In March 2010, Congress enacted President Barack Obama’s signature—although controversial—health care policy proposal. The legislation, commonly dubbed “Obamacare,” was formally titled the “Patient Protection and Affordable Care Act,” P.L. 111-148 and P.L. 11-152 (ACA). The ACA has wide-ranging implications. Not only has the ACA significantly changed the landscape of U.S. health care, it has also prompted strong reactions from the public.
The centerpiece of the ACA is an individual mandate obligating the American public to purchase health care coverage. The individual mandate operates as a “penalty,” which imposes a financial payment obligation on individuals who do not maintain minimum essential health insurance coverage. The ACA also introduced numerous federal tax changes. The ACA was structured to push compliance with the numerous tax law changes for future years.
The ensuing legal challenges to the ACA are well-known and received extensive coverage in the popular media. Not since the 2000 election battle, Bush v. Gore, has a Supreme Court case gained as much public attention as the recent proceedings involving the ACA. Opponents of the ACA were optimistic that the conservative majority of the Supreme Court would strike down the ACA either entirely or, at a minimum, declare the individual mandate unconstitutional. On June 28, 2012, the Supreme Court spoke by issuing a mildly surprising opinion in National Federation of Independent Business v. Sebelius. The majority opinion of Chief Justice John Roberts in National Federation of Independent Business upheld the ACA reasoning that the individual mandate was a “tax” for purposes of the Constitution.
The byproduct of the legal challenges to the ACA generated uncertainty with respect to whether the ACA could survive constitutional scrutiny. As a result, many businesses delayed efforts to prepare for the implementation of the ACA. The Supreme Court’s decision in National Federation of Independent Business at least provides the business community with some much-needed certainty: The ACA will continue to be law in the United States.
If not already doing so, businesses should now begin compliance plans for the many changes that will be ushered in by the ACA. With new taxes becoming effective, businesses will face new compliance issues and deduction limitations. This article identifies some of the more significant tax law changes of the ACA, which become effective in the near term.
Summary of ACA Tax Provisions
While the individual mandate feature of the ACA captured much of the public’s attention, the numerous tax law changes of the ACA may have far more sweeping effects. Below is a summary of several of the tax law changes that are effective beginning in 2013 and 2014.
Increased Medicare Hospital Insurance Tax
For tax years beginning in 2013, the ACA provides for an increase in the Medicare hospital insurance (HI) tax rate. The HI tax is one of two taxes that comprise the Federal Insurance Contribution Act (FICA) taxes imposed on employers. The other FICA tax is the Old Age, Survivors and Disability Insurance tax. FICA taxes are imposed separately on employers and employees. Self-employed individuals pay an alternative tax, which is essentially equal to both the employer and employee portion of the FICA taxes. Employers pay FICA taxes on wages paid in connection with employment, while employees pay FICA taxes on wages received. The HI tax rate is presently equal to 1.45 percent on wages paid and is not subject to a wage cap.
Beginning in 2013, the ACA increases the HI tax rate for certain “high-income” individuals. An additional HI tax is imposed at a rate of 0.9 percent on taxpayers with wages above: (1) $250,000 and filing a joint return; (2) $125,000 if married filing separately; and (3) $200,000 for all others. For employers, the increased HI taxes will require greater compliance monitoring because of the introduction of graduated rates. In other words, employers will need to be prepared to closely monitor wages.
Surtax on Non-Wage Income for High-Income Individuals
For tax years commencing in 2013, the ACA introduces a surtax on certain high-income individuals, which is imposed at 3.8 percent. The base of the surtax is the lesser of either “net investment income” or the portion of a taxpayer’s modified adjusted gross receipts that exceeds the threshold amounts. The threshold amounts are $250,000 for joint returns, $125,000 for married filing separately and $200,000 for all other taxpayers.
Limitation on Contributions to Health FSA
Flexible Spending Accounts (FSAs) have become popular tax-favored features for employer-sponsored health care coverage plans. Employees can contribute pre-tax money to an FSA. Funds held in an FSA can then be used to pay certain qualifying medical-related expenses. Under the ACA, the amount of pre-tax dollars that can be contributed to an FSA will be capped at $2,500.
Imposition of the Comparative Effectiveness Fee
One of the new “fees” introduced by the ACA is the comparative effectiveness fee. The comparative effectiveness fee was codified through amendments to the Internal Revenue Code of 1986, as amended (IRC) to add Sections 4375 and 4376. Generally, the comparative effectiveness fee is imposed on both group health insurance policies and self-insured health plans. Liability for the payment of comparative effectiveness fees to the government turns on the manner in which the health plan is funded. As a practical matter, the economic cost of the comparative effectiveness fee, in all likelihood, will be passed on to end consumers. IRC § 4375 imposes the comparative effectiveness fee on the issuer of most accident and health insurance policies, while IRC § 4376 imposes the comparative effectiveness fee on self-insured health plans.
IRC § 4375 – Specified Health Insurance Policies
Beginning in policy years that end after Sept. 30, 2012, IRC § 4375(a) provides that “each specified health insurance policy” shall pay a fee equal to the sum of $2, and $1 for policy years ending after 2013, multiplied by the number of lives covered by the policy. IRC § 4375(c) defines “specified health insurance policy” to mean “any accident or health insurance policy (including a policy under a group health plan) issued with respect to individuals residing in the United States.” The person arranging to provide the coverage is treated as the issuer for purposes of IRC § 4375. See IRC § 4375(c)(3). Proposed regulations promulgated under IRC § 4375 reiterate that “an issuer of a specified health insurance policy is liable for a fee imposed by Section 4375.” Prop. Reg. § 46.4375-1(a). While the issuer of a specified policy must remit the comparative effectiveness fee to the government, it can be expected that the cost of the fee will be passed through to consumers.
IRC § 4376 – Self-Insured Plans
Employers are liable for payment of the comparative effectiveness fee attributable to self-insured plans. IRC § 4376 provides that the “plan sponsor” must pay the comparative effectiveness fee with respect to self-insured plans. The “plan sponsor” of a self-insured plan means the employer, employee organization, the association board, cooperative or association that maintains the plan. Accordingly, an employer with a self-insured plan will be obligated to pay the comparative effectiveness fee directly to the government.
IRC § 4980I imposes an excise tax, popularly known as the “Cadillac tax,” on the value of certain excess benefits offered under health insurance policies. The Cadillac tax is imposed at the rate of 40 percent. See IRC § 4980I(a). The tax base of the Cadillac tax is the amount of “excess benefits” an employee receives under certain employer-sponsored coverage. See id.
“Each coverage provider” is liable for payment of the Cadillac tax. See IRC § 4980I(c)(1). IRC § 4980I(c)(2) identifies three parties that may qualify as a “coverage provider.” Relevant to the business community, an employer is treated as the coverage provider for purposes of the Cadillac tax for plans that include employer contributions to a health savings account or an Archer medical savings account as described in IRC § 106(b) or (d). See IRC § 4980I(c)(2)(B). The consequence for employers is that employers will incur new compliance obligations, including reporting and payment obligations.
The series of new taxes and fees imposed by the ACA will require greater compliance efforts. For example, employers may now have to begin monitoring the value of health care benefits offered to employees and may be responsible for new reporting obligations. Beginning this year, some of the new taxes and fees will become effective.
In many instances, the ACA taxes and fees will be directly remitted by insurance companies, pharmaceutical companies and/or medical device manufacturers. It can be expected that these costs will ultimately be passed through to consumers.