades or businesses classified as passive activities as defined by the passive loss limitation rules of section 469.[xx] Tax advisors often struggle to determine what activities are passive under section 469, and avoiding section 469 passive income is particularly problematic for trusts and estates.[xxi] Taxpayers are allowed to claim the deductions “properly allowable to such gross income or net gain” in figuring net investment income.[xxii] Because investment expenses are miscellaneous itemized deductions subject to a floor of 2 percent of adjusted gross income, and because itemized deductions are subject to a phase-out for higher income taxpayers, both of these limitations will prevent full use of investment expenses in reducing net investment income for many taxpayers.[xxiii]

            The new “shared responsibility payment” and the expanded Medicare tax will present significant challenges in preparing 2013 tax returns. Tax preparers and advisors will need to seek out more detailed explanations of these and other changes caused by the Affordable Care Act to successfully cope with 2013 tax returns, particularly for higher income taxpayers.[xxiv]

[i] The US Supreme Court held that the shared responsibility payment was constitutional as a tax in NFIB v. Sibelius, _____ US _____, 132 S.Ct. 2566 (2012).
[ii] I.R.C. § 5000A(a), (b)(1).
[iii] I.R.C. § 5000(b)(3).
[iv] Questions and Answers on the Individual Shared Responsibility Provision, January 20, 2013 at 4. Separate coverage for vision, dental, or for specific medical conditions does not constitute minimum essential coverage. Id.
[v] I.R.C. § 5000A(c)(4).
[vi] I.R.C. § 5000A(c)(3)(A) & (B). The $695 amount will increase with inflation. Id. at (D).
[vii] 5000A(c)(3)(C).
[viii] I.R.C. § 5000A(b)(2).
[ix] I.R.C. §§ 3111(a) and (b)(6), 3101(a) and (b)(1), 3102(a).
[x] I.R.C. § 1401(a), (b)(1).
[xii] I.R.C. § 3101(b)(2), 1401(b)(2).
[xiii] I.R.C. § 3102(f).(1).
[xiv] I.R.C. § 3102(f)(2).
[xv] I.R.C. § 1411(a)(1)(A), (b). To arrive at modified adjusted gross income, one adds back the foreign earned income excluded by section 911. Id. at (d).
[xvi] I.R.C. § 1411(a)(2); see also Rev. Proc. 2013-15, 2013-5 I.R.B. 444 at Section 1, Table 5.
[xvii] I.R.C. § 1411(c)(1)(A)(i). Also, income from the investment of working capital in an active trade or business also qualifies as net investment income. Id. at (c)(3).
[xviii] I.R.C. § 1411(c)(1)(A)(iii).
[xix] I.R.C. § 1411(c)(1)(A)(i) and (c)(5).
[xx] I.R.C. § 1411(c)(2)(A). Trades or businesses “of trading in financial instruments or commodities” are also treated as generating net investment income. Id. at (c)(2)(B).
[xxi] Richard L. Dees, 20 Questions (and 20 Answers!) On the New 3.8 Percent Tax, 140 Tax Notes 683, 688-700 (2013).
[xxii] I.R.C § 1411(c)(1)(B).
[xxiii] Prop. Reg. § 1.1411-4(f)(3)(ii).
[xxiv] See the article by Mr. Dees, and its second part, at 140 Tax Notes 785 (2013) among others.