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Understanding Obamacare: Health Reform Affordable Care Act Taxes

Taxes: We’re making some sense of the New Obamacare Health Insurance “Affordable Care Act” and discussing healthcare taxes and how you can use this for yourself and others.

Making Some Sense of the Newly Upheld Health Care Law

Please bear with me on this one. I’m a little confused about this new law and how it’s going to work, just like most everybody else is. What I’m going to try to do is lay out the important data about the mandatory health care law which was upheld by the Supreme Court about a week ago. It’s important that I do this because you’re almost certain to be effected by it, and you should understand some of the ways in which it might effect you.

Before I get into the “thou shalt/shalt not’s” of this new law, I would like to make a comment about its legal background. Congress wanted to mandate that everybody have health insurance, which meant that all those who weren’t already somehow covered would have to buy and pay for health insurance. They felt it was important that everybody be in the system because they wanted to force insurers to cover all the bad risks, and in order to make that even vaguely feasible from an economic point of view, they had to insist that all the good risks be in the pool too. See, if all the bad risks got covered, it meant that insurers’ costs would go way up, and the only way to hope to make up the shortfall would be to force everybody who didn’t need health care to buy in too. That way, the dollars from the healthy people would be made available to support the costs incurred in caring for the sick people, and hopefully it would all work out. You my heave heard this economic philosophy before; it had a run of popularity in the 20th century.

The only bug was that the Constitution says Congress can’t force people to do things with their money that they don’t want to do. You know, liberty and freedom and all that. But, Congress went ahead anyway, mandated universal health coverage, and created penalties to be imposed against anyone who didn’t buy into this new program, with the purpose of forcing them to buy in. Since we already have to report and pay tax to IRS annually, they just added this new penalty to the list of those things IRS already enforces and collects.

Lots of people felt that forcing Americans to buy insurance, whether they wanted to or not, was unconstitutional. So, there were lawsuits, one of which made it up to the Supreme Court fairly quickly. The Court’s take on this requirement was that Congress was not requiring anybody to do anything, but was simply laying a tax on those who didn’t care to buy insurance, and that the penalty wasn’t really a penalty, after all. It was just another tax.

What makes it ironic is that the penalties Congress imposed (which the law still calls penalties) had to be soft-pedaled in order to get enough votes for passage. For example, the penalty tax for a single person failing to buy health coverage in 2014 is $95, increasing to $325 in 2015 and $695 in 2016. Considering that health insurance rates are probably going to seriously escalate real soon now as all the people who haven’t been able to get health coverage jump in with both feet and send costs spiraling upward, it will probably end up being cheaper for most average people to pay the penalty tax than it will be to buy insurance. Which is exactly what Congress wanted….? Many average working people will still not be able to afford insurance, but now they’ll have a new penalty tax to “help them out”.

Actually, states are supposed to set up health insurance exchanges to make good and affordable insurance available to all, and I’m sure that will work out wonderfully, just like that other health insurance program which states administer under Federal mandate called Medicaid. Also, there will be substantial tax incentives to those who are considered “lower income” to help them buy health insurance. The Congressional Budget Office estimates that the average health insurance subsidy for lower income individuals and families will be about $5,000 annually.

And, of course, even Congress knows this will all cost a bit of money, so there’s going to be new taxes (in addition to the penalty tax on failing to buy insurance) on many activities designed to help foot the bill.

As you can see we, as tax experts, are going to find ourselves up to our hips in health insurance issues. As well all now know, mandatory health care is really just another pile of taxes. So, what are the issues for individuals?

Issues for Individuals (keep Reading)

Obamacare? Healthcare Reform & Taxes – Making Some Sense of the Newly Upheld Health Care Law

Mandatory Coverage

Starting in 2014, if you don’t already have qualifying health coverage, you have to buy health insurance or pay a tax. Some people are exempt, such as those covered by Medicare or Medicaid, incarcerated people, illegal aliens, members of Indian tribes, and those who are members of a religion conscientiously opposed to accepting benefits. There’s a 90-day grace period each year, meaning you can go without insurance for no more than 90 days before the penalty tax kicks in.

Also, people who can’t afford coverage are exempt. “Unable to afford” in this case means people where the cheapest possible qualifying policy available through a state exchange would cost more than 8% of their household income. People whose household incomes are below the tax filing thresholds are also exempt.

The Penalty Tax

The penalty tax will be imposed on each month you don’t have qualifying insurance (1/12 of the penalty to be imposed for each month you are insurance-less). The annual amount of the penalty tax, per individual, will be $95 for 2014; $325 for 2015; and $695 for 2016 and subsequent years. These amounts are halved if the individual in question is under 18 years old. The flat dollar amounts are then compared to a percentage of your household income, and the larger of the two amounts is your penalty. The percentages are 1% for 2014; 2% for 2015; and 2.5% for 2016 and subsequent years.

In regard to the details of just exactly how this will be computed; who is considered a member of the household; what income is considered; etc., etc., I dunno. IRS will be issuing regulations to explain how they plan to enforce all this someday.

Premium Assistance Tax Credit

Starting in 2014, certain low-income individuals who get qualifying insurance through a state exchange (assuming they aren’t adequately covered elsewhere) may qualify for a premium assistance tax credit. If your household income (there’s that term again) is between 100% and 400% of the Federal poverty level for your family size, you may qualify.

If your employer offers affordable coverage (meaning that your contribution is not more than 9.5% of your household income), that insurance counts for these purposes whether you get it or not, and you would not qualify for the credit.

Higher Medical Deduction Threshold

For years medical expenses have been deductible to the extent they exceeded 7.5% of your adjusted gross income. It’s going to be 10% of adjusted gross income starting in 2013. However, if you’re 65 or older before the end of 2013, you still get the old 7.5% limit through the end of 2016. In case you were one of the few people whose medical expenses were already over 7.5% of their income, this will make your medical expenses less deductible, if deductible at all.

Higher Taxes on HSA and MSA Distributions

Just in case you have distributions from a health savings account (HSA) or medical savings account (MSA) which exceed your actual medical expenses for the year, the overage will immediately be subject to an additional penalty tax of 20% of the overage, in addition to being included in your taxable income. So, don’t take the money out of those HSAs and MSAs unless you know you’ve spent at least that much on allowable medical expenses.

Additional Medicare Tax

Starting in 2013, there will be an additional 0.9% Medicare tax imposed in the wages and self-employment income of individuals with earned income over $200,000 and married couples with earned income over $250,000. This will be in additional to all other and regular income taxes.

If your wages go over $200,000 your employer should withhold this additional tax. If your income, when combined with that of your spouse goes over the limit, but is not over $200,000 by itself, you will need to be aware of this additional tax because your employer won’t withhold for it. If you’re self-employed or earn income as an owner from a company taxed as a partnership, you’re just going to have to plan for this new additional tax.

The IRS has not released regulations on this either, so I have no idea of exactly how it will work, and what exactly will be covered.

Medicare Tax on Investment Income

Starting in 2013, there will be a 3.8% Medicare tax on unearned income. This will be in additional to all other and regular income taxes. The tax will be imposed on your net investment income for the year (meaning gross investment income less related expenses), or your modified adjusted gross income in excess of $200,000 ($250,000 for married couples).

Investment income is defined by law as including:

● Gross income from interest, dividends, annuities, royalties and rents, unless you get these type of income in the ordinary course of your business;
● Other gross income from any passive trade or business; and
● Net gain attributable to the sale of property, other than property held in the normal course of a business which is not a passive business.

What does this include? Well certainly interest, dividends, capital gains, rental income, annuities, royalties, and partnerships (if you’re a passive investor). It also includes things like the taxable portion of the sale of your house, should you have a taxable gain on selling your house. Remember, in regard to the sale of a personal residence, the first $250,000 of profit is not taxable if you’re single; it’s the first $500,000 for couples.

The IRS has also not released regulations on this, so I have no idea about how it will specifically be implemented. We have to wait and see.

Planning Issues

Of course, if you have substantial taxable capital gains pending, you might want to take a look at getting them realized before the end of 2012. Don’t forget that the Bush-era tax cuts, which brought down overall tax rates as well as the tax rates on capital gains and dividends, are scheduled to expire on December 31, 2012. This means that the effective tax on capital gains, interest and dividends for Californians (as well as those in other high-tax states) could go over 50%.

It’s possible that inter-company loans could also be subject to this new tax, so if you have a situation where Company A has borrowed from Company B, or maybe where Mr. Shareholder has borrowed from Company A, you might want to look at getting those loans reduced or off the books.

Retirement plan contributions might also start looking more valuable, if the alternative is paying higher taxes. Some investors might also want to look at revising annuity plans they have in place, or thinking about tax-exempt bonds.

Depending on how the regulations play out, Subchapter S corporations might also be a good planning tool, because the way it looks now, profits from these corporations which go to owners who actively work in the business might not be subject to either the new Medicare tax on wages or the Medicare tax on investment income.

In Conclusion…

Please be aware that the purpose of this message is not to provide exact data or advice about what’s going to happen or what you should do. I’ve left out tons of details which would have bogged it down in order to get you a workable overview.

Unfortunately, we can’t really go much further than this right now, because without regulations which provide the down-and-dirty details of how this is all going to be enforced, we can’t really say what will fly and what will flop. However, you can bet we’ll be keeping an eye on this, and will let you know as soon as the landscape firms up.

William D. Truax, E.A., Inc.

Infographic Source: Heratage.org