November 14, 2012

What employers need to know about Obamacare tax provisions

With the 2012 presidential election decided, we now know that Barack Obama will remain president for the next four years, and the Democrats will control the Senate for at least two more years.

The result means businesses and individuals should prepare for full implementation of the Patient Protection and Affordable Care Act of 2010 (ACA).

The ACA, also widely referred to as Obamacare, includes some significant tax-related provisions affecting employers and individuals that are scheduled to take effect in 2013 and 2014.

In this post, we will discuss what employers should expect as Obamacare is implemented and several related tax provisions: a tax on wages, self-employment and unearned income, flexible spending account contributions, and the pay or play provisions.

Wages and self-employment tax

Starting in 2013, individuals will face an extra 0.9 percent Medicare tax on wages and self-employment (SE) income in excess of $250,000 for married couples filing jointly and $200,000 for single taxpayers. This tax is in addition to the current Medicare tax on salary and/or SE income of 2.9 percent split between the employer and employee.

Employers must withhold the extra 0.9 percent in Medicare taxes, but are not required to match that extra payment. To avoid penalties, employers must do little more than arrange to withhold the additional amounts. Nonetheless, it’s a good idea to alert affected employees that, upon reaching the threshold amount, they will see a drop in their paychecks.

Tax on investment income

Also starting in 2013, a 3.8 percent Medicare tax on unearned income will be applied to individuals, trusts, and estates. The tax will be equal to 3.8 percent of the lesser of net investment income or the excess of Modified AGI in excess of $250,000 for married couples filing jointly and $200,000 for single filers.

Net investment income includes interest, dividends and rents, passive trade or business income (i.e., most income reported on Form K-1), and capital gains. It does not include qualified retirement plan distributions from an IRA or tax exempt income, such as interest from municipal bonds.

Flexible spending accounts contributions

Starting in 2013, the ACA applies a $2,500 limit to employee contributions in flexible spending accounts (FSA). According to the IRS, the $2,500 limit on pre-tax employee FSA contributions applies on a plan-year basis. Thus, non-calendar-year plans must comply with the plan year that starts in 2013.

Employers must amend their plans and summary plan descriptions to reflect the $2,500 limit (or a lower one if they wish) by Dec. 31, 2014, and institute measures to ensure that employees don’t elect contributions that exceed the limit. There will continue to be no limit on employer contributions to FSAs.

“Shared responsibility” provisions

Starting in 2014, a penalty tax will be levied on individuals who don’t purchase health insurance, with a penalty that will be no more than $285 per family or 1 percent of income, whichever is greater. In 2015, the cap rises to $975 or 2 percent of income. And by 2016, the penalty will go to $2,085 per family or 2.5 percent of income, whichever is greater.

Although the ACA does not require employers to provide health care coverage, employers will face a “shared responsibility” excise tax scheduled to take effect Jan. 1, 2014. These provisions levy stiff penalties if larger employers do not offer coverage or provide coverage that does not qualify as “affordable” or provide “minimum value.” These penalties are not deductible, so they are more expensive after tax than premium payments.

Employers with 50 or more full-time employees or equivalents (those working 30 hours or more per week) that don’t provide employees with health coverage will be assessed a penalty if just one of their workers receives a premium tax credit when buying insurance in a health insurance exchange. The annual penalty is $2,000 per full-time employee in excess of 30 workers. For example, if the employer has 53 full-time employees, the penalty would be $46,000 (53 – 30 = 23 x $2,000).

Penalties will also be triggered if the coverage provided does not encompass at least 60 percent of covered health care expenses for a “typical population,” or the premium for the coverage exceeds 9.5 percent of a worker’s income. In such cases, the worker can opt to obtain coverage in an exchange and qualify for a tax credit. For each worker receiving the credit, the employer must annually pay the lesser of $3,000 per employee for each employee receiving a premium credit or $2,000 for each full-time employee beyond the first 30 employees.

The amount of the penalties is indexed for inflation, but it is tied to increases in the costs of health care premiums. And with health insurance premiums expected to rise at a faster rate than wages, employers with no one in the “over 9.5 percent” group currently could find that trend reversed quickly in later years.

Next steps 

From a business and individual planning standpoint, the time to act is now. We don’t know what additional tax changes the future will bring, especially with the fiscal cliff looming. However, we do know the changes the ACA will bring to employers and individuals.

Check back soon for a post that will go into greater detail on the mandates, expansion of coverage, and state insurance exchanges associated with the ACA.

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