04.01.10

Tax Implications of the Health Care and Reconciliation Acts

Recently Congress passed the Patient Protection and Affordable Care Act of 2010 along with the Health Care and Education Reconciliation Act (Reconciliation Act) of 2010. While you have no doubt heard a great deal about both acts, we wanted to bring to your attention several of the tax provisions that might affect your 2010 and 2011 federal income tax liability and reporting requirements.

Business / Small Business / Self-Employed Individuals

Credit for Employee Health Insurance Expenses of Small Business

Beginning in 2010, new §45R provides eligible small businesses with a nonrefundable credit of up to 35% (25% for tax-exempt small employers) of the total premium cost of providing health care to their workers. To be eligible, the employer must contribute at least 50% of the total per employee premium cost of an employer-offered qualified health plan offered by the employer. For taxable years beginning in 2010 through 2013, employers with 10 or fewer employees and average annual wages of not more than $25,000 per employee are eligible for the full credit. Employers who employ between 11 and 25 full-time employees with average annual wages between $25,000 and $50,000 per employee are eligible for a reduced credit based upon a sliding-scale formula. The following are not employees for purposes of new §45R: a self-employed individual, a 2% shareholder of an S corporation, a 5% owner of an eligible small business, or an individual related to any of these three.

Qualifying Therapeutic Discovery Project Credit

Pursuant to new §48D, taxpayers are eligible for a 50% nonrefundable investment tax credit for qualified investments in “qualifying therapeutic discovery projects.” The provision allocates $1 billion during the two-year period 2009 through 2010 for the program, and applies to amounts paid or incurred after December 31, 2008.

The “qualifying therapeutic discovery project credit” for any taxable year beginning in 2009 or 2010 is equal to 50% of the “qualified investment" for that taxable year. It applies to any “qualifying therapeutic discovery project” of a taxpayer that employs not more than 250 employees in all of its businesses. A “qualified investment” is the aggregate costs, with certain exclusions, paid or incurred in that taxable year for expenses necessary for and directly related to the conduct of a “qualifying therapeutic discovery project.” A “qualifying therapeutic discovery project” is a project designed to:
(a) treat or prevent diseases or conditions by conducting pre-clinical activities, clinical trials, and clinical studies, or carry out research protocols for securing product approval; (b) diagnose (or determine molecular factors relating to) diseases or conditions by developing molecular diagnostics to guide therapeutic decisions; or (c) develop a product, process, or technology to further the delivery or administration of therapeutics.

Pursuant to the provision, a project program to award certifications is to be established within 60 days after March 30, 2010, which will determine the eligibility requirements for the credit, as well as provide rules relating to the submission of applications and selection criteria.

There are special rules dealing with: (a) the basis of assets that qualify for the credit; (b) property eligible for bonus depreciation; (c) deduction limitations vis-a-vis the credit; and (d) the use of the credit in coordination with the research credit. Please feel free to contact us to discuss these more technical issues.

Grants in lieu of the credit are available for 50% of a 2009 or 2010 qualified investment in a qualifying therapeutic discovery project. Tax exempt and governmental entities are not eligible for grants.

Trade or Business Expenses

Effective March 30, 2010, §162(l) is expanded to allow self-employed taxpayers to deduct amounts paid during the taxable year for medical insurance covering the taxpayer, the taxpayer's spouse, dependents, and children under age 27.

Inclusion of Cost of Employer-Sponsored Health Coverage on W-2

Effective for taxable years beginning after December 31, 2010, new § 6051(a)(14) requires employers to include on Form W-2 the aggregate cost of the employer-sponsored health care coverage. Amounts contributed to an Archer MSA, an HSA of the employee or employee's spouse, or the amounts of any salary reduction contributions to an FSA are excluded from the reporting requirement.

Codification of economic substance

The Reconciliation Act codifies the judicially created “economic substance" doctrine, effective for transactions entered into after March 30, 2010. Pursuant to new §7701(o), a transaction entered into in connection with a trade or business or an activity engaged in for the production of income is treated as having economic substance only if: (1) the transaction changes in a meaningful way (apart from federal income tax effects) the taxpayer's economic position; and (2) the taxpayer has a substantial purpose (apart from federal income tax effects) for entering into such transaction. In this regard, any state or local income tax effect which is related to a federal income tax effect is treated in the same manner as a federal income tax effect. Also, a purpose of achieving a favorable accounting treatment for financial reporting purposes is not taken into account as a non-federal-income-tax purpose if the origin of the financial accounting benefit is a reduction of federal income tax.

New, stronger penalties apply to an understatement attributable to any disallowance of claimed tax benefits by reason of a transaction lacking economic substance. The penalty rate is 20%, but increases to 40% if the taxpayer does not adequately disclose the relevant facts affecting the tax treatment in the return or a statement attached to the return. No exceptions (including the reasonable cause rules) to the penalty are available (i.e., the penalty is a strict-liability penalty).

Individual

Expansion of Adoption Credit and Adoption Assistance Programs

Effective for taxable years beginning after 2009, the adoption credit and adoption assistance programs are expanded by increasing the maximum amount of adoption expenditures that may be claimed as a credit from $10,000 to $13,170, including a child with special needs. This amount is indexed for inflation for taxable years beginning after 2010. Likewise, the §137(b)(1) exclusion from gross income is increased from $10,000 to $13,170. Finally, the Act makes the adoption credit refundable.

The adoption credit's sunset, scheduled for the end of 2010, is delayed until the end of 2011.

Amounts Received Under Accident and Health Plans

Effective March 30, 2010, the Reconciliation Act amends §105(b) to provide that taxpayers are no longer required to include in income employer-provided accident or health plan reimbursements for medical care expenses paid on behalf of an employee's child who has not attained age 27 as of the end of the taxable year.

We hope you have found this information helpful. If you have any questions about the Reconciliation Act or pending legislation, please contact our office.

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