The Affordable Care Act, enacted in 2010, continues to challenge taxpayers with its rolling effective dates -- something new every year.
This year, especially as we approach a transition between rules applicable to 2014 and 2015, the ACA brings a new set of challenges, as well as raising some holdover concerns from last year. Although certain of the newer ACA provisions require year-round vigilance, others can be "tweaked" during the last quarter in 2014 to yield some favorable tax benefits ... or at least they might help reduce some unfavorable results.
EMPLOYER MANDATE
Effective Jan. 1, 2015, the act's employer shared responsibility requirements (the "employer mandate") take effect for applicable large employers. A one-year delay, however, is carved-out for ALEs that are midsized employers with an average of at least 50 but fewer than 100 full-time employees, including full-time-equivalent employees. Measurements keyed to 2014 data highlight the benefit of 2014 year-end assessment and planning with respect to these rules.
An employee is a full-time employee for employer-mandate purposes if they work on average at least 30 hours a week. Final regulations provide that 130 hours of service in a calendar month is treated as the monthly equivalent of at least 30 hours of service per week. Although bills in Congress have been introduced to raise that, odds are that nothing will be in time to impact 2014 strategies.
Midsized employers. The average number of full-time employees for purposes of calculating "applicable large employer" status is calculated by taking the sum of the total number of full-time employees (including any seasonal workers) for each calendar month in the preceding calendar year, and the total number of FTEs (including any seasonal workers) for each calendar month in the preceding calendar year, and dividing by 12. The result is rounded to the next lowest whole number. If the result is 50 or more, the employer is an ALE for the current year, unless the seasonal worker exception applies.
For 2015, the first year of the mandate, the "preceding calendar year" is 2014. Under transition relief for 2015, when counting full-time employees in 2014 the employer only needs to look at any six-month period during 2014, rather than the whole calendar year. As explained, full-time means 30 hours per week. Converting full-time positions to part-time equivalents (e.g., making a 40-hour-per-week position into two 20-hour-per-week positions) would not enable an employer to escape ALE status (though it might reduce exposure to liability if the employer is an ALE).
During the period beginning Feb. 9, 2014, and ending on Dec. 31, 2014, an employer must make no reduction in the size of its workforce or the overall hours of service of its employees with the purpose of satisfying the workforce size requirement under the employer mandate. A reasonable business reason for a reduction in staff, however, does trump this rule. "Reasonableness," especially for year-end dismissals or other staff changes, should be carefully documented.
Seasonal worker exception. Especially relevant for some year-end holiday-intensive businesses, the ACA provides a special exception for employers with seasonal employees. An employer will not be liable for the employer mandate if the employer's workforce exceeds 50 full-time employees (including FTEs) for 120 or fewer days during the year; and its employees in excess of 50 employed during the 120-day period are seasonal.
CODE SEC. 45R CREDIT
An ACA-created Code Sec. 45R credit allows a qualified small employer to help offset the cost of health insurance coverage for its employees. For tax years beginning in 2014 or later, the Code Sec. 45R credit reaches 50 percent of premiums paid for small-business employers and 35 percent of premiums paid for small tax-exempt employers.
A qualified small employer must have fewer than 25 FTE employees with average wages of less than $50,800 (for 2014, as adjusted for inflation). FTE employees for the under-25 employee cutoff is determined by counting hours worked over the course of the entire year under consideration (for example, 2014 in determining qualification for the Code Sec. 45 credit in 2014). The enhanced credit beginning in 2014 is only available for two consecutive years and only to qualified small employers who offer one or more qualified health plans through an exchange.
INDIVIDUAL MANDATE
Effective Jan. 1, 2014, the ACA requires individuals to carry minimum essential health insurance coverage for each month or make an individual shared responsibility payment, unless the individual qualifies for an exemption. Individuals liable for a shared responsibility payment during 2014 will make their payment when they file their 2014 returns.
For the individual shared responsibility payment, an individual is considered to have minimum essential coverage for the entire month as long as they have minimum coverage for at least one day during that month. The penalty is computed on a monthly basis.
Exemptions. An individual may qualify for an exemption from the requirement to carry minimum essential coverage. There are exemptions for members of federally recognized Native American nations, individuals whose income is below the minimum threshold for filing a tax return, incarcerated individuals, persons not lawfully present in the U.S., members of health-sharing ministries, short lapses for a period of less than three months, and individuals having a hardship that makes them unable to obtain coverage.
Shared responsibility payment. The individual shared responsibility payment amount is the greater of a percentage of household income or a flat dollar amount, but is capped at the national average premium for a Bronze-level health plan available through the Marketplace. An individual will owe one twelfth of the annual payment for each month that they (or dependent(s)) do not have coverage or do not qualify for an exemption. For 2014, the annual payment amount is the greater of: 1 percent of household income that is above the tax return filing threshold for the taxpayer's filing status, or the flat dollar amount, which is $95 per adult and $47.50 per child, limited to a family maximum of $285.
For the 2014 penalty, which is computed for each month of non-coverage, the minimum filing threshold and total household income is keyed to annual (and not monthly) 2014 data taken from 2014 tax year returns filed (or exempt from filing) in 2015. Household income is adjusted gross income plus any excludible foreign earned income and tax-exempt interest; it also includes the incomes of all dependents who are required to file tax returns. The tax return filing threshold is the amount of gross income that an individual of the taxpayer's age and filing status must make to be required to file a tax return.
MEDICAL DEDUCTION
The medical expense deduction underwent significant changes in the ACA - changes that taxpayers are continuing to take into account. Effective for tax years beginning after Dec. 31, 2012, the 7.5 percent adjusted gross income threshold for itemized medical expense deductions generally increases to 10 percent. However, there is a carve-out for taxpayers (or their spouses) who are 65 or older before the close of the tax year; they may continue to apply the 7.5 percent threshold for tax years through 2016. The AMT threshold for itemized deductions remains unchanged at 10 percent for all taxpayers, including seniors.
For deductions by cash-basis taxpayers in general, including for purposes of the medical expense deduction, a deduction is permitted only in the year in which payment for services is actually made. Under this general rule, payment by credit card constitutes payment in the year the charge is made, as opposed to the year in which the credit card statement is paid. Prepayment of medical expenses prior to the year in which services are rendered, however, generally does not accelerate the deduction, absent some legitimate payment-in-advance requirement of the service provider.
HEALTH FSAs
Annual contributions to health flexible spending arrangements are capped at $2,500 (as inflation adjusted) under the ACA. Any salary reductions in excess of $2,500 will subject an employee to tax on distributions from the health FSA.
In late 2013, the IRS announced relief from the "use-or-lose" rule for health FSAs by allowing a new up-to-$500 carryover option for year-end balances. Employers may amend their cafeteria plan documents to provide for this. The up-to-$500 carryover amount will not count toward the following year's $2,500 inflation-adjusted salary-reduction limit. Any unused amount above $500 will be forfeited.
The 2-1/2 month grace period for covered medical expenses after year-end and the new carryover of up to $500 are optional; and they are an either/or option - the plan can't offer both. Employees need to check what option is available for 2014; if the $500 carryover applies, spending down all of their elected contribution less $500 by year-end is critical. In those cases, the grace period will no longer apply.
ADDITIONAL MEDICARE TAX
The ACA's Additional Medicare Tax increases the employee-share of Medicare tax by an additional 0.9 percent of covered wages in excess of certain "higher-income-level" threshold amounts, and increases Medicare tax on self-employment income by an additional 0.9 percent of self-employment income in excess of certain threshold amounts. It is not imposed until an individual's covered wages, compensation and/or self-employment income exceed the threshold amount.
The threshold amounts are: $200,000 for single individuals (and heads of household); $250,000 for married couples filing a joint return; and $125,000 for married individuals filing separate returns. Thus, single individuals liable for the Additional Medicare Tax pay 1.45 percent Medicare tax on the first $200,000 of compensation plus 2.35 percent (1.45 percent plus 0.9 percent) on compensation in excess of $200,000. These threshold amounts are not indexed for inflation. There is no change in the threshold amounts from 2013 to 2014; nor will there be for 2015 unless Congress says otherwise.
Withholding. Employers are required to collect Additional Medicare Tax with respect to wages earned for duties performed by the employee for the employer only to the extent the employer pays wages to the employee in excess of $200,000 in a calendar year. The thresholds for Additional Medicare Tax liability are (as discussed) above this amount.
Taxpayers who now discover that they had insufficient income tax withholding may request that their employer(s) take out an additional amount of income tax withholding before year end. That amount will then be applied against taxes shown on the taxpayer's individual income tax return, including any Additional Medicare Tax liability. Taxpayers may also consider making higher estimated tax payments.
NII TAX
The ACA also imposes another surtax, the Net Investment Income Tax, which is also not directly related to healthcare but nevertheless very much in play in connection with year-end tax planning. Starting in 2013, a 3.8 percent Net Investment Income Tax applies to individuals who have NII and whose "modified" AGI exceeds specified statutory thresholds. The tax is the lesser of the NII for the year or the excess of MAGI over the threshold amount (which are the same as those used by the ACA for the Additional Medicare Tax). MAGI is AGI increased by foreign income exclusions and deductions allowed by Code Sec. 911.
For 2013, taxpayers had a choice of cherry-picking whether to use the 2012 proposed regulations or the 2014 final regulations. For 2014, however, taxpayers must follow the final regulations.
AGI management. Threshold income is essentially any taxable income, not just income treated as NII. Thus, distributions from a qualified pension plan are not treated as NII, but are included in AGI when applying the thresholds. Tax-exempt income, such as interest from tax-exempt bonds, is not counted toward the threshold and, being nontaxable, is not included in NII. Thus, one year-end strategy is to reduce threshold AGI and, where practicable, keep it below the applicable threshold. This can be done by shifting some investments to tax-exempt income; by spreading taxable income over two or more years (for example, by selling high-profit assets in an installment sale); or by reducing compensation by contributing to transportation plan benefits or cafeteria plan benefits (child care, health care). Above-the-line deductions that reduce gross income, such as contributions to an IRA, are also useful. All may figure into year-year planning.
Passive activity management. NII includes income from passive activities. Taxpayers involved in two or more income-producing activities should consider whether to group the activities. If done properly under Code Sec. 469, grouped activities may together satisfy the material participation standard, whereas an ungrouped activity might separately fail to satisfy the standard. Taxpayers can only regroup activities in the first year that they become liable for the NII tax. If the first year is 2014, regrouping should definitely be considered. If this was 2013, taxpayers should investigate whether they can elect regrouping on an amended return (although those opportunities are limited). In planning, taxpayers should keep in mind that grouping activities may require the disposition of all of the grouped activities before passive losses may be claimed in excess of passive income under the passive loss rules.
While material participation is a facts-and-circumstances determination, so that suddenly materially participating at year end does not cure all, certain numerical thresholds might be achieved through greater year-end activity. For example, real estate professional status for purposes of being excluded from NII may be achieved under a 500-hour-per-year safe harbor.
Losses -- trading. In a change from the 2012 proposed regulations, the 2013 final regulations allow taxpayers in the trade or business of trading in securities to net gains and losses from trading. Moreover, excess losses can be deducted as "properly allocable deductions" and can be used to offset other net investment income items. Taxpayers should carefully track losses so that they can be used to reduce NII, especially as part of an overall year-end strategy.
Trusts. Trusts are also subject to the NII. The tax applies to the lesser of the trust's undistributed NII for the year, or the excess of the trust's AGI over the dollar amount at which the highest income tax bracket begins for trusts. Unlike the thresholds for individuals, this income tax rate is indexed for inflation. For 2014, it starts at $12,150. Since trust income is subject to NII at a low threshold, it is important for trusts to make distributions to their beneficiaries, unless the trust needs to retain amounts for other administration purposes.
CONCLUSION
The Affordable Care Act continues to add to the complexity of "normal" year-end tax planning. Much of ACA compliance and penalty assessment are keyed to the calendar tax year. Further, tax principles within that framework are intertwined, both in connection with health-care-related ACA provisions and those unrelated, such as the NII and Additional Medicare Taxes. In addition to "traditional" year-end tax planning considerations, therefore, tax practitioners must now get used to dealing with the entirely new "ACA" subset of year-end considerations as a result.
George G. Jones, JD, LL.M, is managing editor, and Mark A. Luscombe, JD, LL.M, CPA, is principal analyst, at Wolters Kluwer, CCH.
