Patient Protection and Affordable Care Act – Part I

Codification of Economic Substance Doctrine and Penalties

The Economic Substance Doctrine is codified as requiring that both of the following requirements must be met to satisfy the doctrine: (1) the transaction changes the taxpayer’s economic position in a meaningful way (apart from Federal income tax effects); and (2) the taxpayer has a substantial purpose for entering into the transaction (apart from Federal income tax effects). The provision is effective for transactions entered into after the date of enactment (March 30, 2010).A section 6662 penalty is created for an underpayment attributable to the disallowance of claimed tax benefits because the transaction lacked economic substance. The penalty is 20 percent (40 percent if the transaction is not adequately disclosed) and there is no reasonable cause exception. 

Increased Threshold for Medical Expense Itemized Deductions

The 7.5% of AGI threshold for a medical expense itemized deduction will increase to 10%, effective for taxable years beginning after 2012. An exception applies through 2016 for taxpayers age 65 or older.

Small Businesses Tax Credits to Offset the Impact of the Employer Mandate

Firms with fewer than 25 employees and average annual wages of less than $50,000 will be eligible for a credit for certain contributions to purchase health insurance for employees.  The credit phases in from 35% of the employers contribution to 50% by 2014. Smaller firms with 10 or fewer employees and average annual wages of less than $25,000 can get up to a 100% credit. Effective for taxable years beginning after 2009.

Not included in the definition of an employee are seasonal workers, self employed individuals, 2 percent shareholders of an S Corporation , 5% owners of a small business, and dependents. Leased employees are eligible for the credit. These rules are effective as of date of enactment.

W-2 Forms will be Required to Include Information on Employee Health Benefits.

Employers will be required to include on an employee’s W-2 the value of health benefits provided to the employee. This will become effective for taxable years beginning after 2010.

Special Cafeteria Plans for Small Employers

Small employers will be permitted to adopt new “simple cafeteria plans” that will include safe harbor participation and contribution rules similar to those in SIMPLE 401(k) or SIMPLE IRA rules effective for taxable years beginning after 2010.  By satisfying the minimum participation and contribution requirements the employer will not be required to meet the non-discrimination rules that otherwise would apply. 

Limitation on Health Flexible Spending Arrangements under Cafeteria Plans

For taxable years after 2012, in order for a health FSA to be a qualified benefit under a cafeteria plan, the maximum amount available for reimbursement of medical expenses incurred by the employee, the employee’s dependents, and other eligible beneficiaries with respect to the employee must not exceed $2,500 for a plan year (indexed for inflation).

Increase in Additional Tax on Distributions from HSA or Archer MSA

The additional tax on distributions from an HSA or an Archer MSA that are not used for qualified medical expenses is increased to 20 percent of those distributions, effective for distributions made during the tax years starting after 2010.

Increased Medicare Tax – Employer Withholding Responsibilities

An employer is required to withhold from wages the employee’s portion of the Medicare tax currently part of the FICA tax and equal to 1.45 percent of covered wages. Employers will be required to withhold the new .9% Medicare surtax on employees whose wages exceed $200,000. However, the employer is not required to take into account a spouses wages if the combined incomes exceeds the threshold.

New Medicare Tax on Unearned Income

Individuals, estates and trusts will be subject to a Medicare tax on unearned income. For individuals, the tax will be 3.8 percent of (1) net investment income or (2) excess of modified AGI over a threshold amount, whichever is lower. The threshold is $250,000 for a joint return, $125,000 for married filing separately, and $200,000 for a single taxpayer. The provision is to apply for taxable years beginning after 2012.

New Excise Tax on Employer based “Cadillac” Group Health Plans

After 2018 a premium excise tax to be paid by the insurance company will apply to medical plans where the premium threshold is greater than $10,200 for individuals and $27,500 for families.  The excise tax is 40% of the excess and is non-deductible.