Whether or not you disagree with the Supreme Court’s recent ruling, it would appear that the Health Care Reform Act (HCRA) – informally referred to by many as ObamaCare – is likely to become law in 2013. In the words of former Saturday Night Live comedian and current United States Senator Al Franken, the question becomes, “What does that mean for me?”
There really are several pillars of the plan that create additional expenses for individuals, whether you choose to call those expenses costs (such as the requirement to purchase health insurance), penalties (such as when you don’t comply with the law) or taxes – which are ubiquitous.
Individuals will be required to pay for or enroll in some sort of base coverage or pay a penalty (in the words of Chief Justice Roberts – a tax). Failure to cover oneself with minimal essential health coverage will result in a penalty tax of a currently undetermined amount. Changes to tax deductible health care spending accounts, additional Medicare taxes on wages, surtaxes on income and a redefinition of “dependent” under the law are all part of the plan.
Let’s take a closer look at each component:
“Essential” Base Coverage Requirement
In order to satisfy the minimum essential coverage requirement, individuals will have to enroll in or otherwise pay for a plan such as Medicare or Medicaid, an employer sponsored health plan, an individual market plan, some sort of a grandfathered plan or some other coverage – where state health insurance exchanges are expected to play a role
State sponsored health insurance exchanges would qualify for the base coverage requirement, although these exchanges are not mandated under federal law until 2014. Some states governors, such as Florida’s Rick Scott, have warned that they don’t intend to follow the federal mandate. These state health insurance exchanges are a key element to the plan, as they include federal premium assistance credits for those at or near the poverty line. There are also anticipated savings for small businesses with 100 or fewer employees through the state exchanges.
Many unanswered questions remain over these state exchanges, including what happens if a state elects to not follow them.
Failure to comply with the essential base coverage requirements results in a tax to the individual – but not until 2014. The tax is computed using formulas based on the cost of the national exchange premiums which haven’t been determined yet.
Health Care Flexible Spending Accounts
In 2013 contributions to health care flexible spending accounts will be limited to a maximum of $2,500.00, indexed to inflation. Employers will no longer be able to establish their own limits. The itemized deduction floor for medical expenses will be raised from 7.5% to 10% of adjusted gross income before you receive a tax deduction. Taxpayers 65 or older before December 31, 2010 get to keep the 7.5% floor through the 2016 calendar year.
Most wages and self employed income will be taxed at an additional 0.9% for Medicare for those earning more than $200,000 (individuals) or $250,000 (joint) filers. The tax is imposed on the combined earnings of both spouses, which currently is not the case for the Medicare tax. Normally there is no risk of under withholding under current law – but since employers will have no idea what the employee’s spouse makes that risk now becomes evident. It is incumbent for employees to advise employers if additional withholding should apply.
Self employed individuals will not be able to deduct the additional Medicare tax. Only the employer portion of the self-employment tax is deductible – and that does not increase under the law.
Modified Adjusted Gross Income Surtax
A surtax of 3.8% will be imposed on taxpayers with Modified Adjusted Gross Income (MAGI) in excess of $200,000 for individuals and $250,000 for joint filers. Consequently, a surtax of $380 would be imposed on an individual’s MAGI of $210,000. This is calculated as follows: MAGI $210,000 less $200,000 threshold = $10,000 multiplied by 3.8%.
MAGI is deemed to be the taxpayer’s adjusted gross income increased by any foreign earned income or foreign housing costs excluded under the tax law.
The surtax is limited to a calculation using the lesser of the MAGI or the taxpayer’s net investment income.
Investment income does include interest, dividends, rents, passive income from a trade or business, annuities and gain on the disposition of property. Investment income does not include IRA or other qualified retirement account distributions, tax exempt bond interest, veterans benefits or the gain on the sale of a principal residence.
In my example above if the individual taxpayer had net investment income of $25,000 included in their MAGI of $210,000 then the surtax would still equal $380. Here, the MAGI in excess of $200,000 ($10,000) is the lesser of that calculation and the net investment income ($25,000).
A taxpayer’s withholding requirements for the year should also equal the amount necessary to pay any surtax that may apply.
While many of us hope to have our children on their own before reaching age 27, the HCRA treats children under age 27 as a dependent for many purposes.
As mentioned above, the penalties for failure to comply with enrolling in or purchasing essential health coverage is based upon a formula for which the factors have not yet been determined. Normal taxpayer penalties will also apply for failure to pay or withhold proper amounts for the Medicare and income surtaxes.
The new law makes end of year income tax planning important if you are a taxpayer earning over the threshold amounts delineated under the law. Generally speaking, when coupling the effects of the expiration of the Bush tax cuts along with the implementation of the HCRA, taxpayers may want to consider accelerating the recognition of income and capital gains taxes before the end of the year, as well as accelerating medical expense deductions as well.
Since everyone may be affected differently by these changes, you should always consult with your tax professionals as to your own individual circumstances prior to acting.
©2012 Craig R. Hersch