NEW MEDICARE TAXES & AFFORDABLE CARE ACT : Summation of Impact

Effective January 1, 2013, the Affordable Care Act imposed two new Medicare taxes on qualified taxpayers: a 3.8 percent net investment income (NII) tax and a 0.9 percent Additional Medicare Tax. Throughout much of 2013 …and despite proposed reliance regulations issued in 2012, many taxpayers and their advisors continued to have questions regarding the application of these new taxes. Finally, on November 26, 2013 -a full 330 days into the first year in which the two new taxes applied, the IRS released much-anticipated final regulations.

IMPACT.

The final NII tax regulations are intended to clarify many issues, largely in favor of taxpayers, but also defer complete resolution of other questions to guidance promised in 2014. They arrived late enough in the year to foreclose consistent or aggressive strategies for the 2013 tax year.

Net Investment Income Tax. The NII tax on taxpayers (individuals and trusts and estates) equals 3.8 percent of the lesserof: (1) net investment income for the tax year, or (2) the excess, if any of: (a) an individual's modified adjusted gross income (MAGI) for the tax year, over (b) the threshold amount.

The threshold amount is $250,000 in the case of a taxpayer making a joint return or a surviving spouse, $125,000 in the case of a married taxpayer filing a separate return, and $200,000 in any other case (these amounts are not indexed for inflation). The threshold amount for trusts and estates is the start of their 39.6 percent tax bracket, which, for 2013 was $11,950 ($12,150 for 2014).

Final regulations. The November 2013 final regulations retained most provisions from the 2012 proposed reliance regulations, but nevertheless changed several key portions to accommodate what it conceded was legitimate criticism (TD 9644). The final regulations addressed dozens of requests for changes to the 2012 proposed regulations. Some recommendations were adopted, some were tweaked, and some were rejected by the IRS.

Some of the more significant pro-taxpayer changes in the final regulations include:

• ▪ Allowing Code Sec. 465 net disposition losses to offset other categories of investment income and treating as properly allocable deductions net operating losses allocable to investment income;
• ▪ Concluding generally that income treated as nonpassive under the Code Sec. 469 passive activity limitations also may qualify as nonpassive under Code Sec. 1411;
• ▪ Classifying income from self-rented property more favorably;
• ▪ Providing safe harbors under which some real estate professionals will avoid the NII tax;
• ▪ Acknowledging that renting out even a single item of property may qualify as a trade or business, depending on facts and circumstances; and
• ▪ Providing regrouping opportunities on passive activities that apply to Code Sec. 469 in addition to Code Sec. 1411.

New proposed regulations. In response to taxpayer feedback, the IRS issued new proposed reliance regulations at the same time as the final regulations. The proposed reliance regulations are intended to provide, among other things, simplified methods to compute NII vulnerable gain or loss on the sale of pass through entities (NPRM REG130843-13). The proposed reliance regulations address areas that either were not covered in the 2012 proposed regulations, or that the IRS subsequently revised.

Additional Medicare Tax. Final regulations on the Additional Medicare Tax were also released by the IRS in November (TD 9645). The Additional Medicare Tax applies to employee compensation/self-employment income in any tax year beginning after December 31, 2012. The final regulations generally track proposed regulations issued in 2012, with some clarifications.

The IRS acknowledged that the Additional Medicare Tax requires new recordkeeping and withholding procedures for employers. However, the agency declined to give employers additional time to correct errors, allow corrections for a certain period without penalty, or exempt de minimis errors from penalties. The IRS also described correction of overpayments and underpayments by employers in the final regulations.

IMPACT.

Employers should be aware of the requirement that they withhold additional income tax from employees whose wages exceed the threshold for the tax (generally, $200,000). Employers that did not properly withhold for 2013 compensation may expect to be assessed penalties since corrections under the regulations are generally only allowed if made within the same tax year.

AFFORDABLE CARE ACT

When Congress passed the Affordable Care Act in 2010 it delayed the effective dates of many key provisions. Effective January 1, 2014, the individual mandate took effect; however, the Obama administration mitigated the requirements for some individuals as the deadline approached. And the Obama administration delayed the effective date of the employer mandate entirely.

Employer mandate. The IRS issued proposed regulations on the employer mandate in January (NPRM REG-138006-12). The proposed regulations describe an applicable large employer (ALE) for purposes of Code Sec. 4980H, the number of hours of service in a calendar month treated as fulltime, how the requirement would apply to a new employer that is an applicable large employer, and more.

IMPACT.

Under the Affordable Care Act, an ALE with respect to a calendar year is an employer that employed an average of at least 50 full-time equivalent employees on business days during the preceding calendar year. The proposed regulations would treat 130 hours of service in a calendar month as the monthly equivalent of 30 hours of service per week.

Delay. In July, the Obama administration announced that the employer mandate would not apply until 2015. The administration explained that it took this action to give employers additional time to implement reporting requirements underCode Sec. 6056. The IRS subsequently issued transition relief providing that information reporting under Code Sec. 6056(and Code Sec. 6055 for insurers) is optional for 2014.

Individual mandate. The IRS issued proposed regulations on the individual shared responsibility payment requirement (individual mandate) in January (NPRM REG-148500-12). Under the proposed regulations, minimum essential coverage for purposes of the individual mandate includes (not an exhaustive list) qualified employer-sponsored coverage, Medicare, Medicaid, and coverage for veterans and children. Certain individuals are exempt from the requirement to carry minimum essential coverage, such as individuals who experience a short gap in coverage, individuals who are unlawfully present in the U.S., and individuals who are incarcerated. The Obama Administration also grandfathered for 2014 certain additional plans that were being cancelled.

Unlike the employer mandate, the individual mandate in general is not delayed and took effect January 1, 2014. However, individuals will not report any liability for failing to carry minimum essential coverage until they file their 2014 returns in 2015.

Code Sec. 36B credit. Individuals who obtain health insurance coverage through an Affordable Care Act Marketplace after 2013 may be eligible for the Code Sec. 36B credit to offset the cost of coverage. In January, the IRS released final regulations on the Code Sec. 36B premium assistance tax credit (TD 9611). In May, the IRS issued proposed regulations to clarify the meaning of "minimum value" (MV) for purposes of claiming the Code Sec. 36B credit (NPRM REG-125398-12).

The IRS also issued proposed reliance regulations on reporting the Code Sec. 36B credit (NPRM REG-140789-12). Marketplaces will report the level of coverage, advance payments of the credit and more to the IRS.

Marketplaces will provide qualified taxpayers with a written statement that includes this same information on or beforeJanuary 31 of the year following the calendar year of coverage.

The Code Sec. 36B credit has been challenged in litigation. In October, a federal district court declined to dismiss a suit claiming that Congress intended for the Code Sec. 36B credit to be available only when individuals purchase health insurance through a state-established Marketplace (Halbig v. Sebelius, D-D. C., No. 13-00623).

Health insurance fees. In November, the IRS issued final regulations on the application of annual fees to health insurance providers under the Affordable Care Act. The annual fee on covered entities is effective after 2013. The IRS intends to notify each covered entity of the preliminary fee calculation by June 15 of each fee year and the final fee calculation on or beforeAugust 31. The fee must be paid by September 30 of each fee year (TD 9643).

Branded prescription drug fee. The IRS issued guidance on the branded prescription drug fee for the 2014 fee year in August (Notice 2013-51). The IRS explained it will mail each covered entity a paper notice of its preliminary fee calculation for the 2014 fee year by March 3, 2014. The IRS will notify each covered entity of its final fee calculation for 2014 by August 29, 2014.

90-day waiting period. The IRS and the U.S. Departments of Health and Human Services (HHS) and Labor (DOL) issued proposed reliance regulations in March to describe the 90-day limitation for group health insurance under the Affordable Care Act (NPRM REG-122706-12). Insured and self-insured group health plans are generally precluded from imposing a waiting period that exceeds 90-days before coverage can begin for eligible group members.

Compensation. The IRS issued proposed reliance regulations on the $500,000 deduction limitation on compensation provided by health insurance providers under the Affordable Care Act in April (NPRM REG106796-12). The deduction limit applies to a covered health insurance provider in a tax year beginning after December 31, 2012.

Charitable hospitals. In April, the IRS released proposed reliance regulations on the Code Sec. 501(r)(3) requirement that charitable hospitals perform a community health needs assessment (CHNA) every three years or risk losing their tax-exempt status (NPRM REG-106499-12). The IRS issued temporary and proposed regulations in August for charitable hospital organizations on how to report excise taxes and file any excise tax return for failing to meet the CHNA requirements (TD 9629, NPRM REG-115300-13).

Indoor tanning tax. In June, the IRS issued final regulations on the Affordable Care Act's indoor tanning tax when services are bundled (TD 9621). This excise tax generally took effect in 2010.

PCORI. The Affordable Care Act established the Patient-Centered Outcomes Research Institute (PCORI), which is funded by the Patient-Centered Outcomes Research Trust Fund. The trust fund is funded—in part—by fees paid by issuers of certain health insurance policies and sponsors of certain selfinsured health plans. In July, the IRS posted frequently asked questions (FAQs) on its website about the PCORI fees that apply to specified health insurance policies with policy years ending after September 30, 2012, and before October 1, 2019.

IRS Chief Counsel determined in 2013 that the Patient-Centered Outcomes Research Trust Fund fee is deductible underCode Sec. 162(a) (AM 2013-002).

Preventative services. In July, the IRS issued final regulations on the coverage of certain preventative services under the Affordable Care Act (TD 9624). The final regulations generally provide that the requirement to offer coverage for certain preventive services without cost sharing is subject to the religious employer exemption and eligible organization accommodations.