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Tax Changes in Health Care Reform Legislation Taking Effect in 2013

Increased HI tax for high-earning workers and self-employed taxpayers. For tax years beginning after Dec. 31, 2012, an additional 0.9% hospital insurance (HI) tax applies to wages received with respect to employment in excess of: $250,000 for joint returns; $125,000 for married taxpayers filing a separate return; and $200,000 in all other cases. The additional 0.9% HI tax also applies to self-employment income for the tax year in excess of the above figures.

Surtax on unearned income of higher-income individuals. For tax years beginning after Dec. 31, 2012, an unearned income Medicare contribution tax is imposed on individuals, estates, and trusts. For an individual, the surtax is 3.8% of the lesser of either (1) net investment income or (2) the excess of modified adjusted gross income over the threshold amount ($250,000 for a joint return or surviving spouse, $125,000 for a married individual filing a separate return, and $200,000 for all others). For surtax purposes, gross income doesn't include excluded items, such as interest on tax-exempt bonds, veterans' benefits, and excluded gain from the sale of a principal residence.

Higher threshold for deducting medical expenses. For tax years beginning after Dec. 31, 2012, unreimbursed medical expenses are deductible by taxpayers under age 65 only to the extent they exceed 10% of adjusted gross income (AGI) for the tax year. If the taxpayer or his or her spouse has reached age 65 before the close of the tax year, a 7.5% floor applies through 2016 and a 10% floor applies for tax years ending after Dec. 31, 2016.

Dollar cap on contributions to health FSAs. For tax years beginning after Dec. 31, 2012, for a health FSA (flexible spending account) to be a qualified benefit under a cafeteria plan, the maximum amount available for reimbursement of incurred medical expenses of an employee (and dependents and other eligible beneficiaries) under the health FSA for a plan year (or other 12-month coverage period) can't exceed $2,500.

Deduction eliminated for retiree drug coverage. Sponsors of qualified retiree prescription drug plans are eligible for subsidy payments from the Secretary of Health and Human Services (HHS) for a portion of each qualified covered retiree's gross covered prescription drug costs (“qualified retiree prescription drug plan subsidy”). These qualified retiree prescription drug plan subsidies are excludable from the taxpayer's (plan sponsor's) gross income for regular income tax and alternative minimum tax (AMT) purposes. For tax years beginning before 2013, a taxpayer may claim a business deduction for covered retiree prescription drug expenses, even though it excludes qualified retiree prescription drug plan subsidies allocable to those expenses. But for tax years beginning after Dec. 31, 2012,  the amount otherwise allowable as a deduction for retiree prescription drug expenses is reduced by the amount of the excludable subsidy payments received.

Information reporting of health insurance coverage. Employers filing 250 or more Forms W-2 for 2011 were required to report the aggregate cost of the applicable employer-sponsored health insurance coverage provided to employees during 2012 on the Form W-2, Wage and Tax Statement filed before the end of January, 2013, and then filed with the Social Security Administration (SSA). The reporting to employees is for their information only. It is intended to inform them of the cost of their health care coverage, and doesn't cause excludable employer-provided health care coverage to become taxable.

For small employers (i.e., those required to file fewer than 250 Forms W-2 for the preceding calendar year), reporting is optional for health coverage provided through at least 2012, or until further guidance is issued by IRS. Thus, these employers won't have to report the cost of health care coverage on any forms required to be furnished to employees before January 2014, at the earliest.