The New Medicare Tax on Investment Income
Under the 2010 Health Care Act, Medicare taxes will be going up for certain people on January 1, 2013. There are two separate Medicare tax increases. One will be a 3.8% Medicare tax on unearned income. The other is a 0.9% Medicare tax on wages and self-employment income. This post describes the 3.8% Medicare Contribution Tax on unearned income.
The Medicare Contribution Tax (3.8%) on Unearned Income
This tax is levied on unearned income such as interest, dividends, annuities, royalties, rents, and capital gains. It also includes flow through income from an LLC or S corporation in which the owners are not active (e.g., investors ).
The tax is 3.8% of the lesser of:
- Net investment income OR
- The excess of modified adjusted gross income over the applicable threshold amount
Some definitions:
Net Investment Income is investment income reduced by investment expenses (e.g., research expenses, advisory fees, etc.)
Modified Adjusted Gross Income is adjusted gross income increased by excluded foreign earned income (there is an exemption from U.S. tax for certain income earned overseas-but this is a topic for a separate blog post).
The Applicable Threshold Amount is $250,000 for joint filers or surviving spouses, $200,000 for single filers, and $125,000 for married filing separate filers.
Net Investment Income Does NOT Include:
- Distributions from regular or Roth IRAs
- Distributions from 401(k) or other qualified plans
- Social Security Income
- Life insurance proceeds
- Municipal bond interest
- Veterans’ benefits
- Gain from the sale of a personal residence if the gain doesn’t exceed the exclusion amounts of $500,000 for a joint return and $250,000 for a single filer
- Income from businesses where the owners materially participate
Example: John files a joint return and has $150,000 in wages, $30,000 in interest income, $70,000 in rental income, and a $30,000 gain on the sale of a rental property. John’s modified adjusted gross income is $280,000. John’s net investment income is $130,000 (the $30,000 in interest, $70,000 in rental income, and $30,000 gain from the rental property). John’s Medicare Contribution tax equals 3.8% times the lesser of:
- Net investment income of $130,000 OR
- The excess of modified adjusted gross income over the applicable threshold amount. This amount is $30,000 ($280,000 modified adjusted gross income less $250,000 threshold amount).
John’s Medicare Contribution tax is therefore $1,140 (3.8% times $30,000).
Example 2: Jill has $200,000 in wages. She is a passive investor in an S corporation, ABC Corp (i.e., outside of her investment in ABC Corp, she has no involvement in the business). She has $100,000 in flow through income from ABC Corp. She also sold some of her ABC Corp stock for a $50,000 gain. Jill’s modified adjusted gross income is $350,000. Since Jill is not active in ABC Corp, her flow through profit of $100,000 and her gain on sale of stock of ABC Corp of $50,000 are considered investment income. Jill’s Medicare Contribution tax is calculated as 3.8% times the lesser of:
- Net investment income of $150,000 OR
- The excess of modified adjusted gross income over the applicable threshold amount. This amount is $100,000 ($350,000 modified adjusted gross income less $250,000 threshold amount).
Jill’s Medicare Contribution tax is $3,800.
Example 3: Joan works full time in her S corporation, ABC Corp. She has $200,000 in wages and $100,000 in flow-through profit from ABC Corp. She also sold some of her ABC Corp stock for a $50,000 gain. Based on Joan’s full time employment in ABC Corp, she materially participates in the business. Since she materially participates, her flow through profit of $100,000 and gain on sale of stock of ABC Corp of $50,000 are NOT included in net investment income. Therefore, Joan is not subject to the 3.8% Medicare Contribution tax.
Some tips on avoiding the Medicare Contribution Tax:
- Try to accelerate income into 2012 so that modified adjusted gross income in 2013 will be under the threshold
- People owning rental property should try to qualify as a real estate professional
- This requires more than 50% of time spent in real estate activity and 750 hours per year in real estate activity
- Consider investing in municipal bonds
- Municipal bond interest is not subject to the 3.8% tax
- It also does not increase modified adjusted gross income so it may reduce the tax on other investment income
- Business owners should try to qualify as active owners in their businesses so that flow through income and gain on sale of ownership interests are not subject to the tax.
For more information on how this applies in your situation, please give us a call.
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.
Any tax advice contained in the body of this post was not intended or written to be used, and cannot be used, by the recipient for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions. Any information contained in this post does not fall under the guidelines of IRS Circular 230
The Small Business Health Care Credit
Beginning in 2010, small businesses are eligible for a tax credit by providing qualified health care coverage for their employees. The credit starts off smaller during 2010 to 2013, but fully kicks in starting 2014. However, the credit expires at the end of 2015. Despite the hype, very few businesses have qualified for this credit due to its limitations on the number of employees and average wage of employees.
How Much is the Credit?
During 2010 to 2013, the maximum credit is 35% of the employer’s premium expenses. Starting in 2014, the maximum credit is increased to 50% of the employer’s premium expenses.
Who Qualifies for the Credit?
Small businesses must meet three requirements to qualify for the credit:
- employers must have fewer than 25 full time equivalent (FTE) employees
- the average annual wages must be less than $50,000 per FTE
- the employer must pay the premiums under a qualifying arrangement.
Determining Number of FTEs
Employers calculate the number of FTEs by dividing the total number of employee hours worked (by both full time and part time employees) during a year by 2,080. If the result is not a whole number, the result is rounded down.
Example: ABC Corp reviews its payroll reports and determines that all of its employees (full and part time) worked 10,000 hours during the year. ABC Corp divides the 10,000 total hours worked by 2,080 to calculate its FTEs (10,000 hours divided by 2,080 equals 4.81 rounded down to 4 FTEs).
Determining Average Annual Wages
To calculate average annual wages, the employer divides its total wages for the year by the number of its FTEs.
Example: ABC Corp has $80,000 total payroll for the year. To determine if its average annual wages are under $50,000 it divides its total payroll ($80,000) by the number of its FTEs (4). Its average annual wages for the year is $20,000.
In calculating average annual wages, wages for seasonal employees and owners and their families are excluded from the calculation.
What, Pray Tell, is a Qualifying Arrangement?
Under a qualifying arrangement, the employer pays premiums for each employee enrolled in health care coverage offered by the employer in an amount equal to a uniform percentage (not less than 50%) of the premium cost of coverage. The credit only applies to the employer paid portion.
Example: ABC Corp pays 80% of the premiums for each of its employees. Since it pays more than 50% of each employee’s premium, it qualifies for the credit (but only on the 80% that the employer pays, not on the 20% paid by employees).
Example 2: ABC Corp pays 40% of the premiums for each of its employees. Since it pays less than 50% of each employee’s premium, it does not qualify for the credit.
Example 3: ABC Corp pays 60% of the premiums for some employees, and 30% of the premiums for other employees. ABC Corp does not qualify for the credit because it does not pay a uniform percentage of each employee’s health premium.
There is an upper limit on the amount of premiums that qualify for the credit. If the average premium for a small group market in a State is less than the premiums paid by the employer, the amount of the average premium for a small group market in the state will be used instead of the actual premiums paid by the employer.
Calculating the Credit Phaseout
The full credit is allowed if the employer has up to 10 employees and up to $25,000 average annual wages. If the employer has more than 10 employees OR average annual wages exceeding $25,000 the credit begins to phase out.
The credit reduction for the FTE phaseout is calculated as:
Number of FTE over 10 divided by 15
ABC Corp has $80,000 of insurance premiums, and its maximum credit for 2010 is $28,000 ($80,000 times the 35% credit).
If ABC Corp has 18 employees, the credit reduction is calculated as follows:
(18 minus 10) divided by 15 = 53%
The FTE phaseout reduces the $28,000 credit from above by 53%. The credit must be reduced by $14,840.
The credit reduction for the average wage phaseout is calculated as:
Amount of Average Wages over $25,000 divided by $25,000.
If ABC Corp has average annual wages of $30,000, the phaseout is calculated as:
($30,000 minus $25,000) divided by $25,000 = 20%.
The average annual wage phaseout reduces the $28,000 credit from above by 20%. The credit must be reduced by $5,600.
When the employer has more than 10 FTEs and more than $25,000 in average annual wages, the FTE credit reduction and the wage credit reduction are added together. Thus, ABC Corp’’s total reductions are 20,440 ($14,840 FTE reduction plus $5,600 wage phaseout). So, ABC Corp’s credit is $7,560 (total credit of $28,000 reduced by total credit reductions of $20,440).
At this point you’re probably sick of reading this post, so I’ll leave you with a few quick bullet points:
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The credit is claimed on the employer’s annual income tax return
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it is NOT a refundable credit
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It is a general business credit that can be carried back 1 year and forward 20 years
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However, since 2010 is the first year, it cannot be carried back for 2010.
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Tax exempt organizations qualify for the credit under slightly different rules (check back for upcoming blog posts).
There you have it, a brief 3 page overview of the new small business health care credit. I’ll be posting more frequently (possibly twice a week) over the next few months to keep you up to date on the constant tax law changes. The tax laws are a-changin’.
If you have any questions on how this applies to your business, please feel free to give us a call.
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.
Any tax advice contained in the body of this post was not intended or written to be used, and cannot be used, by the recipient for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions. Any information contained in this post does not fall under the guidelines of IRS Circular 230
The Health Care Law Giveth and Taketh
The recently upheld health care law giveth by providing a tax credit to those who purchase health insurance through a state exchange. The health care law taketh by imposing an excise tax on uninsured individuals. This article will explain both the tax subsidy and the excise tax.
The Tax Law Giveth–Premium Assistance Credit
Beginning January 1, 2014, a refundable tax credit is available for people who buy health insurance through a state exchange. A person can enroll in a plan offered through an exchange and report his/her income to the exchange. Eligibility for the premium assistance credit is based on the individuals income for the year ending two years prior to enrollment (e.g., if someone enrolls in coverage in 2014, the credit is based on the person’s income for 2012.)
The credit is available for individuals (single or joint filers) with household incomes between 100% and 400% of the federal poverty level who do not receive health coverage through an employer or through a spouse’s employer.
The amount of the credit is determined by the secretary of Health and Human Services, based on the excess of premiums over a threshold amount—2% of income for those at 100% of the poverty level to 9.5% of income for those at 400% of the poverty level.
Example: John and Jane, who have one child, have income at 100% of the federal poverty level. Their income is $18,310. They buy health insurance through a state exchange and pay $4,000 in premiums. The credit is the amount by which their premiums ($4,000) exceeds 2% of their income, or $366.20 ($18,310 * .02). Their credit is $3,633.80 ($4,000 minus $366.20).
Example 2: Same as above except John and Jane have income at 400% of the poverty level. Their income is $73,240. To claim the credit, their health insurance premium has to exceed 9.5% of their income, or $6.957.80 ($73,240 * .095). Since their premiums of $4,000 are less than 9.5% of their income, they cannot claim a credit.
The poverty level is based on the number of people in the family, so if John or Jane have more or fewer children, the amount of the credit will change.
The Department of Treasury will pay the credit to the state exchange, and taxpayers will be liable for the balance of the insurance premium. Alternatively, taxpayers may pay the full premium to the state exchange, and then claim the credit on their income tax returns.
The Tax Law Taketh—Excise Tax on Uninsured Individuals
Beginning January 1, 2014 the evil twin of the Premium Assistance Credit, the excise tax on uninsured people, begins. The excise tax is phased in during 2014 and 2015.
When the excise tax is fully phased in during 2016, individuals who do not have minimum essential coverage will be subject to a penalty equal to the GREATER of :
- 2.5% of the amount by which the taxpayer’s household income for the year exceeds the threshold amount of income required for filing a tax return
- The “threshold amount of income required for filing a tax return” is based on filing status. If your income is below these amounts, you generally do not need to file a tax return. For 2009, examples of some of the thresholds were:
- Single $ 9,350
- Married Filing Joint $18,700
- Married Filing Separate $ 3,650
- $695 per uninsured adult in the household.
Example: Joan is single and has $60,000 of income and does not have health insurance. The filing threshold for a single person is $9,350. Her excise tax equals the greater of:
- 2.5% of her income over her filing threshold=.025 * ($60,000 minus $9.350) = $1,266.25 or
- $695.
Joan must pay an excise tax of $1,266.25.
The filing thresholds in the example are for 2009, they will be different in 2014 when the excise tax takes effect.
The excise tax is phased in during 2014 to 2015 as follows:
2014: greater of 1% of income over filing threshold or $95
2015: greater of 2% of income over filing threshold or $325
According to the statute, the IRS cannot enforce collection by lien or seizure, and noncompliance will not be subject to criminal penalty. Regardless, if you don’t pay the excise tax, expect some nasty collection letters and expect the IRS to reduce any federal tax refunds by the unpaid excise tax.
If you have any questions on how this applies to your business, please feel free to give us a call.
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.
Any tax advice contained in the body of this post was not intended or written to be used, and cannot be used, by the recipient for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions. Any information contained in this post does not fall under the guidelines of IRS Circular 230
Mandate for Employers with 50 or More Full Time Employees
The health care law requires employers with 50 or more full time equivalent employees to provide health care coverage or pay a penalty. An employer with 50 or more full time employers is considered a large employer. A full time employee is defined as an employee working 30 or more hours per week. The hours worked by part-time employees (i.e., those working less than 30 hours per week) are included in the calculation of a large employer, on a monthly basis, by taking their total number of monthly hours worked divided by 120.
Example: ABC Company has 40 employees who work more than 30 hours per week and 20 employees who work 24 hours per week. Each of the 40 employees working more than 30 hours per week is a full time employee. Full time equivalent employees are calculated as:
Number of part time employees (20) times the number of hours they work in a month (96, which is 24 hours per week times 4 weeks in a month). This product is 1,920. Dividing 1,920 by 120 equals 16 full time equivalent employees. The employer therefore has 56 full time equivalent employees (40 employees working more than 30 hours per week plus part time employees who are equivalent to 16 full time employees).
A NONDEDUCTIBLE penalty will be assessed on a large employer that:
- Fails to offer any full time employee the opportunity to enroll in minimum essential coverage under an employer plan if at least one full time employee is enrolled in an insurance exchange AND receives a premium assistance credit or cost sharing
- The monthly penalty is 1/12 * $2,000 * (the number of full time employees minus 30). The penalty would apply to employers with 50 or more workers, but would subtract 30 workers from the payment calculation.
- Offers its full time employees coverage in minimum essential coverage under an employer plan and any full time employee is enrolled in an insurance exchange and receives a premium assistance credit or cost sharing. Here, the employer offers health insurance coverage, but at least one employee decides to enroll in an exchange.
- The monthly penalty is the LESSER of:
- the number of full time employees receiving a premium assistance credit or cost sharing for purchase of insurance through an exchange multiplied by 1/12 of $3,000.
- the number of full time equivalent employees minus 30, multiplied by $2,000.
Bottom line: if you are approaching 50 employees, make sure to consult with a tax practitioner to determine how much any additional employees will cost you.
If you have any questions on how this applies to your business, please feel free to give us a call.
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.
Any tax advice contained in the body of this post was not intended or written to be used, and cannot be used, by the recipient for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions. Any information contained in this post does not fall under the guidelines of IRS Circular 230
How the New Health Care Law Affects Taxes on Over the Counter Medication
There is a provision in the new Patient Protection and Affordable Care Act that changes the taxability of over the counter medications purchased through flexible spending arrangements (FSAs), health reimbursement arrangements (HRAs), Health Savings Accounts (HSAs) and Medical Savings Accounts (MSAs). Basically, for HRAs and FSAs, you can no longer receive reimbursements to pay for over the counter medications. For HSAs and MSAs, you can no longer take distributions to pay for over the counter medications. If you do take a distribution from an HSA or MSA to pay for over the counter medications, the distribution is taxable and is subject to a 20% penalty. These provisions became effective January 1, 2011.
ABCs of FSAs, HRAs, HSAs, and MSAs
An FSA (flexible spending account) is a savings account funded by employee pre-tax contributions. The funds in the account can be used to pay for medical expenses on a pre-tax basis. In some cases, FSAs may also be funded by employer contributions. Amounts are contributed each year based on expected medical expenses. Any amounts not spent during the year are forfeited.
An HRA (health reimbursement account) is a savings account funded by employer contributions on a pre-tax basis. The employee is not allowed to contribute to an HRA. The employee submits medical expenses and is reimbursed with pre-tax dollars. Amounts not spent are carried forward (in contrast with an FSA where the funds are forfeited).
HSAs (health savings accounts) and MSAs (medical savings accounts) are used in conjunction with a high deductible health insurance plan. MSAs were discontinued and replaced by HSAs. HSAs and MSAs are savings accounts that can be funded with employee or employer contributions on a pre-tax basis. Amounts can be withdrawn from these accounts tax-free if they are used to pay medical expenses.
Health Care Law Shows No Love for Over the Counter Medications
Effective January 1, 2011, expenses incurred for a medicine or drug will be treated as:
- a qualifying reimbursement under a FSA or HRA or
- a qualifying distribution from an HSA or MSA
for medical expenses only if such medicine or drug is a prescribed drug (determined without regard to whether such drug is available without a prescription) or is insulin.
Therefore, under the new law, expenses incurred for medicines or drugs may be paid or reimbursed by an employer provided plan or distributed from an HSA or MSA if the medicine or drug:
- requires a prescription
- is an over the counter medicine or drug and the individual obtains a prescription for it (this refers to the italicized and bold language in the preceding paragraph)
- is insulin
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.
Any tax advice contained in the body of this post was not intended or written to be used, and cannot be used, by the recipient for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions. Any information contained in this post does not fall under the guidelines of IRS Circular 230.
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