Understanding the Health Benefit 'Pay or Play' Decision

The first question employers need to resolve is whether or not it has enough employees to be subject to the pay-or-play requirement (also known as the employer "shared responsibility" requirement).
The simple definition -- employers with 50 or more full-time equivalent workers -- doesn't provide the full answer.

First, "full-time equivalent" (FTE) covers employees who average 30 (not 40) hours per week. The time period during which the employee count is determined is the prior year -- in other words, 2013, for purposes of whether you'll face the mandate in 2014.

Note: The IRS, recognizing that determining FTE status can become complicated based on timing issues and seasonal work patterns, issued some "safe harbor" rules last year to help with the determination. (IRS Notice 2012-58)

Attempting an End-Run?

The law also attempts to discourage employers near the 50 FTE threshold to drop below it by cutting back employees' hours to less than 30 so that they flunk the FTE test. It does so by requiring that an employer add up all of the hours worked by part-time workers over the course of a month, then divide that number by 120. The number that results from that calculation is added to an employer's FTE total to determine where it is in relation to the 50 FTE minimum.

Note: Even if the calculation determines that an employer is subject to the pay-or-play requirement, it is not obligated to provide health benefits to part-time employees.

Some employers could, in theory, lay off a requisite number of employees to fall below the 50 FTE threshold, and deal with them as independent contractors. Of course, simply calling a worker an independent contractor doesn't make it so. Independent contractor status is determined by a multi-pronged test.

Assuming you are subject to the "shared responsibility" provisions, and even if you are already providing some level of health benefits, you'll need to determine whether your benefit package provides at least 95 percent of your employees a benefit package that meets "minimum essential coverage" standards. (The fine points of this remain a work in progress). If the answer is no, and you don't beef up your benefits, the "pay" requirement kicks in. (This would also be true if you didn't offer any health plan.)

The penalty is the annualized equivalent of $2,000 a year for each full-time employee, minus up to 30 employees, if at least one full-time employee signs up for health benefits through a health exchange "and receives a premium tax credit or cost-sharing reduction from the government." Therefore, the penalty for an employer with 70 FTEs would be 70 minus 30 equals 40 times $2,000 equals $80,000.

Passing the "Value" Test

But even if an employer provides minimum essential coverage to enough employees, another hurdle it has to clear is whether the employees receive a minimum value for the coverage. That essentially requires that the employer is paying at least 60 percent of the cost of the benefit. A parallel test is whether the employee cost is deemed "affordable" to the employee. A "safe harbor" standard is whether or not it exceeds 9.5 percent of an employee's household income.

If either the "value" test or the affordability test is not met, something called a "Subsection (b) penalty" kicks in. It is calculated as $250 per month for each FTE employee who enrolls in a health exchange and is eligible, based on income, to receive federal tax credits.

Eligibility for tax credit and subsidies ends at 400 percent of the U.S. official poverty level. Eligibility starts once an individual, who does not have access to a qualified affordable plan through employment, is deemed to be able to afford insurance with an exchange credit (approximately 100 percent of the poverty level).

If you determine that, based on your current health benefits package, you won't meet the employer responsibility standards of the Affordable Care Act next year, the financial dimension of the decision you'll face is whether it's cheaper to drop benefits and pay the penalty, or improve benefits to meet the requirements. In some circumstances, the penalty would be cheaper.

Don't Neglect Human Resource Strategy

But what about the human resource strategy considerations? Basic issues include the impact on employee morale, as well as how critical health benefits are to your ability to recruit strong talent. You may already be exceeding the Affordable Care Act's requirements -- and employees may consider it a fair substitute for higher wages.

Tax considerations also can play a role. If you were to drop health benefits and simply pay employees more so they can go out and secure their own health benefits via a health care exchange, the added compensation is taxable to them, unlike the value employer provided health benefits (assuming it falls below so-called "Cadillac" benefit levels). Also, the penalties you would pay, unlike the cost of providing health benefits, would not be tax deductible for your company.

Finally, a decision to maintain a health benefit plan that's generous enough to satisfy the Affordable Care Act's standards isn't a permanent one. An employer may simply decide to meet the standards in 2014, and see how things play out with health exchanges and the actions of other employers who it competes with for employees.

Tougher New Rule for Medical Expense Deductions Starts this Year

With the ever-increasing cost of health insurance and medical care, you should be vigilant in looking for chances to claim any possible healthcare-related tax breaks.
Unfortunately, changes taking effect this year make that harder than ever.  Here's the story, along with some potential solutions.

IRS-Approved Medical Expenses Here's an alphabetical list of some costs that count as medical expenses for itemized deduction purposes: ·    Acupuncture; ·    Ambulance; ·    Artificial limb and artificial teeth; ·    Bandages; ·    Braille books and magazines; ·    Car (cost of special equipment so disabled person can drive); ·    Chiropractor; ·    Christian Science practitioner; ·    Crutches; ·    Dental care; ·    Diagnostic devices; ·    Drugs (prescription only except for insulin); ·    Eyeglasses and contact lenses (plus wetting and cleaning solutions); ·    Eye surgery; ·    Guide dog; ·    Hearing aid; ·    Home improvements for medical purposes (to the extent they don't add to the value of your home); ·    Hospitalization; ·    Insurance premiums for health coverage (including age-based); ·    Premiums for qualified long-term care insurance; ·    Laboratory fees; ·    Lifetime care fees (percentage of fees paid under lifetime contract with a continuing care retirement community); ·    Meals (while staying in hospital or similar facility); ·    Medicare insurance premiums; ·    Nursing home and long-term care services; ·    Nursing services; ·    Optometrist services; ·    Osteopath services; ·    Oxygen; ·    Psychiatric care; ·    Psychoanalysis; ·    Stop smoking program; ·    Surgery; ·    Telephone (cost of special equipment for hearing impaired); ·    Television (cost of special equipment to display subtitles for hearing impaired); ·    Therapy; ·    Transplant; ·    Transportation to receive medical care (24 cents per mile for 2013, which is up from 23 cents per mile for 2012); ·    Weight loss program (if part of treatment for specific disease or condition, such as obesity); ·    Wheelchair; ·    Wig (if hair is lost due to medical issue); ·    X-rays. Source: IRS Publication 502, Medical and Dental Expenses

Itemized Medical Deduction Threshold is Now Higher

Before this year, you could claim an itemized deduction for medical expenses paid for you, your spouse, and your dependents, to the extent those expenses exceeded 7.5 percent of your adjusted gross income (AGI).

Your AGI is the number at the bottom of page 1 of your Form 1040. It includes all your taxable income items and is reduced by certain write-offs -- such as those for moving expenses, deductible IRA contributions, alimony payments, and student loan interest.

The 7.5 percent-of-AGI hurdle was hard enough to clear. Now, thanks to the 2010 healthcare legislation, an even higher threshold of 10 percent of AGI applies to most taxpayers --beginning this year. However if either you or your spouse will be 65 or older as of December 31, 2013, the unfavorable new 10 percent-of-AGI threshold will not affect you until 2017. Until then, the longstanding 7.5 percent-of-AGI threshold will continue to apply for those 65 and older.

Potential Tax-Smart Idea: Pay Medical Expenses Every Other Year

Many types of medical expenses do qualify for the deduction (see right-hand box). However, there are also many expenses that are not eligible, such as cosmetic surgery that improves a person's appearance but doesn't treat illness or disease or help the body function better.

If you have flexibility about when medical expenses are incurred, you may be able to concentrate them in alternating years. That way, you can claim an itemized medical expense deduction every other year, or every third year -- instead of never getting a tax benefit.

Example: Let's say your AGI is $65,000. You pay $11,000 of medical expenses in 2013 because you have elective surgery, buy new contact lenses, and have a dentist put sealants on your children's teeth. Next year, you pay only $2,000 in medical expenses.

On your 2013 Form 1040, you can claim an itemized deduction of $4,500 ($11,000 minus the $6,500 10 percent-of-AGI threshold). Next year, you won't have any deduction. But if you simply spread the two-year total of $13,000 of medical costs evenly over this year and next year, you'll be completely out of luck in both years.

Bottom Line: Deductions in some years are better than not getting any deductions.

Another Tax-Smart Solution: Take Advantage of Your Company's Healthcare FSA

Until this year, there was no tax-law limit on contributions to your employer's healthcare flexible spending account (FSA) plan (although many plans impose their own limits). But the FSA situation has also changed.

Background: Amounts you contribute to the FSA plan are subtracted from your taxable salary. Then, you can use the funds to reimburse yourself tax-free to cover qualified medical expenses that are not reimbursed by insurance.

Starting this year, however, the maximum annual FSA contribution for each employee is capped at $2,500 by law. That doesn't change the fact that you should take full advantage of your company's FSA plan if one is offered. Failing to do so is like leaving money on the table. But you may be able to get less taxable benefit from an FSA.

What If You Are Self-Employed?

Self-employed taxpayers who pay their own medical and dental insurance premiums are generally allowed to deduct these costs "above the line" on page 1 of Form 1040. This rule is helpful, because you do not need to itemize to benefit from an above-the-line deduction.

Unfortunately, that's about the end of the good news. In general, your only recourse for other out-of-pocket medical expenses (other than health premiums) is claiming an itemized deduction when those costs exceed 10 percent of AGI (or 7.5 percent if you qualify for the lower threshold due to your age or your spouse's age).

Conclusion

The federal income tax treatment of out-of-pocket medical expenses has taken a turn for the worse. However, your tax results might be able to be improved if you plan ahead for medical expenditures (to the extent possible) and take advantage of your employer's healthcare FSA (if one is offered). If you have questions or want more information about your situation, contact your tax adviser.

IRS News: Audits and Home Office Deductions

The IRS announced recently:

1. Audits were down overall for fiscal 2012 but some taxpayers faced increased scrutiny.
2. There will be a new, simpler option for deducting home office expenses, starting in 2013.

Here are details of these two tax announcements.

The IRS Is Conducting Fewer Individual Audits -- But Examining More Businesses The IRS just released data showing that overall audits were down in fiscal 2012 to 1.03 percent of all tax returns filed, as compared with 1.11 percent the previous year. However, audits of all types of businesses went up. Here are some highlights from the latest IRS enforcement results. ·    Audits of taxpayers in the upper income ranges remained substantially higher than other categories. For example, 0.94 percent of taxpayers with incomes of less than $200,000 were audited as compared with 12.14 percent of taxpayers with incomes of $1 million or more. ·    According to the recently released statistics, audits that are conducted by mail, called "correspondence audits," are significantly higher than "field audits," which are conducted in person. In 2012, there were 359,750 field or face-to-face audits as compared with 1,122,216 correspondence audits. ·    The IRS increased examinations across all categories of business returns in 2012 as compared with the previous year. Specifically, 0.48 percent of Subchapter S corporations were audited, as compared with 0.42 percent in fiscal 2011. Partnerships audits were conducted at a 0.47 percent rate, as compared with 0.40 percent the previous year. ·    Small corporation returns (with assets under $10 million) were audited at a 1.12 percent rate, as compared with 1.02 percent the previous year. Nearly 18 percent of large corporations (with assets of $10 million and higher) were audited. The very largest corporations with assets of $250 million or more had a 29.41 percent audit rate, as compared with 27.6 percent in fiscal 2011. ·    In terms of tax-exempt organizations, 1.34 percent were audited, compared with 1.36 percent the year before. ·    Levies, liens and seizures were down in fiscal 2012, as compared with the previous year. In criminal tax cases, the IRS had a 93 percent conviction rate on prosecutions it recommended. The average sentence for criminal tax and tax related cases was 32 months, compared with 25 months the previous year.

New Option for Writing Off Home Office Expenses The IRS announced a simplified option that many owners of home-based businesses and some home-based workers can use to figure their deductions for the business use of their homes. (IRS Revenue Procedure 2013-13) The new option is effective beginning January 1, 2013 so it will be available for tax returns filed in 2014. It is an alternative to the current calculation, allocation and substantiation requirements. However, because the new option has limits, a taxpayer may get a larger deduction by continuing to use the current rules. The optional deduction is capped at $1,500 per year based on $5 a square foot for up to 300 square feet. Current rules: A taxpayer is generally required to fill out the 43-line IRS Form 8829. It may contain complex calculations of allocated expenses, depreciation and carryovers of unused deductions. New rules: Taxpayers claiming the optional deduction will complete a different, simplified form. They cannot depreciate the portion of their homes used in a trade or business but they can claim allowable mortgage interest, real estate taxes and casualty losses on the home as itemized deductions. The deductions do not need to be allocated between personal and business use, as is required under the current method. Important: The new option does not change the current restrictions on home office write-offs, such as requirements that a home office must be used "regularly and exclusively" for business and that the deduction is limited to the income derived from a particular business. A taxpayer can elect from taxable year to taxable year whether to use the new method or to calculate and substantiate actual home office expenses. An election for any taxable year, once made, is irrevocable. "A change from using the new method in one year to actual expenses in a succeeding taxable year, or vice-versa, is not a change in method of accounting" and does not require IRS consent, according to the new Revenue Procedure. The new option will "reduce the paperwork and recordkeeping burden on small businesses by an estimated 1.6 million hours annually," the IRS stated. In tax year 2010, the most recent year for which figures are available, nearly 3.4 million taxpayers claimed deductions for the business use of a home.