Barbara’s Blog

Starting on January 1, 2013, there is an additional Medicare tax of 0.9% on earned income over a threshold amount (this threshold depends on your filing status). This tax was created by the Patient Protection and Affordable Care Act as a way to help pay for health care reform and will take effect in 2013 regardless of any resolutions Congress may come to with respect to the so-called fiscal cliff.

This new tax is only on the worker; not on the employer. The IRS recently provided some guidance in the form of proposed regulations and employers should master them to they can field questions from employees and adjust their payroll system if they handle payroll in-house. The new tax also affects self-employed individuals who have net earnings over the same threshold amounts.

The thresholds and the tax
The thresholds depend on filing status and only reflects earned income:
•    Joint filers: $250,000
•    Single filers: $200,000
•    Married persons filing separately: $125,000

Once earnings pass the threshold, the 0.9% additional tax then applies to amounts over the threshold. Thus, if a single individual has a salary of $185,000 and receives a year-end bonus of $40,000, the additional tax applies to $25,000 (the amount of earnings over the $200,000 threshold for a single filer). In effect, the employee pays the basic 1.45% Medicare tax on earnings up to the threshold amount ($200,000 in this example), plus 2.35% Medicare tax on earnings over the threshold amount ($25,000 in this case). The employer pays 1.45% on all of the employee’s earnings.

Earned income for purposes of the additional Medicare tax has the same meaning as used for the basic Medicare tax. Thus, taxable fringe benefits on top of big wages could trigger or increase the additional Medicare tax; tax-free fringe benefits have no impact on the tax.

Withholding
The tax is paid by the individual when he or she files the return. However, employers must withhold the additional Medicare tax once earnings exceed $200,000. (There is no withholding for this tax in anticipation of having excess earnings.) The employee’s filing status or income from another employer or from self-employment is not taken into account by an employer. If it turns out that the employee does not owe the additional tax (e.g., she is a joint filer and she and her spouse have earnings below $250,000), the over-withholding is claimed as a tax credit on the employee’s income tax return.

The employee cannot ask an employer to withhold any additional Medicare tax. However, if the employee wants a tax-withholding cushion, he or she can have additional income tax withheld. This is done by filing a new Form W-4, Employee’s Withholding Allowance Certificate, with the employer. Then, at tax time, the extra income tax withholding is effectively credited toward the additional Medicare tax.

Special concerns for self-employed individuals
Since self-employed individuals do not have wage withholding, they must incorporate the new tax into their quarterly estimated tax payments. Certainly, a payment need not include any anticipated tax based on expected net income; wait until net income reaches the applicable threshold. Of course, many self-employed individuals do not know their net income until well after the year has ended (some do not know theirs until receiving a Schedule K-1 from a business in which they have an ownership interest).

Use the estimated tax safe harbor rules to avoid any underpayment penalties. Essentially, if estimated taxes for 2013 are based on 100% of tax liability for 2012 (110% if adjusted gross income in 2012 exceeds $150,000, or $75,000 if married filing separately), then you won’t incur any penalty even if your estimated tax payments fell short of your 2013 tax liability.

Final thought
This additional Medicare tax on earned income dovetails with another additional Medicare tax on net investment income (called the NII tax). Earned income is specifically exempt from the NII tax but is factored in (as part of modified adjusted gross income) when determining the threshold for imposing the NII tax.

Bottom line: 2013 is going to be a new tax day!

The Senate is focusing on passage of a bill (S. 2237) that purports to help small businesses. It would give them a tax credit for expanding payroll and allow them to take 100% bonus depreciation for certain equipment purchases (rather than the 50% write-off that’s currently in effect for 2012). Would this be a good law?

It’s time that we analyzed whether tax incentives really induce the intended action. The problem is that there are existing counterweights already in the tax law to the proposed incentives. Let’s take a look at the first proposal — a tax credit for expanding payroll by taking on new workers or raising pay for existing workers.

Payroll credit

Qualifying for this tax credit will cut or eliminate eligibility to claim the small employer health tax credit. This other credit, which is up to 35% of health insurance premiums paid by small businesses for their staff, is determined with reference both to:

1. The number of workers (although the credit has a complex formula based on so-called full-time equivalent employees); and
2. The average payroll.

The higher both of these factors go, the lower the small employer health insurance credit. The credit, which is part of the now-constitutional Patient Protection and Affordable Care Act (Obamacare), was supposed to help 4 million small businesses, but fewer than 400,000 actually claimed the credit, and of these, fewer than 40,000 qualified for the full 35% credit. 

Bottom line: Enactment of a jobs credit would merely exchange one tax credit for the other in some small businesses.

Even worse, expanding payroll to 50 employees or more will trigger a business mandate under Obamacare to provide essential health coverage to workers starting in 2014. What this will cost is unknown at this time, but what is certain is that many companies that already have 45 or so employees are not growing their payrolls at this time. And, in fact, companies already over the tipping point may cut their payroll to have fewer than 50 employees.

Bonus depreciation

The other provision — to encourage investments in capital equipment by allowing a full write-off using bonus depreciation — is another provision that may help large companies but won’t be significant for small businesses. Any business, regardless of the number of employees, the amount of revenue, or profitability, can claim bonus depreciation; it’s not exclusively a small business tax break.

On the other hand, the Section 179 deduction (up to $139,000 in 2012) is meant specifically for small businesses because the dollar limit phases out for purchases over another limit ($560,000 in 2012); large companies spending more than $560,000 in equipment purchases lose some or all of the deduction.

Bottom line: Very few small businesses invest annually more than $139,000 in machinery and equipment (including computers, smartphones, and off-the-shelf software), so again there is no need to raise the cap on bonus depreciation. Don’t get me wrong; 100% bonus depreciation would be a nice break, but it is not essential for small companies at this time.

FYI: NFIB’s small business optimism survey for June shows that only about half of small companies expect to make capital expenditures in the next six months and, of those that do, about 20% represents vehicle purchases (which have their own tax rule limitations).

Conclusion

Good policy or bad distraction? This tax bill, labeled as being for small businesses, belies the fact that it really won’t matter much for its intended target: small businesses. In my opinion, it won’t incentivize action. What’s really needed to help small businesses is tax certainty (not rules that expire year after year) and continuation of the current tax rates.

So the U.S. Supreme Court says Obamacare is constitutional. What does this mean for you and your business?

Here are 5 results of this court decision that are problematic to me.

1. The IRS governs health care?

Apparently so, according to the Supreme Court’s ruling that the individual mandate is constitutional. The rationale for upholding the mandate: the penalty that individuals will have to pay if they don’t have required medical coverage starting in 2014 is merely a tax. And who’s going to collect the tax? The IRS!

While the law prevents any criminal action for those who won’t pay the penalty, who knows how enforcement by the IRS will be actualized. Will the IRS ultimately be able to say what medical treatments will be covered by insurance?

2. There’s a loss of privacy for your tax return

Currently, your personal and business tax returns are subject to strict privacy rules. If IRS employees divulge any information, there are serious consequences. Now, under Obamacare, the IRS must tell the “Health Choices Commissioner” and state health programs about taxpayers, including their filing status, modified adjusted gross income, the number of dependents, and “other information as prescribed by” regulations (Secs. 431(a) and 245(b)(2)(A)) of the Patient Protection and Affordable Care Act) (purportedly to verify new tax credits for those who cannot afford to pay health premiums). Also, the Social Security Administration can obtain from the IRS tax data on anyone who may be eligible for the low-income drug subsidy under Obamacare (Sec. 1801(a) of the Act). In sum, tax information is no longer confined to the IRS; it will be shared with certain other government agencies.

In this environment of increasing identity theft, there has to be concern about more eyes on a tax return.

3. Health care premium costs are not coming down anytime soon

The theory about the personal mandate lowering costs, if I have it correct, is that with more people being brought into the insurance pool, premiums will fall. I haven’t seen any indication of that yet. Of course, the mandate is not set to take effect until 2014, so for now the premiums for self-employed individuals and small businesses are continuing to increase.

4. There are increased tax burdens on many small business owners

Earn $200,000 in salary from your business or self-employment activities as a single person and you will pay an additional 0.9% Medicare tax starting in 2013. (The threshold for the tax for married persons filing jointly is $250,000, or $125,000 for those filing separately.) This tax is on top of the basic Medicare tax of 1.45% (or 2.9% if you’re self-employed) that you already pay, and it’s not deductible.

If you do your payroll in-house, you’ll probably have to start soon to get ready to withhold the additional Medicare tax for employees with wages over the threshold amount.

5. There’s still uncertainty

While the legal challenge to Obamacare is settled, the political challenge has just begun. If there are significant changes resulting from the November election, Obamacare may be repealed with the expectation of replacing it with another health care law. Whether there will be such a political shift, and if so, what, when, and if such new law is enacted, leaves us with uncertainty about tax-related provisions. Are current tax rules to be changed? Will good provisions in Obamacare that have already taken effect, such as coverage for a child up to age 26 on a parent’s medical plan, be retained?

Bottom line

What’s that adage about good intentions and some road? There has to be a better way to bring the cost of medical coverage down and make it available to those who are presently uninsured.

The Patient Protection Act of 2010 was supposed to be the panacea for high premium costs that pose a barrier for small businesses to provide coverage. To date, most small business owners I talk to say their premiums costs continue to rise, undaunted by the legislation. What’s more, uncertainty about future costs and government regulation on health care abounds. Here are some recent developments on the health insurance front:

• The U.S. Supreme Court has agreed to hear a case on whether the law (particularly the personal mandate requiring all individuals to have coverage or pay a penalty) is constitutional. Oral arguments likely will be in March 2012, with a final decision coming in June 2012. However, June may not bring a final determination on the constitutionality of the law; the court could decide to rule on procedural grounds, which would delay an ultimate ruling on constitutionality until 2015 or later.
• House Ways and Means Oversight Subcommittee heard testimony that the small employer health insurance credit designed to encourage small companies to provide or continue their coverage has been a flop. Critics say the credit is too complex (“convoluted”) and does not provide any incentives; it merely operates as a reward for those employers that happen to qualify for it. (If you want to learn more about the credit, read the instructions to IRS Form 8941, Credit for Small Employer Health Insurance Premiums.
• A report from the Treasury Inspector General for Tax Administration found that as of mid-May 2011, just over 228,000 taxpayers had claimed the credit. This is far fewer than the 4 million predicted when the credit was enacted last year.

On November 16, 2011, MyVenturePad held a webinar on Rising Costs, Unclear Mandates: How to Contain the Growing Cost of Employee Health Insurance. I was the moderator and the panelists were Robert Levin, editor-in-chief and publisher of the New York Enterprise Report, Dr. Bob Graboyes, the senior health care advisor for the National Federation of Independent Business (NFIB), and David Williams, co-founder of MedPharma Partners and author of Health Business Blog. If you missed the program, you can read a transcript through MyVenturePad.

Remember the promise made during the health care debate that “if you like your health care coverage, you can keep it?” Now it seems that fewer than 20% of small businesses will be able to do so.

The Administration estimates that 43 million individuals covered by plans of small businesses will probably lose existing coverage because of how the so-called grandfather rule has been defined.

What’s the grandfather rule? Under the Patient Protection and Affordable Care Act, insurance plans in effect on March 23, 2010, can be retained indefinitely (the plan is “grandfathered”) if they satisfy certain requirements. Businesses with plans that fail to satisfy the grandfather rule will have to obtain new, more expensive, coverage (they will be more expensive because they will have to include certain benefits not currently mandated).

More …

Interim final regulations detail how to remain a grandfathered plan. The plan will not be grandfathered if any of the following occurs:

• There is a decrease in the types of benefits covered by the plan (e.g., eliminating special benefits for diabetics).
• There is a significant increase in co-payments, which is defined as more than the greater of $5, adjusted annually for medical inflation, or a percentage equal to medical inflation plus 15 percentage points (e.g., a co-payment increase from $30 to $50 over the next two years would cause the loss of grandfathering).
• There is a significant increase in plan deductibles, which is defined as no more than a percentage equal to medical inflation plus 15 percentage points (e.g., if medical inflation is 5%, then the deductible cannot increase by more than 20%).
• There is a substantial increase in the cost of coverage borne by employees by decreasing the employer’s share (e.g., decreasing the employer’s share by more than 5 percentage points).
• There is a change in insurance companies, even if comparable insurance is purchased.

What to do now?

Review the details of the grandfather rule in a fact sheet from HealthReform.gov. If you currently have health coverage for your business, before you make any changes, consult with an expert who understands the new grandfather rule.

Your insurance agent may not be the right expert (although some may master the new rule).  You may want to review your proposed changes with your accountant.

There’s been much talk about raising the income tax rates for so-called “wealthy individuals,” which has been defined by President Obama as singles with income over $200,000 and couples with income over $250,000. What has been left out of the discussion is the fact that on January 1, 2013, there will be additional taxes imposed on these individuals, regardless of any additional income tax changes that are made. These taxes were created last year by the Patient Protection and Affordable Care Act as a way to help pay for more than half of “Obamacare.”

Additional Medicare tax for earners
Starting in 2013, there will be a 0.9% tax on wages and net earnings from self-employment of “high-income taxpayers.” These are single filers with modified adjusted gross income (MAGI) over $200,000, joint filers with MAGI over $250,000, and married persons filing separately with MAGI over $125,000; only earnings over these limits are subject to the additional tax.

This tax is in addition to the regular Medicare tax of 1.45% for employees and 2.9% for self-employed individuals. But there are differences between the basic Medicare and additional Medicare taxes:

• For self-employed individuals, there is no deduction for one-half of the additional Medicare tax as there is for one-half of the basic Medicare tax.
• For married couples, while the basic Medicare tax is levied on each spouse’s earnings, the additional Medicare tax is on their combined earnings.
• For employers, the obligation to withhold the additional Medicare tax only applies if the employee’s wages from an employer exceed the applicable limit, while for the basic Medicare tax there is mandatory withholding on all earnings from an employer.

All individuals will have to take the additional Medicare tax into account in figuring withholding and estimated taxes. Underpaying can result in estimated tax penalties.

Additional Medicare tax on investment income
In addition to the extra Medicare tax on earnings, there will be a 3.8% additional Medicare tax on certain unearned income. The additional tax will be levied on the lesser of net investment income or MAGI over $200,000 for singles, $250,000 for joint filers, and $125,000 for married persons filing separately.

Net investment income is the difference between certain income—interest, dividends, annuities, royalties, rents (other than derived from a business), and other income from a passive activity, and deductions related to investment income. Gain on the sale of a principal residence that is excludable ($250,000 for singles and $500,000 for joint filers) is not treated as investment income for this purpose.

Again individuals will have to take the additional Medicare tax into account in figuring withholding and estimated taxes. Underpaying can result in estimated tax penalties.

Total tax
So what do these additional taxes amount to? An estimated $210 billion over 10 years! For small business owners, it means more taxes, which translates into less money available for hiring, capital investments, and business growth. Don’t let these additional taxes be left out of the discussion about the “fairness” of wealthy people paying a higher tax rate. And don’t let these additional taxes be overlooked in efforts to repeal parts of Obamacare. The Small Business Health Relief Act introduced on May 23, 2010, would repeal certain aspects of Obamacare and make other changes; it does not address the additional Medicare taxes poised to take effect in a year and a half.

Tax legislation is not exclusively about raising revenue; it’s about incentivizing certain actions that Congress deems worthy. Last year there was a deduction for sales tax on new car purchases as a way to stimulate car sales. For the past two years, there has been a tax credit for certain homebuyers as a way to stimulate the housing market. And there are various business-related tax incentives.

Business incentives

Under the Hiring Incentives to Restore Employment Act, there currently is a payroll tax holiday for employers who hire workers who have been unemployed for at least 60 days. The payroll tax holiday is 6.2% of wages (the Social Security portion of FICA paid by employers); employees still owe their full share of FICA.

The question is: does the payroll tax holiday stimulate employers to hire new workers or is it merely a reward for action that would have been taken in any event?

Under the Patient Protection and Affordable Care Act there is a tax credit for certain small employers (no more than the equivalent of 25 full-time employees) who pay at least half of the cost of health insurance premiums for their staff. The credit is up to 35% of these premiums (find details here).

Again, the question is: will this tax credit cause small employers to pay for premiums if they are not already doing so in order to claim the credit?

Evidence that tax breaks work as incentives

The Treasury released a report on August 2 showing that between February and June, 5.6 million workers have been hired who entitle employers to the payroll tax holiday. If these 5.6 million newly-hired employees remain on the payroll for the rest of the year, their employers are eligible for an estimated $6.2 billion in payroll tax savings (employers can claim the exemption from Social Security taxes for all wages paid to qualifying employees through the remainder of 2010).

A report by FamiliesUSA and Small Business Majority claim that more than 4 million businesses will qualify for the small employer health credit in 2010; of these, 1,198,700 will qualify for the maximum credit.

No conclusion yet

The government report would seem to imply how well the tax break is working to stimulate employment. The numbers, however, don’t bear this out.

How many of these employers would have hired the new workers even if there were no tax incentive? There are no numbers on this information.

The report by the Small Business Majority merely reveals eligibility based on company payroll size; it doesn’t indicate how many employers who previously did not pay premiums now will do so because of the credit.

Business owners I’ve spoken with indicate that the payroll holiday is nice but not enough to get them to add to their payroll. The tax credit for health insurance is nice, also, but those who do not currently pay for coverage are still put off by the high cost of premiums.

It would be nice to poll small business owners to discover whether their actions are tax-motivated in any way.

Remember the promise made during the health care debate that “if you like your health coverage, you can keep it?” Now it seems that fewer than 20% of small businesses will be able to do so. The Administration estimates that 43 million individuals covered by plans of small businesses will probably lose existing coverage because of how the so-called grandfather rule has been defined.

What’s the grandfather rule? Under the Patient Protection and Affordable Care Act, insurance plans in effect on March 23, 2010, can be retained indefinitely (the plan is “grandfathered”) if they satisfy certain requirements. Businesses with plans that fail to satisfy the grandfather rule will have to obtain new, more expensive, coverage (they will be more expensive because they will have to include certain benefits not currently mandated).

Grandfather rule
Recently released interim final regulations detail how to remain a grandfathered plan. The plan will not be grandfathered if any of the following occurs:

• There is a decrease in the types of benefits covered by the plan (e.g., eliminating special benefits for diabetics).
• There is a significant increase in co-payments, which is defined as more than the greater of $5, adjusted annually for medical inflation, or a percentage equal to medical inflation plus 15 percentage points (e.g., a co-payment increase from $30 to $50 over the next two years would cause the loss of grandfathering).
• There is a significant increase in plan deductibles, which is defined as no more than a percentage equal to medical inflation plus 15 percentage points (e.g., if medical inflation is 5%, then the deductible cannot increase by more than 20%).
• There is a substantial increase in the cost of coverage borne by employees by decreasing the employer’s share (e.g., decreasing the employer’s share by more than 5 percentage points).
• There is a change in insurance companies, even if comparable insurance is purchased.

What to do now
Review the details of the grandfather rule in a fact sheet from HealthReform.gov. If you currently have health coverage for your business, before you make any changes, consult with an expert who understands the new grandfather rule. Your insurance agent may not be the right expert (although some may master the new rule); you may want to review your proposed changes with your accountant.

The Hiring Incentives to Restore Employment (HIRE) Act, which was signed into law on March 18, 2010, gives employers two new tax breaks for adding to their payroll.  Will this induce you to create jobs?

Tax incentives

The HIRE Act has one incentive for expanding your staff that starts immediately and one that you may be able to claim on your 2011 return:

Immediate payroll tax relief. You won’t owe the employer share of FICA that covers Social Security taxes (6.2% of wages up to $106,800) on wages paid to anyone hired after February 3, 2010, and before January 1, 2011, who has been unemployed for at least 60 days before the start date or who worked fewer than a total of 40 hours during this 60-day period. Employees hired during this period will have to certify to you that they meet this condition.

Relief on 2011 returns. If you retain a worker for at least 52 weeks, you can claim a tax credit of up to $1,000. There is no limit on the number of employees for whom you can claim the credit.

Is this enough?

While these tax incentives are helpful, they are smaller than tax increases taking effect after 2010, especially on business owners in higher income tax brackets in light of changes made by the Patient Protection and Affordable Care Act signed into law on March 23, 2010, and other anticipated tax increases to come.

From a financial perspective, hiring new employees is wise only if their cost, which is generally their wages plus about 15%, at least equals what you expect they can earn for you in terms of productivity and sales. Keep in mind that the Patient Protection and Affordable Care Act penalizes employers with 50 or more full-time employees who fail to provide health coverage, so growing companies may aim to keep their payroll below this critical size. (Next week’s blog covers the Patient Protection and Affordable Care Act.)