Monthly Archives: December 2014

Update on $100 Per-Day Penalty for Reimbursing Employees for Health Insurance

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A short while back, we issued an alert about the $100 per-day per-employee penalty for violating the Affordable Care Act’s market reform provisions.  OnAlert November 6, the Department of Labor issued additional guidance on its FAQ page that makes clear that the market reform provisions were stricter than originally thought.

Brief Background

The market reform provisions place a whole host of new restrictions on employer-provided group health plans.  These provisions apply to all employer-provided group health plans—including small businesses with less than 50 employees.  The provisions were not affected by the one or two year delay in the mandate for large employers to provide health coverage.

The chief issue is that group health plans cannot have annual or lifetime limits on coverage.  The market reform provisions include medical reimbursement plans in the definition of group health plans.  Many small businesses reimburse their employees for the cost of the employees’ individual health insurance and for other medical expenses under medical reimbursement plans.  The problem is that these medical reimbursement accounts are treated as having limits on coverage because the plans almost always have an annual limit.  If the employer only reimburses employees for individual health insurance and for no other medical expenses, the annual limit is treated as being the amount the employer is paying to reimburse the employee for individual health insurance premiums.

How Things Just Got Worse

It was previously believed that employers could avoid the $100 per-day per-employee penalty if the employer included the health insurance reimbursement in the employee’s taxable compensation.

According to DOL Q#1, an employer that reimburses employees for an individual health policy has established a group plan because the arrangement’s purpose is to provide medical care to employees.  The employer cannot avoid this result by treating reimbursements as after-tax payments.   Now, even if the employer treats the reimbursement as after-tax, the employer will still be subject to the penalty.

The penalty is too large ($36,500 per employee per year) to ignore.  It is unlikely that this penalty will be delayed since the DOL issued guidance on this issue in the past month.

How to Avoid the Penalty

IRS Notice 2013-54 allows employees to freely choose between cash and an after-tax amount that they have the option (not the requirement) to apply toward health insurance.  These arrangements will still avoid the penalty as long as the employee is free to spend the cash anyway she wants.  The employee will then be able to deduct the health insurance premium as a medical expense (but only if the employee’s total medical expenses exceed 10% of AGI, or 7.5% of AGI if the employee is age 65 or older).

If the employee is required to purchase health insurance with the additional taxable income, the employer will be subject to the penalty.

The other way employers may avoid the penalty is by purchasing an Affordable Care Act-approved employer-sponsored group health plan.

Finally, the penalty will not apply if only one employee is reimbursed for individual health insurance and/or other medical expenses.

Example:  ABC Corp has two employees.  Each employee earns $40,000 per year.  ABC Corp is willing to reimburse the employees for their individual health insurance coverage.  Each policy’s premium is $4,000 per year.  ABC Corp can increase the employees’ compensation by around $4,000 to cover the health insurance premium (it probably is best if the additional pay does not exactly match the premium).  As long as the employee is free to use the additional compensation for any purpose, the employer will not be subject to the penalty.  If ABC Corp requires the additional compensation to be used to pay the premium, the penalty will apply.

If you have questions about how this applies to you, please contact us.

 

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Buzzkill Disclaimer:  This post contains general tax information that may or may not apply in your specific tax situation. Please consult a tax professional before relying on any information contained in this post.

Child’s Investment Income Can be Taxed at Parents’ Higher Tax Rate

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A common tax strategy among high wealth individuals is to shift income to their children where it will be taxed at a lower tax rate.  If the child works in kiddie taxthe taxpayer’s business, this can be done by putting the child on payroll.  The taxpayer can deduct the payroll (as long as it is reasonable considering the services the child provides) and the payroll is taxed as income at the child’s lower tax rate.

Another technique is to shift income producing assets to the child.  The intent is to have the investment income taxed at the child’s lower tax rate.  However, the IRS is wise to this technique and if the child’s investment income exceeds $2,000, the excess investment income is taxed at the parents’ higher tax rate.  This rule is known as the kiddie tax.

When Does the Kiddie Tax Apply?

The kiddie tax applies if:

(1) the child’s unearned income is more than $2,000

(2) the child meets one of the following age requirements

  • the child is under age 18 at the end of the year
  • the child is age 18 at the end of the year and the child’s earned income did not exceed one-half of the child’s own support for the year
  • the child is a full time student who is under age 24 at the end of the year and the child’s earned income did not exceed one half of the child’s own support for the year (excluding scholarships)

(3) at least one of the child’s parents is alive at the end of the year

(4) the child is required to file a tax return for the year

(5) the child does not file a joint return for the year

It is important to keep in mind that the kiddie tax only applies to unearned income, earned income such as wages is not subject to this provision.

Example:  Joan, who is in the 25% tax bracket, transfers investments to her child, Tommy (age 15).  Tommy has interest income of $3,200 in 2014.  The first $1,000 is sheltered by his standard deduction.  The next $1,000 is taxed at his tax rate of 10%.  The remaining $1,200 of interest income is taxed at Joan’s 25% tax rate.

How to Avoid the Kiddie Tax

It is possible to minimize the kiddie tax by shifting to children investment assets that do not generate current taxable income, such as:

Municipal Bonds:  These investments are not subject to federal tax and therefore escape the kiddie tax.

Growth Oriented Investments:  An example would be growth stocks or mutual funds that do not pay large dividends to shareholders. Most of the income is capital appreciation that is recognized for tax purposes when the investment is ultimately sold.  If the child can hold the growth stocks past age 23 (if the child is a full time student), the stocks can be sold without being subject to the kiddie tax.

U.S. Discount Bonds:  These bonds are issued at a discount and do not generate taxable interest income until they are redeemed.  The bonds can be redeemed after the child is no longer subject to the kiddie tax.

If you have questions about how this applies to you, please contact us.

 

freeconsultation

Buzzkill Disclaimer:  This post contains general tax information that may or may not apply in your specific tax situation. Please consult a tax professional before relying on any information contained in this post.

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