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2010 Health Care Reform: Tax Considerations

On March 23, 2010, President Obama signed the Patient Protection and Affordable Care Act (Patient Act) into law. On March 30, 2010, the president signed into law a reconciliation bill, the Health Care and Education Affordability Reconciliation Act of 2010, which included substantial changes to the Patient Act. Together, both pieces of legislation make sweeping reforms to health care in the United States.

Tax provisions—individuals

Adoption credit and employer-provided adoption assistance

Prior to the health care reform legislation, the maximum tax credit allowed for qualified adoption expenses for tax year 2010 was $12,170 per eligible child (the credit phased out for taxpayers with modified adjusted gross income between $182,520 and $222,520). Additionally, the adoption credit was scheduled to revert to its pre-2001 level of $6,000 for special needs adoptions (there would be no credit for non-special needs adoptions) beginning in 2011. Prior to the health care reform legislation, the same dollar limits and phase-out range applied to the exclusion of employer-provided adoption assistance from gross income, and no exclusion would be available beginning in 2011.

The health care reform legislation increases the 2010 maximum credit for qualified adoption expenses, as well as the maximum amount of employer-provided adoption assistance that can be excluded from adjusted gross income to $13,170. As was the case before the new legislation, the credit (or the exclusion for employer-provided assistance) will be phased out for taxpayers with adjusted gross income between $182,520 and $222,520. The credit is also made refundable. These limits are also extended for one year, through 2011, and adjusted for inflation.

FSAs, HRAs, HSAs, and Archer MSAs

Tax treatment of over-the-counter medications

For tax years prior to 2011, over-the-counter medications are treated as qualified medical expenses for purposes of flexible spending arrangements (FSAs), health reimbursement arrangements (HRAs), health savings accounts (HSAs), and Archer MSAs. This means that, in the case of FSAs and HRAs, reimbursements can be made for expenses relating to such over-the-counter medications (such reimbursements are excludible from gross income). In the case of HSAs and Archer MSAs, distributions relating to over-the-counter medications are also excludible from gross income.

The health care reform legislation modifies the definition of qualified medical expenses for purposes of employer-provided health coverage (including FSAs, HRAs, HSAs, and Archer MSAs) to match, generally, the definition of qualified medical expenses for purposes of itemized deductions for medical expenses. Beginning in 2011, FSAs and HRAs will not be able to make reimbursements for the cost of over-the-counter medications, and HSA and Archer MSA distributions used to pay for the cost of over-the-counter medications will not qualify for exclusion from income. The two exceptions will be insulin and over-the-counter medications that are prescribed by a physician.

Increase in additional tax for HSAs and Archer MSAs

Distributions from an HSA that are used for qualified medical expenses are excludible from gross income. Distributions from an HSA that are not used for qualified medical expenses are included in income. Unless an exception applies, an additional tax (equal to 10 percent in 2010) is assessed for all HSA disbursements not made for qualified medical expenses. Archer MSAs are also subject to an additional tax (equal to 15 percent in 2010) for disbursements not made for qualified medical expenses.

Beginning in 2011, the health care reform legislation increases the amount of the additional tax that applies to HSA and Archer MSA distributions not made for qualified medical expenses to 20 percent.

Health FSAs in cafeteria plans—limit imposed

Beginning in 2013, in order for a health FSA to be a qualified benefit under a cafeteria plan, the amount available under the FSA for reimbursement of qualified medical expenses cannot exceed $2,500. The $2,500 amount is adjusted for inflation for years after 2013.

This change has no effect on health FSAs that are not part of a cafeteria plan, HRAs, dependent care FSAs, or adoption assistance FSAs.

Increase in Medicare-related taxes for high-income individuals

New additional Medicare payroll tax

There are two components of the Federal Insurance Contributions Act (FICA) employment tax imposed on wages. The old age, survivors, and disability insurance (OASDI) portion of the tax is equal to 6.2 percent of covered wages up to the taxable wage base ($106,800 in 2010). The hospital insurance or HI (commonly referred to as the Medicare payroll tax) portion of the tax is equal to 1.45 percent of covered wages, and is not subject to a wage cap. FICA tax is assessed on both employers and employees (that is, an employer is subject to the 6.2 percent OASDI tax and the 1.45 percent HI tax, and each employee is also subject to a 6.2 percent OASDI tax and 1.45 percent HI tax on wages as well), with employers responsible for collecting and remitting the employees' portion of the tax.

Self-employed individuals are responsible for paying an amount equivalent to the combined employer and employee rates above on net self-employment income (12.4 percent OASDI tax on net self-employment income up to the taxable wage base, and 2.9 percent HI tax on all net self-employment income).

Effective for tax years beginning after December 31, 2012, a new additional hospital insurance tax is imposed on high-wage individuals. These high-wage taxpayers will be subject to an additional hospital insurance tax of 0.9 percent (for a total HI tax rate of 2.35 percent) on wages received that exceed a specific threshold amount:

Threshold amount for purposes of additional HI tax
Married filing joint or surviving spouse $250,000
Married individual filing a separate return $125,000
All others $200,000

Caution: For married individuals filing a joint return, the additional tax is calculated based on the combined wages of both spouses.

Tip: While employers are responsible for collecting and remitting the additional HI tax, an employer will not consider wages received by an employee's spouse. An employer will withhold the additional HI tax on any portion of an employee's wages that exceeds $200,000. Employees are liable for the additional HI tax even if their employer does not withhold the tax from wages. The additional HI tax applies only to the employee portion of the HI payroll tax.

Example(s): (From the Joint Committee on Taxation's Technical Explanation of the legislation, JCX-18-10, March 21, 2010) If a taxpayer’s spouse has wages in excess of $250,000 and the taxpayer has wages of $100,000, the employer of the taxpayer is not required to withhold any portion of the additional tax, even though the combined wages of the taxpayer and the taxpayer’s spouse are over the $250,000 threshold. In this instance, the employer of the taxpayer’s spouse is obligated to withhold the additional 0.9 percent HI tax with respect to the $50,000 above the threshold with respect to the wages of $250,000 for the taxpayer’s spouse.

In the case of a self-employed individual, the additional HI tax applies to self-employment income in excess of the applicable threshold amount. The applicable threshold amount that applies to self-employment income is reduced by any wages taken into account in determining FICA tax for the individual. No deduction for self-employment taxes paid is allowed for the additional HI taxes.

New unearned income Medicare contribution tax

Effective for tax years beginning after December 31, 2012, a new "unearned income Medicare contribution tax" is imposed on high-income taxpayers. The tax applies to individuals, estates, and trusts.

For individuals, the tax is equal to 3.8 percent of the lesser of:

Net investment income, or

  • The excess of modified adjusted gross income (adjusted gross income increased by any foreign earned income exclusion) over the applicable threshold amount
Threshold amount for purposes of unearned income Medicare contribution tax
Married filing joint or surviving spouse $250,000
Married individual filing a separate return $125,000
All others $200,000

Technical Note: In the case of an estate or trust, the tax is 3.8 percent of the lesser of (1) undistributed net investment income, or (2) the excess of adjusted gross income over the dollar amount at which the highest income tax bracket applicable to the estate or trust begins. The tax does not apply to certain trusts, including trusts that are exempt from tax under IRC Section 501, and charitable remainder trusts exempt from tax under IRC Section 664.

Caution: The tax does not apply to nonresident aliens.

Tip: Net investment income is investment income reduced by the deductions properly allocable to such income. Investment income is the sum of (1) gross income from interest, dividends, annuities, royalties, and rents (other than income derived from any trade or business to which the tax does not apply), (2) other gross income derived from any business to which the tax applies, and (3) net gain (to the extent taken into account in computing taxable income) attributable to the disposition of property other than property held in a trade or business to which the tax does not apply.

Tip: Interest on tax-exempt bonds, veterans' benefits, and excluded gain from the sale of a principal residence that are excluded from gross income are not considered net investment income for purposes of the additional tax.

Technical Note: In the case of a trade or business, the tax applies if the trade or business is a passive activity with respect to the taxpayer or the trade or business consists of trading financial instruments or commodities. The tax does not apply to other trades or businesses conducted by a sole proprietor, partnership, or S corporation.

Technical Note: In the case of the disposition of a partnership interest or stock in an S corporation, gain or loss is taken into account only to the extent gain or loss would be taken into account by the partner or shareholder if the entity had sold all its properties for fair market value immediately before the disposition. Thus, only net gain or loss attributable to property held by the entity that is not property attributable to an active trade or business is taken into account.

Tip: Income, gain, or loss on working capital is not treated as derived from a trade or business. Investment income does not include distributions from a qualified retirement plan or amounts subject to self-employment tax.

Itemized deduction for medical expenses

Effective for taxable years beginning after December 31, 2012, the threshold for the itemized deduction of unreimbursed medical expenses is increased from 7.5 percent of adjusted gross income (AGI) to 10 percent of AGI. In other words, beginning in 2013, unreimbursed medical expenses will be deductible on Schedule A of IRS Form 1040 only to the extent that they exceed 10 percent of AGI.

In 2013, 2014, 2015, and 2016, however, if a taxpayer or a taxpayer's spouse turns age 65 before the end of a taxable year, the 7.5 percent AGI threshold continues to apply. Beginning in 2017, the 10 percent AGI threshold will apply to individuals who have reached age 65 as well.

Tip: The alternative minimum tax (AMT) threshold for the deduction of unreimbursed medical expenses, already 10 percent of AGI, remains unchanged.

Premium assistance credit

Effective in 2014, when state exchange programs have been established, a new refundable tax credit will be allowed for individuals and families who purchase health-care insurance through one of the exchanges:

Eligible individuals who enroll in an exchange plan will provide required information regarding income to the exchange.

  • Individuals who qualify will be entitled to a premium assistance credit—this credit will be paid directly to the individuals' insurance plans. Individuals may instead pay costs out-of-pocket and apply for the credit at the end of the year.
  • Individuals are responsible for paying the insurance plan the difference between the total plan premium and the amount of the premium assistance credit.

To qualify for the credit, individuals must have household income between 100 and 400 percent of the Federal poverty level (FPL) determined according to family size, and cannot receive health insurance through an employer or a spouse’s employer.

Household income is defined as the sum of the modified adjusted gross incomes of all individuals taken into account in determining family size (but only if such individuals are required to file a tax return for the taxable year).

Caution: Individuals who are in the country illegally are not included when calculating family size. Individuals who are claimed as dependents on another individual's federal income tax return are ineligible for the credit. Premium assistance credits, or any amounts that are attributable to them, cannot be used to pay for abortions for which federal funding is prohibited, and are not available for months in which an individual has a free choice voucher.

Generally, the credit is calculated to pay for the cost of an exchange plan's premiums, up to the amount by which the cost of the second lowest-cost silver exchange plan (adjusted for age) exceeds a specified percentage of household income, using a sliding scale that goes from 2 percent of income at 100 percent of the FPL to 9.5 percent of income for those with income up to 400 percent of the FPL.

Tip: The credit is available for any plan purchased through an exchange. However, the credit amount is limited to the amount by which the cost of the second lowest-cost silver exchange plan (adjusted for age) exceeds the relevant percentage of family income. If a plan's actual premiums are less than this calculated credit amount, the full amount of the premium may be covered by the credit. If the plan in which an individual enrolls offers benefits in addition to essential health benefits, the portion of the premium that is allocable to those additional benefits is disregarded in determining the premium assistance credit amount.

Individuals who are offered adequate health coverage through an employer plan are not eligible for the credit, unless:

  1. The plan’s share of provided benefits is less than 60 percent, or the coverage is considered unaffordable (unaffordable is defined as coverage with a premium required to be paid by the employee that is 9.5 percent or more of the employee’s household income), and
  2. The individual declines to enroll in the employer's coverage and satisfies the conditions for receiving a tax credit through an exchange

Cost sharing subsidies for individuals

Individuals with household income more than 100 percent but less than or equal to 400 percent of the federal poverty level (FPL) may qualify for a premium assistance credit (described above) beginning in 2014. Yet, out-of-pocket costs associated with a plan (e.g., co-payments, deductibles) may make it difficult for low-income individuals and families to receive adequate care.

For that reason, a cost-sharing subsidy is provided to reduce out-of-pocket cost for individuals and households that qualify for the premium assistance credit. For individuals with household income of more than 100 but not more than 200 percent of FPL, the out-of-pocket limit is reduced by two-thirds. For those with income of 201 to 300 percent of FPL, the out-of-pocket limit is reduced by one-half, and for those with income of 301 to 400 percent of FPL, the limit is reduced by one-third.

Cost-sharing subsidy basics:

  • A program will be established for determining eligibility
  • The plan is notified that the individual is eligible and the plan reduces the cost-sharing by reducing the out-of-pocket limit under the provision
  • The U.S. Department of Health and Human Services will make payments to the plan equal to the value of the reductions in cost-sharing

Tip: Any premium assistance tax credits and cost-sharing subsidies provided to an individual are disregarded for purposes of determining that individual’s eligibility for benefits or assistance, or the amount or extent of benefits and assistance, under any federal program or under any state or local program financed in whole or in part with federal funds. Specifically, any amount of premium tax credit provided to an individual is not counted as income, and cannot be taken into account as resources for the month of receipt and the following two months. Any cost sharing subsidy provided on the individual’s behalf is treated as made to the health plan in which the individual is enrolled and not to the individual.

Caution: Special rules apply to American Indians and undocumented aliens.

Excise tax on individuals without adequate health coverage

Beginning 2014, U.S. citizens and legal residents will generally be required to maintain adequate health care coverage, or face a penalty tax. Acceptable coverage will include:

  • Government-sponsored programs including Medicare, Medicaid, Children’s Health Insurance Program, coverage for members of the U.S. military, veterans health care, and health care for Peace Corps volunteers
  • Eligible employer-sponsored plans including governmental plans, church plans, grandfathered plans, and other group health plans offered in the small or large group market within a state
  • Plans in the individual market
  • Grandfathered group health plans
  • Other coverage recognized by the U.S. Department of Health and Human Services and the Treasury Department

Individuals who are exempt from the requirement include those who are incarcerated, those not legally present in the United States, and those who qualify for religious exemption. If an individual is a dependent, the person entitled to claim the individual as a dependent is liable for any penalty due.

The penalty excise tax will be equal to the greater of a percentage of income or a specific dollar amount. In 2016, when the penalty tax is completely phased in, the tax will be equal to the greater of:

  • 2.5 percent of the amount of a taxpayer's household income for the taxable year that exceeds the threshold amount required to make it necessary to file an income tax return for the year (generally the threshold amount equals the standard deduction the taxpayer is entitled to plus personal exemption amounts)
  • $695 per uninsured adult in the household (half that amount for each uninsured individual under age 18)

The total annual household penalty may not exceed either:

  • 300 percent of the per-adult dollar amount (300% x $695 = $2,085 for 2016)
  • The national average annual premium for bronze level health plans offered through the exchange that year for the household size

The tax is phased in as follows:

 Tax equals greater of: Â
Year % of household income exceeding threshold Specific dollar amount Maximum household penalty
2014 1% $95 $285
2015 2% $325 $975
2016 2.5% $695 $2,085

For years after 2016, the $695 is indexed for inflation.

Tip: The penalty tax is assessed on a monthly basis. Therefore, the annual penalty tax would be divided by 12 to determine a monthly penalty tax amount.

Individuals who cannot afford coverage because their required contribution for employer-sponsored coverage (or the lowest cost bronze plan in the local exchange) exceeds 8 percent of household income for the year are exempt from the penalty. Taxpayers with income below the income tax filing threshold are also exempt from the penalty. All members of Indian tribes are exempt from the penalty as well.

Other provisions

  • Indoor Tanning Tax: For services performed on or after July 1, 2010, a 10 percent tax is assessed on amounts paid for indoor tanning services. The tax is paid by the individual on whom the indoor tanning services are performed, but if the tax isn't paid by an individual at the time payment for the tanning service is received, the person performing the service must pay the tax.
  • Medical care expenses for children under age 27: Effective March 30, 2010, the general income exclusion for reimbursements for medical care expenses under an employer-provided accident or health plan, as well as the income exclusion for the value of employer-provided health insurance coverage, are extended to any child of an employee who has not attained age 27 as of the end of the taxable year. Self-employed individuals may take a deduction for the cost of health insurance coverage for any child who has not attained age 27 as of the end of the taxable year.
  • Student Loan Repayment Programs: Effective retroactively to amounts received in tax years beginning after December 31, 2008, gross income exclusion rules are modified to allow the exclusion of amounts received under the National Health Service Corps (NHSC) repayment program and State student loan repayment programs intended to provide for the increased availability of health care services in underserved or health professional shortage areas.

Tax provisions—businesses

Small business tax credit

A new general business tax credit is established for qualified small employers who contribute at least 50 percent of the premium cost of a qualifying health plan offered to employees.

Qualified small business employers are defined as employers with fewer than 25 full-time equivalent employees (FTEs) employed during the taxable year, and whose employees have annual full-time equivalent wages that average less than $50,000. However, the full amount of the credit is available only to employers with 10 or fewer FTEs and whose employees have average annual full-time equivalent wages of not more than $25,000.

Full-time equivalent employees (FTEs) - FTEs are calculated by totaling all hours worked by all employees during the tax year, and dividing the result by 2080. For purposes of the calculation, the maximum number of hours that can be attributed to an individual employee is 2080.

Average full-time equivalent wages - Average annual full-time equivalent wages are calculated by dividing total wages paid by the number of FTEs, and rounding down to the nearest $1,000.

Tip: Seasonal workers' hours and wages are not counted in determining FTEs and average annual wages of the employer unless they work for more than 120 days during the taxable year.

The $50,000 and $25,000 wage limits described above will be adjusted for inflation beginning in 2014.

Tip: The credit can be applied against alternative minimum tax (AMT) liability.

For taxable years beginning in 2010, 2011, 2012, and 2013:

  • The credit applies to qualifying employers who purchase health insurance coverage for employees from a licensed insurance company
  • The full credit is equal to 35 percent of the lesser of (1) the amount of contributions the employer made on behalf of employees during the taxable year for the qualifying health coverage and (2) the amount of contributions that the employer would have made during the taxable year if each employee had enrolled in coverage with a small business benchmark premium

For taxable years beginning after 2013:

  • The credit is available only to qualifying employers that purchase health insurance coverage for employees through a state exchange
  • The credit is available for a maximum coverage period of two consecutive years, beginning with the first year in which the employer offers one or more qualified plans to employees through an exchange (not counting taxable years beginning before 2014)
  • The full credit is equal to 50 percent of the lesser of (1) the amount of contributions the employer made on behalf of employees during the taxable year for the qualifying health coverage and (2) the amount of contributions that the employer would have made during the taxable year if each employee had enrolled in coverage with a small business benchmark premium

Tip: The benchmark premium is the average total premium cost in the small group market for employer-sponsored coverage in the employer’s state. The premium and the benchmark premium vary based on the type of coverage provided to the employee.

Credit reduction

The credit is reduced for employers with more than 10 FTEs (employers with more than 25 FTEs are not eligible for the credit). The credit is also reduced for an employer when average wages per employee is more than $25,000 (if average wages are $50,000 or more, the employer doesn't qualify for the credit).

Where an employer has more than 10 FTEs, the otherwise allowable credit is reduced by an amount equal to the amount of credit determined before the reduction (1) multiplied by the number of FTEs in excess of 10, and (2) divided by 15.

Where average wages exceed $25,000, the amount of the reduction is equal to:

  • The amount of the credit (determined before any reduction) multiplied by
  • The average annual wages of the employer in excess of $25,000 divided by $25,000

For an employer with both more than 10 FTEs and average annual wages in excess of $25,000, the reduction is the sum of the amount of the two reductions.

Tip: There are special rules for tax exempt organizations. A 501(c) organization that is exempt under IRC Section 501(a) is eligible for the credit. However, for tax-exempt organizations, the credit percentage for 2010, 2011, 2012, and 2013 is 25 percent (rather than 35 percent), and the credit percentage for taxable years beginning in years after 2013 is 35 percent (rather than 50 percent). A tax-exempt organization is eligible to apply the tax credit against liability as an employer for payroll taxes for the taxable year, but is not eligible for a credit in excess of the amount of these payroll taxes.

Caution: Self-employed individuals, including partners and sole proprietors, 2 percent shareholders of S corporations, and 5 percent owners of an employer are not treated as employees for purposes of this credit. Sole proprietorships are not entitled to the credit by virtue of employing family members, and these individuals are not taken into account in determining the number of FTEs or average full-time equivalent wages.

"Simple" cafeteria plans

Beginning in 2011, a new safe harbor is established for eligible small employers who maintain a cafeteria plan. Under the safe harbor, a cafeteria plan and the qualified benefits available under the plan (including group term life insurance, benefits under a self-insured medical expense reimbursement plan, and benefits under a dependent care assistance program) are treated as complying with all nondiscrimination rules if the plan satisfies minimum eligibility and participation requirements, and minimum contribution requirements.

To be eligible for the safe harbor provision, an employer cannot have employed an average of more than 100 employees on business days during either of the two preceding years. If an employer is eligible for the safe harbor provision, establishes a cafeteria plan for employees, and maintains the plan without interruption, the employer will be deemed to be an eligible small employer for purposes of the safe harbor rule until the employer employs an average of 200 or more employees on business days during any preceding year.

Employee eligibility requirements

All employees must be eligible to participate in the cafeteria plan, and each eligible employee must be able to elect any benefit available under the plan (subject to the terms and conditions that apply to all participants).

Exceptions—a plan can exclude:

  • Employees who have not attained the age of 21 (or a younger age provided in the plan) before the close of a plan year
  • Employees who have fewer than 1,000 hours of service for the preceding plan year
  • Employees who have not completed one year of service with the employer as of any day during the plan year
  • Employees who are covered under a collective bargaining agreement if the benefits covered under the cafeteria plan were the subject of good faith bargaining between employee representatives and the employer, or
  • Employees described in section 410(b)(3)(C) (relating to nonresident aliens working outside the United States)

An employer may have a shorter age and service requirement, but only if such shorter service or younger age applies to all employees.

Minimum contribution requirement

The employer must provide a minimum contribution for each employee who is not a highly compensated employee or a key employee that can be applied toward the cost of any qualified benefit (other than a taxable benefit) offered under the plan. There are two methods to meet the minimum contribution requirement:

Nonelective contribution method—An amount equal to at least 2 percent (a uniform percentage must be used) of each employee's compensation for the plan year, determined without regard to whether an employee makes a salary reduction contribution under the cafeteria plan

  • Minimum matching contribution—The lesser of (1) 200 percent of the amount an employee elects to contribute via salary reduction for the plan year, or (2) 6 percent of the employee's compensation for the plan year.

Penalty tax for employers who fail to provide adequate health coverage

Beginning in 2014, an excise penalty tax will be assessed on an employer who meets all three of the following conditions:

  1. The employer qualifies as an applicable large employer. An employer is an applicable large employer with respect to any calendar year if the employer had an average of at least 50 full-time employees during the preceding calendar year.
  2. The employer fails to provide adequate health coverage. An employer will be considered to fail to provide adequate coverage if the employer: (a) does not offer coverage for all full-time employees, (b) offers coverage that is unaffordable, or (c) offers coverage that consists of a plan under which the plan’s share of the total allowed cost of benefits is less than 60 percent.
  3. Any full-time employee is certified to the employer as having purchased health insurance through a state exchange with respect to which a tax credit or cost-sharing reduction is allowed or paid to the employee.

Tip: An employer is not treated as employing more than 50 full-time employees if the employer’s workforce exceeds 50 full-time employees for 120 days or fewer during the calendar year and the employees that cause the employer’s workforce to exceed 50 full-time employees are seasonal workers.

Tip: In determining whether an employer is an applicable large employer, a full-time employee (for any month, an employee working an average of at least 30 hours or more each week) is counted as one employee and all other employees will be counted on a prorated basis.

Tip: The number of full-time equivalent employees that must be taken into account for purposes of determining whether the employer exceeds the threshold is equal to the aggregate number of hours worked by non-full-time employees for the month, divided by 120 (or another number as provided by regulations).

Amount of the penalty excise tax—no health-care coverage offered to full-time employees

For employers who fail to offer health care coverage to full-time employees, and receive certification that at least one full-time employee has enrolled in health insurance coverage purchased through a state exchange with a premium tax credit or cost-sharing reduction allowed or paid, the penalty excise tax is equal to the number of full-time employees over a 30-employee threshold during the applicable month multiplied by one-twelfth of $2,000:

(Number of full-time employees - 30) x ($2,000/12)

This is true regardless of how many employees are receiving a premium tax credit or cost-sharing reduction.

Amount of the penalty excise tax—health care coverage offered to full-time employees

Employers who offer health care coverage to full-time employees may also face a penalty excise tax for any full-time employee certified as having enrolled in health insurance coverage purchased through a state exchange with a premium tax credit or cost-sharing reduction allowed or paid to such employee. A full-time employee who declines to enroll in an employer's health care coverage may be eligible for a premium tax credit and cost sharing reductions as a result of joining a state exchange in one of two circumstances:

The employer health care coverage consists of a plan under which the plan's share of the total allowed cost of benefits is less than 60 percent.

  1. The employer health care coverage is considered unaffordable for that employee. Unaffordable is defined as coverage with a premium required to be paid by the employee that is more than 9.5 percent of the employee’s household income.

In this case, the penalty, assessed on a monthly basis, equals one-twelfth of $3,000 for each full-time employee receiving a premium tax credit or cost-sharing subsidy through a state exchange for any month. The penalty tax is, however, capped at an amount equal to the excise penalty tax that would be due if the employer did not offer health-care coverage at all.

Example(s): (From the Joint Committee on Taxation's Technical Explanation of the legislation, JCX-18-10, March 21,2010) In 2014, Employer A offers health coverage and has 100 full-time employees, 20 of whom receive a tax credit for the year for enrolling in a state exchange offered plan. For each employee receiving a tax credit, the employer owes $3,000, for a total penalty of $60,000. The maximum penalty for this employer is capped at the amount of the penalty that it would have been assessed for a failure to provide coverage, or $140,000 ($2,000 multiplied by 70 (100-30)). Since the calculated penalty of $60,000 is less than the maximum amount, Employer A pays the $60,000 calculated penalty. This penalty is assessed on a monthly basis.

Free choice vouchers

Beginning in 2014, employers who offer an employer-sponsored health care plan and pay a portion of the cost of coverage must provide qualified employees with a voucher to be applied to the cost of purchasing a health plan through a state exchange.

A qualified employee is an employee:

Whose required contribution for his or her share of the cost of the employer-sponsored health-care coverage is greater than 8 percent of household income for the taxable year, but does not exceed 9.8 percent of household income

  • Whose total household income does not exceed 400 percent of the poverty line for the family, and
  • Who does not participate in the employer’s health plan

The value of the voucher is equal to the dollar value of the employer contribution to the employer offered health plan. The value of the voucher is for self-only coverage unless the individual purchases family coverage in the state exchange. In the case of years after 2014, the 8 percent and the 9.8 percent are indexed to the excess of premium growth over income growth for the preceding calendar year.

Excise tax on "Cadillac" plans

Beginning in 2018, an excise tax will be imposed on insurers if the aggregate value of employer sponsored health insurance coverage for an employee exceeds a threshold amount.

The tax is equal to 40 percent of the amount by which the value of coverage exceeds the threshold amount. For 2018, the threshold amount is $10,200 for individual coverage and $27,500 for family coverage, adjusted to reflect any actual growth in health-care costs exceeding projected growth, and adjusted for age and gender.

In the case of a self-insured group health plan, a health FSA or an HRA, the excise tax is paid by the plan administrator. Where the employer acts as plan administrator to a self-insured group health plan, a health FSA or an HRA, the excise tax is paid by the employer. Where an employer contributes to an HSA or an Archer MSA, the employer is responsible for payment of the excise tax.

The threshold amounts are increased for an individual who:

  • Has attained age 55, is non-Medicare eligible, and is receiving employer-sponsored retiree health coverage, or
  • Is covered by a plan sponsored by an employer, the majority of whose employees covered by the plan are engaged in a high-risk profession or employed to repair or install electrical and telecommunications lines

For these individuals, the threshold amount in 2018 is increased by $1,650 for individual coverage or $3,450 for family coverage.

Tip: Employees considered to be engaged in a high-risk profession are law enforcement officers, employees who engage in fire protection activities, individuals who provide out-of-hospital emergency medical care (including emergency medical technicians, paramedics, and first-responders), individuals whose primary work is longshoring, and individuals engaged in the construction, mining, agriculture (not including food processing), forestry, and fishing industries. A retiree with at least 20 years of employment in a high-risk profession is also eligible for the increased threshold.

Other provisions

Beginning in 2011, employers must disclose on Form W-2 the value of an employee's health insurance coverage sponsored by the employer.

  • Effective 2013, the current rule that allows the sponsor of a qualified retiree prescription drug plan to claim a deduction for retiree prescription drug expenses without regard to any subsidy payments received is eliminated; the deduction that would otherwise be allowed must be reduced by the amount of excludible subsidy payments received.
  • Beginning in 2014, an annual fee will be assessed on health insurance providers. The aggregate amount of the fee ($8 billion for calendar year 2014) will be apportioned among providers based on market share.
  • Reimbursements or premium payments for qualified health plans offered through a state exchange are not considered qualified benefits under a cafeteria plan. An exception will exist for "qualified employers" (generally, employers that employed an average of not more than 100 employees—not more than 50 employees, in some circumstances—and elect to make all full-time employees eligible for one or more state exchange health plans).

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