Understanding the Near-Term Tax Impacts of the Affordable Care Act

By Kevin Hedrick, CPA, Tax Partner at Williams Benator and Libby, LLP

 

July 2012

In spite of the U.S. Supreme Court’s recent ruling on the constitutionality of the Affordable Care Act, many unanswered questions remain about how the Act will affect staffing and other companies. Some of the provisions of the Act—coverage for dependents under their parents’ policies until age 26, exclusion of over-the-counter drugs from qualified flexible spending account (FSA) expenditures—already have been implemented. Other provisions will phase in over the next handful of years, while still others remain vague and undefined. Affordable Care Act implementation will continue to be a moving target until well after the November election. In the meantime and until further notice, companies must prepare for implementation. To help with planning, we have summarized the tax rules that will go into effect in or before 2014 and offer tips to minimize their impact.

Tax Rules to Take Effect in 2013:

For Individuals

  • The medical expense deduction will change from 7.5 % of adjusted gross income (AGI) to 10% of AGI. Bunching of expenses where possible can help increase deductions.
  • The Medicare tax on earned income will increase to 3.8% for single filers who earn more than $200,000 a year (or joint filers who earn more than $250,000 annually). Income subject to the Medicare tax now includes interest, dividends, capital gains, rental income and other passive income.
  • A new cap of $2,500 will be established for FSA contributions.

For Businesses

  • Company and employee annual payments for health insurance will be reported on each employee’s W2 form.

Tax Rules to Take Effect in 2014:

For Individuals

  • All individuals (with the exception of those who are under the tax return filing threshold, undocumented aliens and prisoners) must purchase minimum-coverage health insurance or pay a fine. Minimum fines will be $95 per year or 1% of household income. Employees may participate in employer sponsored plans if available, or purchase insurance from state insurance exchanges. Individuals below certain income levels may receive a tax credit to partially offset their premium.

For Businesses

  • Large employers with more than 50 full-time-equivalent (FTE) employees must offer affordable and adequate health insurance to all full-time employees and their dependents or pay a fine. Insurance is “affordable” if it does not exceed 9.5% of the employee’s household income. If an employee’s wages are $50,000, for example, his contribution for insurance could be up to $4,750 for single coverage and still be considered “affordable.” The IRS does not have clear guidance yet on how it or employers will calculate household income. The IRS will consider related businesses as one entity when calculating the total number of FTEs. The fine for not offering insurance will be $166.67per month (up to $2000 per year) for each employee, minus 30, and the penalty is not tax deductible.

Example: Large employer with 100 full-time employees

A.    Employer offers no insurance

Penalty is assessed based on 100 employees minus 30, or 70 employees, at $2,000 per employee:

(100-30) X $2,000 = $140,000 penalty (after tax cost)
B.    Employer offers insurance to all FTEs

Employer contribution is $5,000 per employee and 80 employees participate:

80 X $5,000 = $400,000; after tax (40% rate) the employers cost is $240,000

Result:

Employer B spent $100,000 more than employer A and provided its employees with $400,000 in tax-free benefits.

  • If an employer offers insurance but the employee opts to purchase coverage from the state exchange and qualifies for the premium assistance credit/subsidy, the employer will be fined $3000 per subsidized employee.

While it depends on the income level of the employee, it would seem that any plan offered, even with minimal employer contribution, would avoid penalties. The biggest hurdle now seems to be finding an insurance plan that will allow for lower employer contributions. The insurance industry is currently studying whether they can create such a product. Doing so would offer employers additional cost-saving options, but whether the industry brings that type of product to market remains to be seen.  As in the past, employers will need to continue to monitor the rules and options as they evolve and balance employee benefits with costs.

Mitigate Tax Impacts with Planning

There are some steps individuals and businesses can take now to plan for these new tax impacts. They include:

  • Reduce taxable income by increasing retirement plan contributions.
  • Consider converting IRAs to Roth IRAs before 2013 to take advantage of the current lower tax rates.
  • Gift money to children. Medicare tax on investment income is not part of the so-called “kiddie” tax. Therefore, minor children will not be subject to it (unless they have income in excess of $200,000).
  • Consider converting limited liability companies (LLC) to S-Corporations. Income earned by a partner in an LLC is considered either self-employment income or investment income and will be subject to the 3.8% Medicare tax (if over the $200,000 threshold). Owners of S-Corporations can earn active income which is not subject to the Medicare tax, even though it may exceed the threshold.
  • Accelerate income into 2012 ahead of rate increases.
  • Businesses employing nearly 50 employees will need to monitor employee count and may choose to outsource some administrative and/or management functions to reduce headcount.
  • Large employers will need to discuss options with insurance providers, consider costs and possible penalties for offering/not offering insurance, and take any increased costs to customers.

Kevin Hedrick is a tax partner at Williams Benator & Libby and leader of the firm’s International Practice. His extensive experience in domestic and international tax planning and compliance services includes tax preparation for corporations, trusts, partnerships and individuals, as well as mergers & acquisition and choice of entity considerations. He has worked with clients across many industries including staffing, technology and manufacturing. For more information on taxes and the staffing industry, contact Kevin at 770-512-0500 or khedrick@wblcpa.com.