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Health Care Reform’s Tax Provisions: Employers Prepare

Health Care Reform’s Tax Provisions: Employers PrepareThe massive health care legislation, signed into law by President Obama, contains provisions that will affect every employer. But timing ranges from items that apply immediately in 2010 to a variety of tax increases that become effective from 2011 to 2018.

Andy Biebl, tax principal with LarsonAllen, urges employers to focus on those items taking effect in the next couple of years. "The tax costs and coverage mandates don’t hit until 2013 or 2014. We can expect further guidance on how these apply, not to mention the possibility of changes from a future Congress."

Effective in 2010

Tax credit for small employers offering health coverage

Presently, employers may deduct the cost of health coverage provided to employees. But for tax years beginning in 2010 through 2015, small employers, including tax-exempts, may qualify for a more lucrative credit to reimburse a portion of the cost of employer-provided insurance.

In general, an eligible small employer is one who meets three criteria:

  • An employer with no more than 25 full-time equivalent employees (FTEs) for the tax year
  • Average annual wages per employee do not exceed $50,000
  • The employer contributed at least 50 percent of the premiums for employee health care

Amount of credit
The credit is calculated as a percentage of employer-provided health insurance premiums, but the percentage varies based on the tax status of the employer and the year:

Tax Year Beginning

Taxable Employer

Tax-Exempt Employer

2010–2013

35 percent

25 percent

2014–2015

50 percent

35 percent

Health insurance coverage purchased from a company licensed under state law qualifies for the credit for 2010–2013. However, the credit amount for the premium must be reduced if it exceeds an average premium (determined by the government) for the small group market and the rating area where the employee enrolls for coverage. For the final years of the credit in 2014 and 2015, the credit is only available to an employer that purchases health insurance coverage for its employees through a state-based exchange.

For taxable employers, this is a business credit that offsets both regular tax and AMT. To the extent the employer claims a tax credit, that amount of the insurance premium is not allowed as a business expense. For tax-exempt employers, the credit is claimed against payroll taxes.

Full credit versus phaseout
An employer only receives the full credit if it has 10 or fewer FTEs and the average annual wages per employee do not exceed $25,000. As either of these thresholds is exceeded, a pro-rata phase-out occurs as the company moves from either 10 to 25 employees or from $25,000 to $50,000 of average annual wages. Each phase-out percentage is applied separately. In measuring the employer’s size, related or commonly controlled businesses must be aggregated.

Example 1

Ace is a small for-profit employer with 10 FTEs and an average annual payroll per employee of $40,000. For 2010, Ace pays $60,000 of health insurance premiums for its employees (assume that this amount is smaller than the small business benchmark premium). The maximum health insurance premium credit that Ace may claim is $21,000 ($60,000 premiums multiplied by 35 percent). However, Ace’s average payroll of $40,000 is 60 percent through the $25,000–$50,000 wage phaseout range, and as a result, 60 percent of its credit is eliminated. Ace is only allowed a health insurance tax credit of $8,400 ($21,000 multiplied by 40 percent).


Example 2

Assume the same facts, except that Ace has 15 FTEs instead of 10. Ace is one-third through the phaseout range on the permitted number of employees (15 employees on a phaseout range moving from 10 to 25 employees), and accordingly another one-third of its $21,000 credit is phased out. Ace is now allowed a tax credit of $1,400 ($8,400 prior computation minus $7,000).

Calculating FTEs
The number of FTEs is not a simple headcount, but rather a detailed computation of total hours of payroll for the year divided by an assumed 2,080 hours per FTE. If any single employee works in excess of this amount, those hours are not considered. While part-time employee hours are included in the mix, seasonal workers are not. Also, owners and their family members are excluded in the FTE count. Owners are defined as self-employed proprietors and partners, more-than-2 percent S corporation shareholders, and 5 percent owners of an eligible small business.

The average annual wages
The average annual wages of the employer are determined by dividing FICA wages by the number of FTE employees. However, wages exclude seasonal workers and owner-employees and their family who are not considered in the FTE computation. The FTE computation and the average annual wages are rounded down to the lowest whole number of FTEs and the lowest multiple of $1,000 in the case of wages.

"The 35 percent credit will be helpful to those with 10 or fewer employees and low average payroll," notes Biebl. "However, there is incredible complexity for those between 10 and 25 workers, between $25,000 to $50,000 of average annual payroll, or with family employees."

Dependent coverage in health plans
In the past, employer-provided health coverage was only tax-free if furnished to employees, their spouses, and children eligible as tax return dependents (i.e., children under age 19 or those in student status under age 24).

Effective as of March 30, 2010, the tax-free exclusion is extended to employer-provided health coverage for the child of a taxpayer who has not attained age 27 as of the end of the tax year. This new definition also applies to a self-employed taxpayer and more-than-2 percent S shareholder who claims a deduction for self-employed health insurance premiums that include a child under age 27. Similarly, employers who offer dependent health insurance coverage must increase the age limit for dependent participation in the plan, although the employer mandate only extends to age 26.

Grant in lieu of tax credit for therapeutic discovery projects
For tax years beginning in 2009 or 2010, a new 50 percent tax credit may be claimed for the cost of qualifying therapeutic discovery projects by a business with 250 or fewer employees. Congress has allocated $1 billion for these credits and defined a subjective set of criteria under which the U.S. Department of the Treasury will award the credits. Taxpayers may alternatively elect to receive credits that have been allocated to them in the form of grants. The credit or grant is 50 percent of qualifying expenses incurred within the year for three types of projects:

  • Clinical studies to secure FDA approval of a product
  • Projects to diagnose diseases or conditions, or to determine molecular factors related to diseases or conditions by developing molecular diagnostics
  • Development of a process, product, or technology to further the delivery or administration of therapeutics

The credit or grant has no limit other than 50 percent of eligible expenses and securing Treasury approval. "This looks like it will be a money rush," observes Biebl. "The IRS was told to develop the grant procedures within 60 days, which means by the end of May we’ll know how the applications are to be submitted. It’s first come, first served until the $1 billion runs out. Businesses potentially qualifying should contact us for more direction on eligibility."

Excise tax on indoor tanning services
Businesses that offer indoor tanning services must impose a 10 percent excise tax on the amount paid for their services, effective for services performed July 1, 2010, and after. The excise tax is imposed on the customer, but the business provider is secondarily liable if it fails to collect and remit the tax.

Effective in 2011

W-2 disclosure of health coverage cost

Beginning in 2011, employers are required to add information on each employee’s W-2 Form, detailing the aggregate cost of employer-sponsored health coverage. This reporting includes all employer-sponsored health benefits, such as medical plans, dental plans, vision plans, and self-insured arrangements. However, reporting is not required for salary-reduction contributions to flexible spending accounts.

New SIMPLE Cafeteria Plans
A cafeteria plan is an arrangement under which an employer offers an array of non-taxable fringe benefits and cash compensation from which employees may select. Cafeteria plans come with complex discrimination rules that require testing to determine if a plan discriminates in favor of highly compensated employees or owners.

For tax years beginning in 2011 and after, the reform legislation creates a new SIMPLE Cafeteria Plan for small businesses that eliminates the nondiscrimination rules that are otherwise applicable to cafeteria plans. An eligible small employer is one with 100 or fewer employees on average during either of the two preceding years who meets minimum contribution and participation requirements with respect to the plan.

An employer with a SIMPLE Cafeteria Plan must contribute a minimum of 2 percent of employee compensation toward plan benefits each year. Alternatively, the employer can contribute twice the amount of salary reduction contributions of each employee, or 6 percent of the employee’s compensation, whichever is less. The employer meets the participation requirements if all employees who had at least 1,000 hours of service in the prior year are eligible to participate, excluding only those who are under age 21 at the close of the plan year, have less than one year of service with the employer, or are under a collective bargaining agreement.

Effective in 2012

Expanded 1099 information reporting requirements

Presently, any person or entity conducting a business must file a Form 1099 Information Return with the IRS for payments totaling $600 or more per recipient in any tax year. This reporting relates to fees and commissions, interest, rents, royalties, and other non-property transactions. Payments to a corporation are generally exempt from these 1099 reporting requirements, except for a few items such as attorney fees and medical and health care payments.

Effective for payments made in 2012 and after, the health care legislation expands 1099 reporting to include amounts paid "in consideration for property." This would include any inventory, material, equipment, or merchandise. Further, the new legislation requires a 1099 be issued to any corporation (other than a tax-exempt entity) for payments for property or services over $600 in a calendar year.

"These changes represent a dramatic increase in Form 1099 reporting for virtually all businesses," notes Biebl. "The expansion of the law to property requires businesses that purchase inventory and equipment to report nearly all of their transactions—the compliance costs will be substantial."

Fee on self-insured health plans 
Effective for plan years beginning on or after October 1, 2012, a self-insured health plan must pay a fee equal to $2 per participant (but only $1 for the 2013 fiscal year). A similar fee is imposed on issuers of health insurance policies. For years beginning on or after October 1, 2014, this fee escalates at a rate equal to national health expenditures. The issuer of the policy or the plan sponsor is liable for and must pay the fee.

Effective in 2013

Add-on to employee Medicare rate

Presently, the Federal Insurance Contributions Act (FICA) payroll tax of 7.65 percent consists of two components: 6.2 percent on the first $106,800 of salary for Social Security and 1.45 percent on all wages for Medicare Hospital Insurance (HI). This employee FICA is withheld from wages, and the employer must match the amount remitted to the government. Self-employed taxpayers pay the same rates through their Form 1040, but must remit both the employer and employee share, and receive an income tax deduction for one-half of the FICA taxes.

Effective in 2013, an additional 0.9 percent Medicare HI tax is imposed on the employee share, but only to the extent that an individual’s wages exceed $200,000. This increase is entirely on the employee share, although the employer is required to withhold the tax and is subject to penalties for any failure to withhold and properly remit. Similarly, the self-employment HI tax is increased by 0.9 percent.

For joint returns, the extra 0.9 percent HI tax is assessed on wages and self-employed income in excess of $250,000 by considering both spouses as one for this computation. Accordingly, if the withholding has been inadequate (i.e., one spouse over $200,000 with the 0.9 percent withholding, but the other spouse under $200,000 of wages with no withholding), the additional 0.9 percent HI tax must be remitted through the Form 1040.

Because this extra tax is only on the employee share, a self-employed taxpayer will not be allowed to claim an income tax deduction for it. The self-employed deduction for half of the self-employment tax will remain at 7.65 percent.

Contribution cap on flexible spending accounts
Presently, the tax law does not place a dollar limit on the amount that an employer’s cafeteria plan permits employees to salary-reduce annually into their health care flexible spending account. Beginning in 2013, this legislation puts a cap of $2,500 on the amount that any employee can annually contribute into a health flex spending account. The $2,500 amount will be inflation indexed for years after 2013.

Elimination of subsidy for retiree Part D coverage
In 2003, when Congress created the Medicare Part D drug coverage, it encouraged employers to continue drug coverage for retirees by providing a double benefit: a federal nontaxable subsidy was added for each employer who extended drug coverage to retirees, while a tax deduction remained allowable for the company-paid prescription drug expenses.

Effective in 2013 and after, a company’s expenses for retiree prescriptions will no longer be deductible, to the extent of the federal nontaxable subsidy received for reimbursement. Rob Schile, a LarsonAllen health care principal, says this is impacting many larger companies that have maintained retiree drug benefits. Under financial statement accounting principles, they are forced to take a current one-time charge to earnings for the loss of the future tax deductions that would have occurred from the payouts to retirees.

Effective in 2014

Health insurance coverage mandate

Beginning in 2014, employers with at least 50 full-time employees during the preceding calendar year will face a non-deductible excise tax if they fail to offer employee health insurance, or if they provide a plan with minimum coverage that is either unaffordable or incurs less than 60 percent of the cost of benefits. The excise tax is assessed if even one full-time employee is certified to the employer as being eligible for federal subsidies (premium tax credit, or cost-sharing reductions).

Employers providing no health insurance
The excise tax is $2,000 annually per employee for employers not offering a health care plan or offering a plan without "minimum essential coverage" and for which at least one employee is eligible for federal subsidies. However, the tax excludes the first 30 employees in the computation.

Employers offering minimum essential health insurance coverage
The excise tax is $3,000 per year multiplied by the number of full-time employees who receive a subsidy based on low income status. However, the penalty is capped at the rate of $2,000 per year multiplied by the total number of full-time employees beyond the 30 employee exemption. Also, the $3,000 penalty will not apply if the employer provides a "free choice voucher" to the employee.

Example

Company D offers health coverage and has 90 full-time employees. However, 15 lower paid employees receive a tax credit for enrolling in a state-sponsored insurance exchange for the year. For each employee receiving assistance, Company D owes a $3,000 excise tax, for a total of $45,000 for the year. The penalty cap does not come into play, as that would be $120,000 [$2,000 excise tax multiplied by 60 employees (90 employee total reduced by a 30 employee exemption)].

Mandatory "free choice vouchers"

Beginning in 2014, employers offering a minimum level of health insurance coverage through an employer-sponsored plan and paying any portion of the costs of the plan are required to offer a free choice voucher to qualified employees. The voucher is equal to the value of the employer contribution to the employer-offered health plan and is used by the employee to purchase coverage through a state insurance exchange. A qualified employee is one who does not participate in the employer health plan, whose required contribution for minimum coverage exceeds 8 percent of the employee’s household income, but does not exceed 9.8 percent, and whose household income is not greater than 400 percent of the poverty line for a family of the size involved. As an illustration, the 400 percent poverty line figure for a family of four is currently $88,200.

An individual receiving a voucher is disqualified from receiving any tax credit or cost sharing credit for the purchase of a health plan in an insurance exchange. Employers will treat their payments on the vouchers as deductible compensation expense.

Reporting self-insurance coverage to IRS

The legislation creates new employer information reporting requirements to both covered individuals and the IRS beginning in 2014. Employers who self-insure must report health insurance coverage information to both the employee and to the IRS. Large employers with 50 or more full-time equivalents are also subject to extensive health insurance reporting requirements regarding the health insurance coverage provided to their workforce. New penalties are imposed on employers for failure to provide this information to the IRS.

Effective in 2018

Excise tax on high-cost employer health coverage

For tax years beginning after 2017, a nondeductible 40 percent excise tax is imposed on a health insurance company or a plan administrator offering high-cost health coverage. This is coverage where the annual premium exceeds $10,200 for single coverage and $27,500 for family coverage. These thresholds for excess coverage will be adjusted modestly for increasing health care costs and also are increased for coverage of retirees and high risk professions. Each employer is required to calculate the excess benefit subject to the excise tax and furnish that to the insurance company or other provider, who ultimately is assessed the excise tax.

Revenue raisers imposed on the health care industry

The reform legislation contains a number of additional taxes or fees imposed on health care insurers and other medical providers. Some are fixed amounts assessed on specific industries. The IRS will have to determine the amount each taxpayer in the industry is responsible for.

Prescription Drugs

Manufacturers and importers of branded prescription drugs must pay a nondeductible excise tax that is allocated across the industry based on market share. The total excise tax charged to the industry begins at $2.5 billion in 2011, and rises to $4.1 billion in 2018. Companies with sales of pharmaceuticals of $5 million or less are exempt from the tax.

Medical Devices

Beginning in 2013, an excise tax equal to 2.3 percent of the sale price is imposed on medical devices. The tax is levied on the manufacturer, producer, or importer of any device intended for humans defined in Section 201(h) of the Federal Food, Drug, and Cosmetic Act. However, the tax does not apply to eyeglasses, contact lenses, hearing aids, and other medical devices generally purchased by the public at retail.

Health Insurance Companies

Health insurance companies are assessed a nondeductible annual fee beginning in 2014. The fee is an industry-wide flat fee, starting at $8 billion in 2014 and increasing to $14.3 billion in 2018. The IRS will allocate the fee across the industry based on net premiums written. Small insurers with $25 million or less of net premiums are exempted from tax.

For more information, contact a tax principal in your region. Read more about health care reform and its effects on individuals, employers, and providers.

Published: 4/6/2010

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