On March 23, 2010, President Obama signed the Patient Protection and Affordable Care Act of 2010 (the "PPACA") into law. The PPACA, which is designed to overhaul the United States health care system, regulates all aspects and players in the health care arena, including individuals, employers and health insurers. On March 30, 2010, President Obama signed the Health Care and Education Reconciliation Act of 2010 (the "Reconciliation Act"), which amends certain aspects of the PPACA. This legislation is funded, in part, by increased taxes. The following provides a summary of certain of the tax-related provisions included in the PPACA as currently adopted and as amended by the Reconciliation Act.
Provisions Affecting Individuals
Excise Tax/Penalty on Individuals Without Essential Health Benefits Coverage
Beginning in 2014, United States citizens and legal residents will be required to maintain "minimum essential coverage," which includes medical coverage under government-sponsored programs, eligible employer-sponsored plans, plans in the individual market, grandfathered group health plans, and such other coverage as recognized by the Secretary of Health & Human Services and the Secretary of the Treasury. Certain individuals are exempt from this requirement during months they are incarcerated or are not legally present in the United States, or who maintain certain religious exemptions.
Individuals failing to maintain minimum essential coverage will be subject to a penalty under new Section 5000A of the Internal Revenue Code of 1986, as amended (the "Code"). The penalty applies to taxable years ending after December 31, 2013. The amount of the penalty in 2014 will equal the greater of $95 or 1 percent of the taxpayer's income over the threshold amount of income required for income tax return filing. The penalty is phased in by increasing the dollar limit and income percentages to $325 and 2 percent in 2015, and $695 and 2.5 percent in 2016. The penalty amount for subsequent years will be based on the 2016 dollar limit (indexed for inflation) and income percentages. Certain taxpayers (such as incarcerated individuals, individuals with income below the income tax filing threshold, and individuals with a valid religious exemption) are exempt from the penalty. Furthermore, the penalty will not be assessed on individuals who do not maintain health insurance for a period of three months or less during the taxable year.
Premium Assistance Tax Credit for Coverage under a Qualified Health Plan
To assist certain low-income individuals who may not be able to afford the cost of purchasing health care coverage, the PPACA adds new Code Section 36B. New Code Section 36B generally provides individuals with household incomes between 100 percent and 400 percent of the federal poverty level (the "FPL") who do not receive health insurance through an employer, with a refundable tax credit (the "premium assistance tax credit") based on income. The premium assistance tax credit will be payable in advance directly to the insurer to subsidize the purchase of certain health insurance plans through an exchange. The amount of the premium assistance tax credit is determined by reference to a benchmark plan (i.e., the second lowest-cost silver plan available in the individual market in the rating area in which the taxpayer resides), based on a sliding scale under which taxpayer contributions toward premiums generally would be limited to 2 percent of income for taxpayers with household income up to 133 percent of the FPL, and phasing out at 9.5 percent of income for taxpayers with household income between 300 percent to 400 percent of the FPL. The premium assistance tax credit is available for taxable years ending after December 31, 2013.
Additional Hospital Insurance Tax on High Income Taxpayers
Currently, the Medicare portion of the Federal Insurance Contributions Act ("FICA") imposes a 2.9 percent payroll tax on an individual's wages. An employee and employer are both liable for 1.45 percent, with the employee's portion being subject to withholding by the employer. As a parallel to FICA, the Medicare portion of the Self-Employment Contributions Act ("SECA") imposes a 2.9 percent tax on the wages of self-employed individuals.
Beginning in 2013, the employee's portion of the 2.9 percent Medicare tax will be increased by 0.9 percent (resulting in an aggregate employee portion Medicare tax rate of 2.35 percent) for individuals with wages in excess of $200,000 ($250,000 for joint returns). This additional tax will be subject to employer withholding. Similarly, a self-employed individual's Medicare tax imposed by SECA will be increased by 0.9 percent (resulting in an aggregate self-employed individual Medicare tax rate of 3.8 percent).
New Tax on Investment Income
The PPACA creates a new Code Section 1411, which will generally impose a 3.8 percent tax on the lesser of "net investment income" or the excess of modified adjusted gross income over a "threshold amount" (generally, $250,000 for taxpayers filing a joint return, $125,000 for married taxpayers filing a separate return and $200,000 in all other cases). Net investment income generally means the excess of (i) interest, dividends, annuities, royalties, rents, income from passive activities, income from trading financial instruments and commodities, and gain from the disposition of certain non-business property, over (ii) allowable deductions properly allocable to such income. In determining the amount of net investment income, special rules apply with respect to dispositions of equity interests in certain partnerships and S corporations, and to distributions from certain qualified plans. This additional tax applies to taxable years beginning after December 31, 2012.
Modify the Itemized Deduction for Medical Expenses
Currently, an individual taxpayer is permitted to take an itemized deduction for unreimbursed medical expenses to the extent such expenses exceed 7.5 percent of adjusted gross income. Beginning in 2013, the threshold for the itemized deduction for unreimbursed medical expenses will increase to 10 percent of adjusted gross income. For taxable years beginning in 2013 and ending before 2017, the increased threshold will not apply if either the taxpayer or the taxpayer's spouse turns 65 before the end of the taxable year.
Limitation on Health Flexible Spending Arrangements under Cafeteria Plans
Under current law, employees are permitted to exclude from gross income that portion of their compensation allocated to a flexible spending arrangement for medical expenses (a "Health FSA"). In general, employees are given the option of reducing their current compensation and instead having the amount of the salary reduction made available for use in reimbursing the employee for his or her medical expenses. Amounts remaining in a Health FSA at the end of the year generally are required to be forfeited by the employee.
Effective for taxable years beginning after December 31, 2012, Health FSA benefits will be limited to $2,500 per year per participant (indexed for inflation in subsequent taxable years). Thus, when an employee is given the option to reduce his or her current compensation and instead have the amount available to reimburse the employee for medical expenses under a Health FSA, the amount of the reduction must be limited to $2,500 per taxable year.
Provisions Affecting Employers
Shared Responsibility for Employers
Effective January 1, 2014, new Code Section 4980H generally will impose an excise tax on "applicable large employers" ("Large Employers"). A Large Employer generally is any employer with at least 50 full-time employees during the preceding calendar year. The excise tax applies only if the Large Employer has at least one employee enrolled in health insurance coverage purchased through a State exchange with respect to which a premium assistance tax credit (as discussed above) or cost-sharing reduction is allowed or paid to such employee(s).
For a Large Employer that does not offer employees and their dependents a plan providing minimum essential coverage, the excise tax for any month generally is equal to the number of full-time employees over a 30-employee threshold during the applicable month (regardless of how many employees are receiving a premium assistance tax credit or cost-reduction subsidy) multiplied by one-twelfth of $2,000. For a Large Employer that offers employees and their dependents a plan providing minimum essential coverage, the excise tax for any month generally is equal to the lesser of (i) one-twelfth of $3,000 multiplied by the number of full-time employees receiving a premium assistance tax credit or cost-reduction subsidy through a State exchange for such month, and (ii) the number of full-time employees over a 30-employee threshold during the applicable month (regardless of how many employees are receiving a premium tax credit or cost-reduction subsidy) multiplied by one-twelfth of $2,000.
Additionally, Large Employers will be required to file information returns with both the Internal Revenue Service (the "IRS") and their covered employees, and penalties will be imposed for failing to comply with such information reporting requirements.
Small Business Tax Credit
Under new Code Section 45R, a tax credit is provided to a "qualified small business employer" for non-elective contributions to purchase qualified health insurance for its employees. A qualified small business employer generally is an employer with no more than 25 "full-time equivalent employees" ("FTEs") during the taxable year (determined based on the total hours worked by all employees during the taxable year), and whose employees have annual "full-time equivalent wages" that average no more than $50,000 (indexed for inflation and determined based on the total wages paid by the employer during the taxable year). For taxable years beginning after 2013, the credit is only available for a qualified small business employer that purchases health insurance coverage for its employees through a State exchange and is only available for a maximum period of two consecutive years.
The amount of the credit generally is equal to the "applicable percentage" of the qualified small business employer's premium for qualified health insurance for covered employees. The "applicable percentage" is 35 percent for taxable years beginning in 2010 through 2013, and 50 percent thereafter. In general, the amount of the tax credit is proportionately reduced for employers with more than 10 FTEs but not more than 25 FTEs, and is also reduced for an employer for whom the average wages per employee is between $25,000 and $50,000.
Excise Tax on High Cost Employer-Sponsored Health Coverage
For taxable years beginning after December 31, 2017, the PPACA generally will impose an excise tax on insurers if the aggregate value of employer-sponsored health insurance coverage for an employee (including a former employee, surviving spouse and any other primary insured individual) exceeds a threshold amount. The amount of this excise tax is not deductible for federal income tax purposes.
The excise tax generally will be equal to 40 percent of the aggregate value that exceeds the threshold amount. For 2018, the threshold amount generally is $10,200 for individual coverage and $27,500 for family coverage (each adjusted for inflation) multiplied by the "health cost adjustment percentage" (designed to increase the threshold if the actual growth in the cost of U.S. health care between 2010 and 2018 exceeds projected growth) and increased by the age and gender adjusted excess premium amount (generally, the excess of the premium cost of standard Blue Cross/Blue Shield coverage for the type of coverage provided the individual if priced for the age and gender characteristics of all employees of the employer over the premium cost for such coverage if priced for the age and gender characteristics of the national workforce). Increased threshold amounts apply in the case of certain retirees and individuals in certain high-risk professions.
If the employer reports to insurers, plan administrators and the IRS a lower amount of insurance cost subject to the excise tax than required, the employer will be subject to a penalty.
Miscellaneous Tax Provisions
Codification of Economic Substance Doctrine
The judicially created economic substance doctrine generally denies tax benefits from a transaction that does not meaningfully change a taxpayer's economic position (other than tax consequences), even if the transaction technically satisfies the applicable requirements of the Code. Courts have not uniformly applied the doctrine.
The PPACA includes a provision that codifies the economic substance doctrine and clarifies that a transaction satisfies the doctrine only if (i) the transaction changes in a meaningful way (apart from federal tax effects) the taxpayer's economic position ("objective" economic substance); and (ii) the taxpayer has a substantial purpose (other than a federal tax purpose) for entering into the transaction ("subjective" economic substance). This provision also clarifies that a transaction will not be treated as having economic substance solely by reason of a profit potential unless the present value of the reasonably expected pre-tax profit is substantial in relation to the present value of the net tax benefits arising from the transaction if the transaction were respected.
An understatement penalty of 20 percent (increased to 40 percent if the relevant facts are not adequately disclosed in the taxpayer's tax return) applies to understatements of tax attributable to transactions lacking economic substance.
This provision applies to transactions entered into after March 30, 2010.
Increased Corporate Estimated Tax Payments
In general, corporations are required to make quarterly estimated tax payments of their federal income tax liability. Such estimated tax payments generally must be made by the 15th day of the fourth, sixth, ninth and twelfth months of the corporation's taxable year. Pursuant to legislation enacted in 2009 and 2010, in the case of a corporation with assets of at least $1 billion (determined as of the end of the preceding taxable year), payments due in July, August, or September 2014 (as applicable, depending upon the corporation's taxable year) generally were increased to 157.75 percent of the payment otherwise due, and the next required payment is reduced accordingly. The PPACA further increases the required payment of estimated tax otherwise due by such corporations in July, August or September 2014 (as applicable, depending upon the corporation's taxable year) by 15.75 percent (for an aggregate estimated tax payment equal to 173.5 percent of the payment otherwise due, with a corresponding reduction in the next required estimated tax payment).
Excise Tax on Medical Device Manufacturers and Importers
The PPACA imposes a 2.3 percent excise tax on any sale occurring after December 31, 2012, of any "taxable medical device" by the manufacturer, producer or importer of such device. A taxable medical device is any device (as defined in section 201(h) of the Federal Food, Drug, and Cosmetic Act) that is intended for humans, subject to certain exclusions, including eyeglasses, contact lenses, hearing aids, and certain other medical devices generally purchased by the general public at retail for individual use. Current law manufacturer excise tax exemptions for further manufacture and for export generally will apply to this excise tax, subject to certain exceptions.
The PPACA also includes a provision that, effective beginning in 2011, imposes an annual "fee" on manufacturers and importers of branded prescription drugs and biological products. The amount of the aggregate industry fees on such manufacturers and importers is specified by the statute ($2.5 billion in 2011, $2.8 billion in 2012-13, $3 billion in 2014-2016, $4 billion in 2017, $4.1 billion in 2018, and $2.8 billion each year thereafter). This fee is not deductible for federal income tax purposes. Furthermore, although this fee is specifically treated as an excise tax for purposes of civil actions for refunds, it is not otherwise explicitly characterized as an excise tax other than for purposes of non-deductibility.
Repeal Business Deduction for Federal Subsidies for Certain Retiree Prescription Drug Plans
Currently, sponsors of qualified retiree prescription drug plans are eligible for certain subsidy payments with respect to covered prescription drug costs. These subsidies are excluded from the plan sponsor's gross income, but plan sponsors are permitted to claim a business deduction for covered retiree prescription drug expenses incurred, notwithstanding that the taxpayer excluded from income subsidies allocable to such expenses.
For taxable years beginning after December 31, 2012, plan sponsors will still be permitted to exclude the amount of subsidy payments from gross income, but the amount otherwise permitted as a deduction for covered retiree prescription drug expenses will be reduced by the amount of the excludable subsidy payments received.
Excise Tax on Indoor Tanning Services
The PPACA imposes an excise tax on each individual on whom indoor tanning services are performed, equal to 10 percent of the amount paid for such services. For purposes of this excise tax, indoor tanning services generally will include any services employing electronic products designed to induce skin tanning, but do not include any phototherapy service performed by a licensed medical professional. This tax will be payable by the individual receiving the indoor tanning services and will be collected and remitted quarterly by the person receiving a payment for such services. This excise tax applies to indoor tanning services performed on or after July 1, 2010.
Require Information Reporting on Payments to Corporations
Under current law, any person making certain payments in the course of a trade or business of $600 or more during the taxable year to a single payee must file an information return. Payments subject to this information reporting requirement generally include any fixed or determinable gains, profits and income (subject to certain exceptions for interest, dividends and royalties). The applicable Treasury regulations generally except from such information reporting otherwise reportable payments to corporations. The PPACA amends the information reporting rules to (i) extend such information reporting to otherwise reportable payments to a corporation that is not a tax-exempt organization, and (ii) expand the type of payments subject to such information reporting to include gross proceeds in consideration of property or services. This provision does not override specific Code provisions exempting certain payments from such information reporting (e.g., securities or broker transactions under Code Section 6045). This provision applies to payments made after December 31, 2011.
This Tax Alert is intended only to provide a general summary of certain tax-related provisions included in the PPACA and the Reconciliation Act. We will update our clients as appropriate upon the issuance of any future guidance with respect to these provisions. If you have any questions or would like additional information about the provisions discussed above, please contact one of the authors or the Reed Smith attorney with whom you regularly work.
Client Alert 2010-068