- Written by: Sidney Kess, CPA, J.D., LL.M.
The Patient Protection and Affordable Care Act (referred to as ACA or Obamacare) requires employers and health insurance marketplaces to report health coverage for an individual starting with coverage for 2014 (Code Secs. 6055 and 6056). Individuals who claimed the premium tax credit (explained below) on an advance basis or may be eligible to claim it when they file their federal income tax return also have special reporting requirements. Those who failed to carry minimum essential health coverage are subject to a penalty unless they can claim exemption from this individual mandate. Claiming the credit or exemption from the individual mandate is effective for 2014 returns. Drafts of new forms that will be used in the next tax season have been unveiled. Here is an overview of the forms and who must file them.
Third parties such as employers with employer health care plans and the government’s health insurance marketplace (also referred to as exchanges) are required to report certain coverage information to the IRS and to the individual. This information is used by the individual to demonstrate that he/she is covered and therefore exempt from the penalty for not having required coverage.
The information returns include:
- Form 1095-A, Health Insurance Marketplace Statement, which is issued by a Marketplace.
- Form 1095-B, Health Coverage, which is issued by employers offering health coverage. This includes small employers which are exempt from the employer mandate but opt to offer coverage anyway. The form usually is not required for medical flexible spend accounts (FSAs), health reimbursement accounts (HRAs), or in some cases health savings accounts (HSAs), because these plans do not offer minimum essential coverage.
- Form 1095-C, Employer-Provided Health Insurance Offer and Coverage, will be used by large employers (100 or more employees).
There are also transmittal forms to accompany each of these information returns that will be used by the marketplace or employers to send all such returns to the IRS. There is some reporting relief for employers with 100 or fewer employees.
Reporting for the premium tax credit
Individuals can obtain federal assistance in paying for required health coverage in the form of an advanceable, refundable tax credit (Code Sec. 36B). Eligibility for the credit depends on household size and income, modified adjusted gross income, and the applicable federal poverty line. The credit applies only if coverage is obtained through a marketplace.
Form 8962, Premium Tax Credit, is used to claim the credit if an eligible individual did not do so when purchasing health coverage through a marketplace. It is also used to reconcile the credit that was claimed with the amount to which the individual is actually entitled. In other words, the individual may receive a larger credit when filing his/her return or have to repay some or all of the credit previously enjoyed. The discrepancy can result, for example, from a change in income or a change in family size.
The credit can only be claimed on Form 1040 or 1040A; it cannot be claimed on Form 1040EZ.
Note: There is a split in the federal appellate courts on the question of whether the premium tax credit can be claimed by an individual who purchases coverage through the federal exchange (those in the 36 states without their own Marketplaces use the federal exchange. The Circuit for the District of Columbia said there was no authority to give the credit to individuals who buy their coverage through the federal exchange (Jacqueline Halbig v. Sylvia Mathews Burwell, No. 14-5018). The Fourth Circuit said just the opposite (David King. v. Sylvia Mathews Burwell, No. 14-1158).
Claiming exemption from the individual mandate
Generally, every individual must have minimum essential coverage for the entire year (Code Sec. 5000A). There is a box on the tax return (Forms 1040, 1040A, and 1040EZ) labeled “Health care: individual responsibility…Full-year coverage” that should be checked if the taxpayer has minimum essential coverage. Failure to have such coverage can result in a penalty. However, there are certain exemptions from this mandate that can be claimed to avoid the penalty, including:
1. The individual has no coverage for up to three months only.
2. The lowest-priced coverage would cost more than 8% of household income.
3. The individual’s gross income is below the filing threshold.
4. The person is member of a federally recognized Native American tribe.
5. The person is a member of a recognized health care sharing ministry or a recognized religious sect with religious objections to insurance.
6. The person is incarcerated.
7. The individual is not lawfully present in the U.S. (is an illegal alien).
8. The person claims a hardship exemption (e.g., because of being homeless; evicted or facing eviction; having received a utility shut-off notice; experienced domestic violence, had a death of a close family member; went through a disaster causing serious property damage; filed for bankruptcy within the last six months; had medical expenses within the past two years resulting in substantial debt or unexpected increases in necessary expenses caring for a ill, disabled or aging family member; having a dependent child denied coverage in Medicaid or CHIP [exemption from the penalty for the child]; being enrolled in a marketplace plan after an eligibility appeals decision; determined ineligible for Medicaid because of the state not expanding its coverage; the person’s individual health plan was canceled and he/she believes the marketplace plans are unaffordable).
Form 8965, Health Coverage Exemption, is used by an individual to claim exemption from the mandate. Part I is the marketplace-granted exemption. Part II is for an exemption claimed by an individual because of having household income below the filing threshold or gross income below the filing threshold.
This form accompanies any of the individual income tax returns: Form 1040, 1040A, or 1040EZ.
Self-employed Use Credit or Deduction
Self-employed individuals deduct premiums they pay for health coverage for them, spouses, dependents, and any child under age 27 as an adjustment to gross income (Code Sec. 162(l)). However, some self-employed individuals may be eligible for the premium tax credit to help pay for coverage. How do these two tax rules relate to each other? The IRS has provided guidance (Rev. Proc. 2014-41).
The challenge is the fact that the deduction for health insurance premiums for self-employed individuals must be taken into account in determining adjusted gross income for purposes of the premium tax credit. And the amount of the deduction is based on the amount of the premium tax credit. In effect, there is a circular relationship between these two tax breaks. Self-employed individuals who have specified premiums (e.g., basic coverage that the self-employed individual purchases through a marketplace) can use the calculations provided by the IRS to determine their tax breaks.
The calculations use two methods: iterative and alternative. Both are complex but will be built into tax preparation software, which avoids the need to personally make these complex computations. To better understand the interplay between the deduction and credit, the IRS has provided a number of examples.
Credit for small employer health insurance premiums
Eligible small employers that are not non-profit organizations may claim a tax credit if they pay at least 50% of the cost of employee health coverage and purchase their coverage through a Small Business Health Options Program (SHOP) exchange (Code Sec. 45R). An eligible small employer is one that has no more than 25 full-time equivalent employees (FTEs), and the average annual wages of its FTEs do not exceed an amount equal to twice a set dollar amount, which is adjusted annually for inflation for tax years starting in 2014. This dollar amount is $25,000; as adjusted for inflation for 2014, it is $25,400. Final regulations clarify some rules related to this credit (T.D. 9672, 6/26/14).
Form 8941, Credit for Small Employer Health Insurance Premiums, is revised to reflect the new credit limits for 2014: 35% for employers that are tax-exempt entities; 50% for all other employers (which is up from 25% and 35%, respectively, for 2010 through 2013).
Absent any radical change in ACA in the coming months, taxpayers will be seeing new forms next year when they prepare their returns (or sign returns prepared by tax practitioners) for 2014. Draft versions of IRS forms may be viewed at http://apps.irs.gov/app/picklist/list/draftTaxForms.html?indexOfFirstRow=0&sortColumn=sortOrder&value=&criteria=&resultsPerPage=25&isDescending=false.
Sidney Kess, CPA, J.D., LL.M., has authored hundreds of books on tax-related topics. He probably is best-known for lecturing to more than 700,000 practitioners on tax and estate planning.
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- Written by: Sidney Kess, CPA, J.D., LL.M.
Technology continues to expand at an ever-increasing rate and taxes are not immune from the impact of technology on the way in which things get done. Technology has affected how returns are filed, how payments for wages, goods, and services are being made, how the IRS disseminates information, and how recordkeeping is handled. Here is a roundup of some recent technology developments.
In the tax filing season for 2013 income tax returns, the IRS reports that about 88% were filed electronically (IR-2014-56, April 24, 2014). It took more than 15 years to achieve the 80% e-filing goal by 2007 set by the Internal Revenue Service Restructuring and Reform Act of 1998, but it was achieved last year when 82.74% of 2012 returns were filed electronically. In part, this goal has been achieved because tax return preparers (those filing more than 10 tax returns) must do so electronically in most cases (www.irs.gov/Tax-Professionals/Frequently-Asked-Questions:-E-file-Requirements-for-Specified-Tax-Return-Preparers-(sometimes-referred-to-as-the-e-file-mandate).
Of the more than 131 million individual income tax returns filed through April 24, 2014, 35% were filed by individuals using their personal computers. Professionals submitted 53% of individuals’ returns electronically. Direct deposit of tax refunds is another feature of e-filing, with direct deposits accounting for nearly 81% of all refunds.
E-filing for 2013 returns is available through October 15, 2014. Late-filed returns submitted after this date must be filed on paper.
Taxpayers filing amended returns, Form 1040X, must file on paper. These returns cannot be submitted electronically.
Technology has led to the creation of virtual (digital or crypto) currency. In December 2013, the National Taxpayer Advocate, Nina Olsen, renewed its 2008 suggestion that the IRS clarify the tax treatment of virtual currency (IR-2014-3, January 9, 2014). This is important because more than 10,000 merchants now accept bitcoin as payment and thousands of charities do so as well. In fact, as pointed out in the report, in the four months between July and December 2013, bitcoin usage has increased by over 75% and the market value of bitcoins in circulation increased more than ten-fold from about $1.1 billion to $12.6 billion.
The IRS has responded with guidance in question-and-answer format on the tax treatment of bitcoin and other virtual currency (Notice 2014-21, IRB 2014-16, 938). The IRS has taken the position that bitcoin and other virtual currency is property, not currency, so that general principles applicable to property transactions apply to transactions using virtual currency. Here are some of the points addressed in the guidance:
Employees paid in bitcoin or other digital currency have taxable compensation based on the fair market value of the bitcoin (determining fair market value is explained below). Essentially, these payments are viewed as in-kind payments and withholding on these payments is figured in the same way as withholding for other payments in property. There are two ways to figure withholding on these payments: add their value to regular wages for a payroll period and figure withholding taxes on the total, or withhold federal income tax on the value of the payments at an optional 25% rate for supplemental wages.
Self-employed individuals who accept payment for goods or services in bitcoin treat the payment as self-employment income based on the fair market value of the bitcoin at the time of payment. The payment is also taken into account for self-employment tax purposes. Similarly incorporated businesses include payments in virtual currency in income.
The amount reported as income is based on the fair market value of the virtual currency on the date the payment is received. If the virtual currency is listed on an exchange where an exchange rate is established by supply and demand, then this rate can be used.
Payments made via bitcoin are subject to the same information reporting requirements as payments made in regular currency. Payers must issue Form 1099-MISC to contractors when total payments for the year, including the value of the payments in bitcoin or other virtual currency, are $600 or more. If merchants accept bitcoin through a processor and have more than 200 transactions totaling more than $20,000, the processor must issue a Form 1099-K for their virtual currency transactions each year.
Previously, the government provided guidance on bitcoin for money service businesses (MSBs) that are subject to certain federal regulations (Financial Crimes Enforcement Network (FinCEN) Guidance on the Application of FinCEN’s Regulations to Persons Administering, Exchanging, or Using Virtual Currencies [FIN-2013-G001, March 18, 2013]). According to this guidance, the term “currency” is limited to coin and paper money of the United States and any other country where such currency is used as legal tender. Therefore, a user who obtains convertible virtual currency and uses it to purchase real or virtual goods or services is not an MSB under FinCEN’s regulations. Such activity does not fit within the definition of “money transmission services” and thus is not subject to FinCEN’s registration, reporting, and recordkeeping regulations for MSBs.
The IRS and Treasury have yet to clarify the treatment of bitcoin for purposes of foreign account reporting. The National Taxpayer Advocate asked “when should digital currency holdings be reported on a Report of Foreign Bank and Financial Accounts (FBAR), or Form 8938, Statement of Specified Foreign Financial Assets?” In other words, should a digital wallet or account be treated as a foreign account for these reporting purposes?
Keeping up with the IRS
The IRS is disseminating information to the public and tax professionals through social media channels. Here are some venues:
- Facebook has information for tax professionals at https://www.facebook.com/IRS. So far, content is limited.
- IRS2go app can be used on iPhones and Android platforms. The app enables individuals to check the status of federal income tax refunds, order a tax return transcript, and connect to social media sites. The 2014 version is available (www.irs.gov/uac/New-IRS2Go-Offers-Three-More-Features?utm_medium=social&utm_source=facebook&utm_campaign=facebook_tabs).
- Tumblr is a blog providing tax information updates at http://internalrevenueservice.tumblr.com.
- Twitter at @irsnews for the general public and @irstaxpros for tax professionals.
- YouTube (https://www.youtube.com/user/irsvideaos) provides videos explaining the premium tax credit (Code Sec. 38B), tax scams, and more. The videos are in English, American Sign Language, and other languages.
However, the IRS does not contact taxpayers through email. Purported IRS communications in this manner are phishing, and are attempts to obtain taxpayers’ personal information that will be used for identity theft or to obtain tax refunds. The IRS warns taxpayers not to respond to such email and to forward the full original email to the IRS at
Electronic tools for recordkeeping
The Tax Code imposes various recordkeeping requirements in order to take deductions and other positions on tax returns. Fortunately, technology has simplified the recordkeeping process. The IRS has long-recognized the use of electronic accounting software for businesses, such as QuickBooks. The IRS has provided guidance on maintaining the integrity of these records and providing them to the IRS when requested (www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Use-of-Electronic-Accounting-Software-Records;-Frequently-Asked-Questions-and-Answers).
While the IRS has not specifically approved of the use of commercial apps for recordkeeping, there is no reason to believe they are not a valid recordkeeping method. Look for apps that can be used on mobile devices to keep track of such items as:
- Charitable contributions
- Hours worked in a business to establish material participation for the passive activity loss rules (Code Sec. 469) and the 3.8% additional Medicare tax on net investment income (Code Sec. 1411).
- Travel and entertainment costs
- Vehicle mileage for tax-deductible purposes
Stay up-to-date with new technology changes that the IRS is using for consumers and tax professionals.Write comment (0 Comments)
- Written by: Sidney Kess, CPA, J.D., LL.M.
There is a 3.8% additional Medicare tax imposed on trusts and estates that have net investment income over a threshold amount (Code Sec. 1411). This tax is called the net investment income (NII) tax. Final regulations issued in November of 2013 and corrected last month provide some guidance for fiduciaries of estates and trusts (T.D. 9644, 11/26/13; corrections 2/24/14). The regulations generally are effective for tax years beginning after December 31, 2013. However, for 2013, the year for which the NII tax first applies, taxpayers can rely on proposed regulations issued in 2012.
Overview of the NII tax
The NII tax is imposed on the lesser of the trust or estate’s net investment income or the excess of its adjusted gross income over a threshold (Code Sec. 1411(a)(2)). The threshold is the dollar amount for the start of the highest tax bracket for trusts and estates ($11,950 for 2013; $12,150 for 2014).
Adjusted gross income for a trust or estate is generally figured in the same way as for individuals. Special rules apply to certain costs which are paid or incurred in connection with the administration of the estate or trust and which would not have been incurred if the property were not held in such trust or estate (Code Sec. 67(e)). Deductions are provided under Code Secs. 642(b) for personal exemptions (e.g., $600 for estates, $300 for simple trusts, and $100 for complex trusts). Special rules apply to the computation of distributable net income (DNI) under Code. Sec. 651, and for distributing accumulated income or corpus under Code. Sec. 661.
Certain domestic trusts are not subject to the NII tax. These include charitable remainder trusts exempt from tax under Code. Sec. 664 and qualified retirement plan trusts exempt under Code Sec. 501(a). The following are also exempt:
- Trusts where all of the unexpired interests are devoted to charitable purposes (Code Sec. 170(c)(2)(B))
- Grantor trusts (Code Secs. 671-679)
- Electing Alaska Native Settlement Funds (Code Sec. 646)
- Perpetual Care (Cemetery) Trusts (Code Sec. 642(i))
- Trusts not treated as such for federal income tax purposes, such as real estate investment trusts (REITs) and common trust funds
Net investment income
Most trusts and estates will have adjusted gross income over the threshold amount, so they likely will be subject to the NII tax. The amount of tax depends on the entity’s net investment income. Net investment income is simply investment income reduced by investment expenses.
Investment income. It includes such income items as interest, dividends, capital gains (from the sales of stocks, bonds, and mutual funds; mutual fund distributions; and gains from investment property sales), rental and royalty income, non-qualified annuities, income from businesses involved in trading of financial instruments or commodities, and businesses that are passive activities.
Investment income does not include wages, unemployment compensation, operating income from a nonpassive business, Social Security Benefits, alimony, tax-exempt interest, self-employment income, Alaska Permanent Fund Dividends, and distributions from qualified retirement plans and IRAs (those described in Code Sections 401(a), 403(a), 403(b), 408, 408A, or 457(b)).
Whether business income is investment income generally follows the passive activity loss rules (Code Sec. 469). Unless there is material participation, the activity is passive and the income is investment income for purposes of the NII tax. The issue of material participation for estates and trusts is currently under study by the Treasury Department and the IRS and likely will be addressed in regulations under Code Sec. 469 for the passive activity loss rules (Preamble to T.D. 9644; Reg. Sec. 1.469-8 is reserved for this purpose). In the absence of regulations, trusts and estates have only conflicting guidance to review in determining whether material participation should be based solely on the activities of fiduciaries or can take activities of beneficiaries and employees into account.
- IRS position: The participation of a beneficiary or anyone else, other than a trustee with suitable discretion, is not taken into account for purposes of determining material participation and whether the business income is passive (investment) income. For example, one trust named a “special trustee” who happened to be the president of the S corporation owned by the trust. The IRS said that the participation of this special trustee is not taken into account because his activities as president were not in the role as fiduciary (TAM 201317010; see also TAMs 200733023 and 201029014). There are seven tests for material participation (Reg. Sec. 1.469-5T(a). Moreover, special rules apply for “real estate professionals” (the 750-hour test). At present, it is unclear whether the same test would apply to a fiduciary. Instead, the fiduciary must be involved directly in the operations of the business on a “regular, continuous, and substantial” basis.
- Court position: Where a trust owned a ranch and the trustee hired a ranch manager and employees, a district court said that there was material participation for purposes of the passive activity loss rules where the trustee had ultimate decision making authority over the financial matters for the ranch (the case pre-dates the NII tax and did not consider the issue in the context of the NII tax) (Mattie K. Carter Trust, DC TX, 256 F Supp.2d 536 (2003)). The court said “[c]ommon sense dictates that the participation of Carter Trust in the ranch operations should be scrutinized by reference to the trust itself, which necessarily entails an assessment of the activities of those who labor on the ranch, or otherwise in furtherance of the ranch business, on behalf of Carter Trust.”
Note: The Tax Court may weigh in soon in the case of Frank Aragona Trust (Doc.
No. 15392-11) in which the taxpayer argued that in determining material participation with respect to rental properties the trust can perform personal services for purposes of Code Sec. 469 through the personal efforts of a non-trustee.
Investment expenses and other deductions. Investment income is reduced by deductions properly allocable to investment income, such as investment interest expense, investment advisory and brokerage fees, expenses related to rental and royalty income, and state and local income taxes properly allocable to items included in net investment income.
Carryovers allowed for regular tax purposes, such as excess net investment income and unused passive activity losses, can be used as well for the NII tax (special rules apply to net operating losses). However, tax credits that can be used only to offset the regular tax, such as the foreign tax credit and the general business tax, cannot be used to offset the NII tax. If the entity opts to treat foreign taxes as a deduction rather than as a credit, then this item reduces net investment income.
Special computational rules for certain entities
Certain trusts require special computations for the NII tax:
Qualified funeral trusts. Each beneficiary’s interest in that beneficiary’s contract is treated as a separate trust but one consolidated Form 8960 can be completed for all beneficiary contracts subject to the NII tax. Instructions to Form 8960 provide details about the computation.
Electing small business trusts (ESBTs). ESBTs in S corporations figure the NII tax in three steps:
1. The ESBT separately figures the undistributed net investment income of the S portion and non-S portion according to the general rules used for income tax purposes and then combines the undistributed net investment income of the S portion and non-S portion.
2. The ESBT determines AGI for purposes of the NII tax by adding the net income or net loss from the S portion to the AGI of the non-S portion as an income item of income or loss.
3. The ESBT compares the combined undistributed net income with the excess of its AGI over the threshold for the year (e.g., $12,150 for 2014) to determine whether the NII tax applies.
Bankruptcy estates of an individual. The estate of an individual debtor is treated as an individual for purposes of the NII tax. The applicable threshold for the NII tax is the applicable amount for a married person filing separately ($200,000), regardless of the debtor’s actual tax filing status.
Foreign trusts and estates. Distributions to a U.S. person of income from a foreign entity are included in the net investment income calculation of this person (beneficiary). However, distributions of accumulated income from a foreign trust are not taken into account.
In view of the NII tax, which is a nearly 4% tax on net investment income, it may be helpful to employ certain strategies that can reduce or eliminate the tax.
Grantors with multiple beneficiaries may, in certain circumstances, prefer to set up separate trusts for each beneficiary. This will allow each trust to keep no more than the triggering amount of taxable income ($12,150 in 2014) and, thus, avoid the NII tax. On the other hand, a single trust reduces administrative costs and may enable better property management. Separate trust shares should be considered. Thus, tax savings from using multiple trusts should be balanced against the cost and practicalities of a single trust.
An important tax savings strategy for existing trusts and estates is to distribute the income to lower-bracketed beneficiaries. This shifts the onus of the NII tax to beneficiaries who, because of their personal tax status, may not be subject to this tax. If the beneficiaries are exempt from the NII tax, there may be added pressure on fiduciaries to make income distributions in the situation where they have the discretion, under the governing instrument and state law, to do so. Fiduciaries must continue to follow state law rules and the terms in the governing instrument (a trust document or last will and testament) regarding discretionary distributions. Attention should be given to the rules under the Uniform Principal and Income Act and the applicable state law.
Fiduciaries should also maximize the use of the discretionary allocation of expense rule under Reg. Sec. 1.652(b)-3(b)). This allows the fiduciary to allocate expenses to any class of income after the required allocation of direct expenses to the associated income category and the required allocation of a share of indirect expenses to tax-exempt income. For example, if expenses for fiduciary fees, accounting fees, and legal fees can be allocated to categories of income that are investment income, the NII tax exposure is reduced. If the entity holds a business that is considered active (see the discussion of material participation above), not allocating expenses to the category of business income is beneficial because it means the expenses can be allocated to investment income categories. These rules will likely be addressed in forthcoming treasury regulations.
Be sure to factor the NII tax into estimated tax payments for trusts and estates. Estates are not required to pay estimated taxes during the first two years of their existence. Thus, it may be helpful for a revocable living trust of a deceased taxpayer to make a Sec. 645 election to be treated as a qualified revocable trust. This makes the trust part of the estate, for at least two years following the decedent’s death, exempt from aying estimated taxes. The election is made on Form 8855.
Despite lengthy regulations issued last year and extensive instructions to Form 8960 released on February 27, 2014, there are still many open questions regarding the NII tax applicable to trusts and estates, such as how to determine material participation and the deduction allocation provisions. Watch for further guidance from the IRS on this topic.
Sidney Kess, CPA, J.D., LL.M., has authored hundreds of books on tax-related topics. He probably is best-known for lecturing to more than 700,000 practitioners on tax and estate planning.Write comment (0 Comments)
- Written by: Sidney Kess, CPA, J.D., LL.M.
The main provision of the Patient Protection and Affordable Care Act of 2010, otherwise known as the Affordable Care Act (ACA or Obamacare), applies starting in 2014: Each person, other than those who are exempt, must have minimum essential coverage or pay a penalty. Each person must ensure that dependents also have minimum essential coverage or pay a penalty, which is one half of the amount that would be paid by the person. In the words of the U.S. Supreme Court in NFIB v. Sebelius (132 S. Ct. 2566 (2012)), the penalty is a tax and it is collected by the IRS. The rules are very confusing to many people. Here are some of the practical and tax considerations of ACA as of now.
The following information has been prepared with the help of Carolyn McClanahan, M.D., CFP® with Life Planning Partners, Inc., in Florida.
Overview of ACA
The massive law is divided into various titles, some of which may be relevant to your practice while others are not.
- Title I (374 pages) covers quality affordable health care (including the individual mandate)
- Title IX (93 pages) covers the revenue provisions
While the individual mandate contained in Title I is effective starting January 1, 2014, many of the revenue provisions have already taken effect.
Every individual is required to have minimum essential coverage or pay a tax penalty (Code Sec. 5000A) unless a specific exemption applies. The exemptions include:
- Financial hardship
- Religious objection
- Native Americans
- Incarcerated individuals
- Those without coverage for no more than three months
- Those whose premiums exceed 8% of income
Individuals obtain insurance through:
- Large groups (employer plans)
- Small groups (plans of small businesses)
- Individual market (through government exchanges or directly from insurers)
- Public programs (Medicare, Medicaid, Tricare, CHIPs).
Individual policies must meet certain coverage requirements (e.g., provide certain preventive care; have no limits for pre-existing conditions). There are five types of acceptable policies:
- Bronze—these plans limit out-of-pocket costs to 60% of the limits under Health Savings Accounts (HSAs)
- Silver—these plans limit out-of-pocket costs to 70% of the limits under Health Savings Accounts (HSAs)
- Gold—these plans limit out-of-pocket costs to 80% of the limits under Health Savings Accounts (HSAs)
- Platinum—these plans limit out-of-pocket costs to 90% of the limits under Health Savings Accounts (HSAs)
- Catastrophic—for those under age 31, covers three primary care visits and preventive care, then all other expenses that are out-of-pocket subject to the HSA limits.
Enrollment. Open enrollment on the exchanges (called the individual marketplaces) for 2014 began October 1, 2013, and is set to end on March 31, 2014. Open enrollment for 2015 begins on November 15, 2014, and ends on January 15, 2015.
Individuals with income of more than 400% of the federal poverty level (FPL) do not have to purchase coverage through an exchange (they are not eligible for the premium tax credit); they can choose to purchase coverage through an exchange. Alternatively, they can purchase coverage directly from insurance companies (many of which offer online shopping) or through health insurance agents. The 2013 FPL is used to determine eligibility for government assistance with health insurance premiums in 2014. The 2013 400% of the FPL means individuals with income over $45,960 and a family of four with income over $94,200.
Premium tax credit. This credit is available to individuals whose income is between 133% and 400% of the FPL and who meet certain eligibility requirements (Code Sec. 36B). This means buying coverage through an exchange or being ineligible for an employer or government plan, filing jointly if married, and not being claimed as a dependent by another taxpayer.
The amount of the credit is keyed to a percentage of household income, which is modified adjusted gross income (adjusted gross income without regard to the foreign earned income exclusion under Code Sec. 911) of all those taken into account in figuring the size of the household. The applicable percentages are:
- Up to 133% of FPL - 2% of household income
- 133% to 150% of FPL – 3% to 4% of household income
- 150% to 200% of FPL – 4% to 6.3% of household income
- 200% to 250% of FPL – 6.3% to 8.05% of household income
- 250% to 300% of FPL – 8.05% to 9.5% of household income
- 300% to 400% of FPL – 9.5% of household income
The credit can be paid in advance by having it applied to premiums (the “get it now” option). The credit amount in this case is sent directly to the insurance company. Individuals who purchased coverage through an exchange and qualify for the credit but did not opt to have it paid in this manner can claim it as a tax credit on their income tax return (the “get it later” option). Thus, the credit for 2014 will be claimed when the 2014 return is filed in 2015. The credit is fully refundable.
Medicaid is a government program that has traditionally provided health insurance for those under age 65 who are disabled, families with children, or pregnant and meet income requirements. ACA extended Medicaid eligibility to individuals with income less than 138% of the FPL. However, in the 25 states that have not expanded Medicaid coverage to include this income threshold for eligibility, some individuals fall into a gap (some have referred to this as the Medicaid donut hole); they have too little income to obtain a tax credit but do not qualify for Medicaid.
Cost-sharing subsidies. In addition to a tax credit to help cover premiums, some individuals may qualify for assistance with paying their deductibles, co-payments, co-insurance, and out-of-pocket spending limits; this help is called cost-sharing subsidies. Cost-sharing subsidies are available for those who have a silver, gold, or platinum plan and whose household income is between 100% and 250% of the FPL. More specifically, the subsidies are:
- 100% to 150% FPL - covers 94% of expenses
- 151% to 200% FPL – covers 85% of expenses
- 201% to 250% FPL –covers 73% of expenses
For example, an individual whose household income puts her at 200% of the FPL has a silver plan. Ordinarily the plan pays 70% of costs; the individual is responsible for 30% of costs. Cost-sharing subsidies change this equation. The cost-sharing subsidies aren’t paid to the individual; they effectively increase the portion paid by the insurer to 73%. So instead of being responsible for 30% of out-of-pocket costs, this exposure is capped at 27% for this individual.
Employer mandate for large employers
Companies with 50 or more full-time employees (including full-time equivalent employees) must purchase coverage for staff or pay a penalty (Code Sec. 5000A). Part-timers are taken into account in figuring whether an employer is subject to the mandate, but an employer subject to the mandate is only required to provide coverage for full-time employees. Volunteer first-responders are not treated as employees and are not counted in determining the employer mandate (Dept. of the Treasury Letter, 1/14/14; www.scribd.com/doc/198549760/Treasury-Letter-to-Senator-Warner-on-Emergency-Responders).
As a general rule, paying the penalty is less costly than providing required coverage.
The employer mandate, which had been set to take effect on January 1, 2014, has been postponed by the U.S. Treasury until January 1, 2015 (www.treasury.gov/connect/blog/pages/continuing-to-implement-the-aca-in-a-careful-thoughtful-manner-.aspx). Final regulations provide additional relief for employers with 50 to 99 employees; they do not have to comply until January 1, 2016 (T.D. 9655, 2/10/14). However, they must file a prescribed return that they not make changes in their staffing because of ACA.
Figuring the penalty. There are different penalty amounts, depending on whether or not the employer offers coverage and other factors. If an employer does not offer coverage and at least one full-time employee obtains individual coverage using a premium tax credit, then the employer pays a penalty of $2,000 for each employee over 30 employees. There is no penalty on the first 30 employees.
For example, a company has 110 full-time employees and does not provide health insurance in 2015. One employee has income low enough to qualify for a premium tax credit to help pay for coverage obtained through a government exchange (the individual marketplace). The employer’s penalty is $160,000 ($2,000 x [110 employees – 30 employees]).
If the employer offers coverage but a worker declines it and uses the premium tax credit to obtain coverage through a government exchange, then the employer’s penalty is the lesser of $3,000 per employee taking the credit, or $2,000 for each full-time employee. For 2015 only, employers that provide coverage for at least 75% of full-time employees will not be subject to a penalty (T.D. 9655, 2/10/14). Starting in 2016, the penalty applies unless 95% of full-time employees are covered.
Employer coverage need not extend to employees’ spouses; it merely must be offered to employees and their dependents.
Small employers (those with 50 or fewer full-time employees) are not required by ACA to provide health coverage or pay a penalty. Instead, they are incentivized to provide coverage by a special tax credit. If they pay at least half the cost of premiums, they can take a tax credit in 2014 and 2015 of 50% of the cost as long as coverage is obtained through the Small Business Health Insurance Options Program (SHOPs) (Code Sec. 45R). Proposed regulations clarify some details about the small employer health insurance credit (NPRM REG-113792-13, 8/26/13).
To qualify for this credit, an employer must have fewer than 25-full-time equivalent employees (FTEs). Those employees must have average wages of less than $50,400 in 2014. However, a full credit applies only for an employer with no more than 10 FTEs who have average wages not exceeding $25,400 in 2014 (Rev. Proc. 2013-35, IRB 2013-47, 537). Owners and their relatives are not taken into account.
The SHOPs are a way for small businesses to purchase coverage without a broker. SHOPs are open to employers with fewer than 50 employees (fewer than 100 starting in 2016). After 2016, states can allow larger employers to utilize SHOPs. For 2014, there is only one insurance choice in the SHOP; choices are set to be expanded for 2015.
When enacted, it had been expected that between 1.4 and 4 million small businesses would be eligible for the tax credit. However, in 2011, only 228,000 employers actually took the credit. The reasons for the disappointing use of the credit: the limitations on the credit (e.g., restricted payroll), complications in computing the credit (e.g., phase-outs for payroll size and amount), and general ignorance of the credit’s existence.
While there have been numerous attempts to repeal or defund ACA, many of the provisions are already well entrenched, making changes difficult at this point. Still, there could be changes made after the mid-year elections in 2014 if there is a major shift in the Congress.
Sidney Kess, CPA, J.D., LL.M., has authored hundreds of books on tax-related topics. He probably is best-known for lecturing to more than 700,000 practitioners on tax and estate planning.Write comment (0 Comments)
- Written by: Sidney Kess, CPA, J.D., LL.M.
Now that the final quarter of the year is under way, it is an ideal time to focus on year-end tax planning to minimize taxes for this year and be better positioned for next year’s taxes. The government’s shutdown may not have a direct impact on planning, but inflation adjustments, expiring provisions, and other factors will affect tax planning at this time.
As a general rule, year-end planning is a multi-year exercise, taking into account current tax rules, rules for next year, and the taxpayer’s income and expenses now and anticipated for the future. For individuals, projections for cost of living adjustments (COLAs) to dozens of tax rules for 2014 are modest. For example, the personal exemption likely will rise only $50. Similarly small increases are projected for tax brackets, the standard deduction, the alternative minimum tax exemption, and income thresholds for Roth IRA contributions. Official COLAs may not be released until later in the year, but this should not dramatically change from projections; thus they can be used for planning purposes.
Defer income. For most taxpayers, deferring income postpones taxation and the tax bill for a year. Income deferral can be used for:
- Year-end bonuses if the employer offers a deferred compensation option.
- Capital gains by not actualizing profits this year. Of course, this tax strategy should be only one factor in investment decisions; don’t forego market opportunities solely to secure tax savings.
- Business income of cash basis self-employed individuals, who may want to delay year-end billing so that payment is received (and becomes taxable) in 2014. Again, this strategy should not be used if funds are needed for cash flow purposes or if there is any risk of collections by delaying the billing.
Harvest capital losses. Individuals holding securities that have declined in value may want to actualize losses for tax advantage. Capital losses on the sale of securities can offset capital gains, dollar for dollar. Capital losses in excess of capital gains can offset up to $3,000 of ordinary income ($1,500 for married persons filing separately). Capital losses in excess of these limits can be carried forward indefinitely to offset gains (and limited ordinary income) in future years. “Banking” capital losses may yield sizable tax savings in the future (especially if an individual expects to be in a higher tax bracket next year).
Make transfers to relatives in low tax brackets. Those in the 10% or 15% tax bracket pay no tax on long-term capital gains and qualified dividends. Thus, an elderly parent in a low tax bracket can dispose of gifted appreciated securities, leaving more after-tax income in the family. Beware: Don’t make transfers to children subject to the “kiddie tax” (Code Sec. 1(g)); it will not achieve the tax savings.]
Taking into Account New Rules for 2013
There are a number of tax rules that premiered in 2013 and can have a serious impact on an individual’s tax bill for the year. These rules include:
Higher tax rates on top filers. There is a new 39.6% tax bracket for the wealthiest individuals (last year the top rate was
35%) (Code Sec. 1). These individuals also pay 20% on long-term capital gains and qualified dividends (last year the top rate was 15%) (Code Sec. 1(h)). The impact of these higher tax rates means such individuals should use every tax-saving strategy to minimize taxable income. This can include:
- Using salary deferral options, including contributions to 401(k) plans, flexible spending accounts, and deferred compensation plans.
- Using installment reporting for sales of eligible property to spread the gain over the period in which installments are received.
- Investing in tax-exempt bonds.
Additional Medicare tax on earned income. This tax of 0.9% applies to earned income over a threshold amount that depends on filing status ($200,000 for singles; $250,000 for joint filers; and $125,000 for married persons filing separately) (Code Sec. 3101(b)(2)). This additional tax can impact year-end bonuses. Employees are subject to withholding once taxable compensation exceeds $200,000 (regardless of filing status). Those who think they won’t have sufficient taxes withheld (for example, they work for two employers and wages at each job do not exceed the threshold even though their total earnings exceed the threshold) can increase income tax withholding and apply it to the additional Medicare tax when they file their personal income tax returns. Self-employed individuals with net earnings from self-employment exceeding the applicable threshold should increase estimated taxes for the year to cover this new Medicare tax. New Form 8959, Additional Medicare Tax, will be used to figure this additional tax; it is attached to Form 1040.
Additional Medicare tax on net investment income (NII tax). This tax of 3.8% applies to the lesser of net investment income (investment income minus investment expenses) or modified adjusted gross income in excess of the applicable threshold amount (the same threshold as the one used for the additional Medicare tax on earned income (Code Sec. 1411).
Determine now which income received by an individual is treated as investment income for purposes of this tax. For example, those who own an interest in a pass-through entity (e.g., S corporation) may convert investment income to noninvestment income by materially participating in the activities of the business. Again, if this tax is projected, it should be taken into account when figuring wage withholding and/or estimated taxes. New Form 8960, Net Investment Income Tax—Individuals, Estates, and Trusts, will be used to figure this additional tax; it too is attached to Form 1040.
Higher threshold for itemized medical expenses. For 2013, only medical expenses in excess of 10% of adjusted gross income (AGI) can be deducted as an itemized deduction (Code Sec. 213(a)). The former 7.5%-of-AGI threshold applies only to those who are age 65 and older. An individual with significant medical expenses that are not covered by insurance or reimbursed by a medical account (such as a health savings account or a flexible spending account) may want to incur voluntary medical costs before the end of the year in order to exceed the threshold and claim a medical deduction. Examples of voluntary costs include: prescription glasses, sunglasses, and contact lenses; Lasix eye surgery, and dental procedures (which may not otherwise be covered by insurance or reimbursements).
Charitable contributions. Those who itemize can boost write-offs by making donations before the end of the year. Keep two things in mind: 1) Obtain required substantiation (Code Sec. 170(f)) and 2) factor in the new phase-out of itemized deductions (Code Sec. 68) on the tax savings that donations will yield.
Using Expiring Rules for Individuals
Numerous tax rules are scheduled to expire at the end of 2013. They may be extended by Congress, but budget woes could nix or delay any action in this regard. Here are some favorable rules to use while they are in effect.
IRA transfers to charity. Those who are age 70½ or older can transfer up to $100,000 directly from an IRA to a public charity (called a qualified charitable distribution) (Code Sec. 408(d)(8)(A)). The benefit: There is no current income tax, even if the transfer includes the required minimum distribution (RMD) for the year. What’s more, by not including the RMD in adjusted gross income, the individual may be eligible for other tax breaks that are pegged to AGI. For example, it may minimize the extent to which Social Security benefits are taxable. Further, for higher-income taxpayers, this transfer may minimize the phase-out for personal exemptions and itemized deductions as well as minimize the additional Medicare Part B and D premiums for 2015 (which are based on 2013 AGI). Note: Individuals who took advantage of a transitional rule (IR-2013-6, 1/16/13) to make IRA transfers in January 2013 that were credited to 2012 can make another transfer for 2013 before the end of the year.
Energy improvements. Adding insulation, storm doors and windows, and certain other energy-saving items to a principal residence can entitle the homeowner to a tax credit if the improvement is added before the end of this year (Code Sec. 25C).
Disposing of homes “underwater.” With some exceptions, debt forgiveness usually results in taxable income. However, if a mortgage up to $2 million on a principal residence is forgiven before the end of 2013, no income results (Code Sec. 108(a)(1)(E)). Short-sales or other workouts accompanied by the cancellation of indebtedness should be completed by the end of December.
Note: A complete list of expiring provisions can be found from the Joint Committee on Taxation (Report JCX-3-13).
Using Expiring Rules for Businesses
Businesses have an even greater list of provisions that expire at the end of 2013 unless Congress extends them. Again, actions before the end of the year can secure tax savings for this year in case the rules are not extended for 2014.
Breaks for purchases of equipment and machinery and certain building improvements:
- First-year expensing (Sec. 179 deduction) of up to $500,000. Unless extended, the limit for 2014 will be $25,000.
- Bonus depreciation of 50% of qualified costs (Code Sec. 268(k)(5)). Unless extended, there will be no bonus depreciation allowance next year.
- Special breaks for qualified leasehold, retail, and restaurant improvements. These include expensing up to $250,000, eligibility for bonus depreciation, and a 15-year recovery period for depreciation of excess costs. Unless extended, such improvements made after this year will have to be depreciated over 39 years.
Employment-related tax breaks:
- Work opportunity credit (Code Sec. 51).
- Credit for wage differential payments made for reservists called to active duty (Code Sec. 45P).
- Indian employment credit (Code Sec. 45A).
- Deduction of $1.80 per square foot for efficient commercial properties (Code Sec. 179D).
- Tax credit for building energy-efficient homes (Code Sec. 45L) and manufacturing certain energy-efficient appliances (Code Sec.45M).
- Issuing qualified small business stock (Code Sec. 1202) to investors and/or employees. These shareholders will be able to exclude 100% of their gain as long as the stock has been held more than five years. The exclusion is set to revert to the 50% limit in 2014 unless Congress extends the full exclusion.
- Donating appreciated property by S corporations (Code Sec. 1367(a)(1)). This move allows shareholders to adjust their basis in S stock by the corporation’s adjusted basis in the property even though their share of the deduction for the donation is based on the property’s fair market value.
Now is an ideal time for individuals and businesses to meet with tax advisors to assess their current tax positions and to learn what steps can be taken to favorably impact their tax bills. Income tax withholding and the final installment of estimated taxes can be adjusted to reflect tax-planning moves. Of course, year-end tax planning should stay flexible to account for last-minute tax changes that could be part of a debt ceiling agreement in Congress.
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