Patient Protection and Affordable Healthcare Act of 2010 FAQs

By Donald J. McAnelly, CPA/ABV/CGMA
Rehmann

September 2012

1.    With the new law, will there be a change in an individual’s ability to deduct medical costs as an itemized deduction on their personal tax return?

Yes, there will be changes and these changes are set to occur for the 2013 tax/calendar year.  These changes will come in the form of an increase in the threshold for the itemized deduction for unreimbursed medical expenses from 7.5% of adjusted gross income to 10% of adjusted gross income. However, there is a break in the law as it waives the increase for individuals age 65 and older for tax years 2013 through 2016.

2.    Will the amount that employees can put away pretax in a flexible spending account for medical expenses change?

Unfortunately, it will change and the change will likely not be for the good for many who take advantage of their flexible spending account. Prior to this legislation, there was essentially no limit on the amount of money an employee could contribute to a flexible spending account for medical expenses. It was up to the plan sponsor to prescribe a contribution limit. The new law will enact a limit on the amount of contributions to a flexible spending account (also known as Section 125 accounts) for medical expenses of $2,500 per year for the first plan year beginning after 12-31-12.  This amount will be increased annually via a cost of living adjustment. Also, note that the new law only impacts medical expenses paid with a flexible spending account; it does not provide any added limits relative to dependent care expense reimbursements under a flexible spending account arrangement.  (Please see IRS Publication 969 for more information on flexible spending accounts.)

3.    How will other pretax accounts, such as a health savings account or a health reimbursement account, be affected?

The new legislation does not affect the current contribution limits on an HSA (health savings account) or an HRA (health reimbursement account). However, the law does create certain limitations on how the accounts can be used. Most non-prescribed, over-the-counter medicines no longer qualify for distributions under these plans. Furthermore, the penalty for any non-qualified distributions has been significantly increased from 10% to 20%. This penalty is in addition to income tax consequences of the non-qualified distribution, whereby the distribution is added to taxable income for the current year.

4.    I understand that Medicare taxes will increase; when and how will they increase?

For 2013, the law increases the Medicare Part A (hospital insurance) tax rate on wages by 0.9% (from 1.45% to 2.35%) on earnings over $200,000 for individual taxpayers and $250,000 for married couples filing jointly. Also, the law will impose an additional Medicare tax at the rate of 3.8% on unearned income for higher-income taxpayers. While its complexities are beyond the scope of this article, in general terms, the tax will be assessed on individuals with a modified adjusted gross income of $200,000 and joint filers with a modified adjusted gross income of $250,000. Unearned income subject to the tax includes interest, dividends, royalties, annuities, rents.

5.    I am hearing about a tax on medical devices. What will be the tax on “medical devices” and are there any other excise taxes I should be aware of?

Effective January 2013, the law imposes an excise tax of 2.3% on the sale of any taxable medical device by a manufacturer or importer. Items to be exempted from the tax are: eye glasses, contact lenses, hearing aids, and any device of a type that is generally purchased by the public at retail for individual use. As of July 2010, the law also imposed an excise tax on indoor tanning salons of 10%.

6.    In 2014, what will be the penalty for employers who do not offer adequate levels of coverage?

The law assesses a fee (essentially a nondeductible excise penalty) of $2,000 per full-time employee, excluding the first 30 employees, on employers with more than 50 employees that do not offer coverage and have at least one full-time employee who receives a premium tax credit. Employers with more than 50 employees that offer coverage, but have at least one full-time employee receiving a premium tax credit, will pay the lesser of $3,000 for each employee receiving a premium credit or $2,000 for each full-time employee, excluding the first 30 employees.

7.    Is there going to be a tax on medical insurance in the future?

Yes, in 2018 the law imposes a 40% excise tax on insurers of employer-sponsored health plans with aggregate expenses that exceed $10,200 for individual coverage and $27,500 for family coverage.  

8.    How do I know if we qualify for the small business tax credit, how does it work, and when does it phase out?

There are two phases of this program. Phase One took effect beginning in 2010 and will last through 2013. For an organization to take full advantage of the non-refundable business tax credit under Phase One, they typically must pay 50% or more of the health insurance premium and be deemed a “small employer.” This means they should have 25 or fewer “full-time equivalent” employees with an average annual salary not to exceed $50,000. Employers meeting these criteria will most likely qualify for a credit equal to as much as 35% (25% for non-profits) of the employer expenses. Phase Two will begin in 2014 and expire in 2017. Under Phase Two, employers will qualify if they have less than 10 full-time equivalent employees with an annual wage of less than $25,000, the employer pays 50% or more of the premiums, and the coverage is purchased through the state-based Exchange. If all these criteria are met, the employer is most likely eligible for a tax credit equal to as much as 50% (35% for non-profits) of the employer expenses.

9.    What impact will the elimination of the tax deduction for Medicare Part D retiree drug subsidy have on corporate income taxes?

This change will likely increase the employer’s tax liability, and effectively increase the cost of offering the program to retirees. Prior to the Act, employers offering the drug program were allowed to deduct the full expense of the program even though they were being reimbursed by the government. The new provisions require employers to treat the subsidy as taxable income. The increased tax liability will depend on the total amount of the subsidy for which the employer qualifies, as well as the corporate tax rate to which the entity is subject.

10.    What will be the tax implications for individuals choosing not to purchase qualifying health care coverage?

Beginning in 2014, with few exceptions, all U.S. citizens are required to have health coverage or face a penalty. The amount of the penalty depends on numerous factors, but begins in 2014 and completes a phase-in period by 2016. The increases over the phase-in period are steep; the 2016 penalty could potentially be as much as 2.5% of total household income.

11.    Who qualifies for the premium assistance tax credit and cost sharing subsidies?

Beginning in 2014, families with income between 133% – 400% of the federal poverty level who purchase coverage through the Exchange may qualify for financial assistance. A premium assistance tax credit can be issued to qualifying individuals to help lower their monthly premium. Cost sharing subsidies will also be used to reduce out-of-pocket expenses typically charged by the insurance provider. The amount of assistance is dependent on several actuarial values.

With extensive experience providing financial solutions to clients – from business operation & efficiency assessments to consulting and corporate tax guidance – Don McAnelly is ideally positioned to provide the support today’s businesses need. He serves as Rehmann’s primary CPA contact for health care clients in East Michigan and his experience extends to tax, valuation and financial matters.