Where we stand on tax cuts and bigger paychecks

It is one thing for Congress to pass a tax bill but it is quite another to see increases in the paychecks of employees – especially the paychecks of America’s small businesses. The mechanical process of increasing paychecks is dependent of the system of controls used by employers and their payroll contractors. The IRS recently issued statements saying that might happen by the end of February 2018 thanks to the independent efforts of payroll companies acting more quickly than the IRS. But for small businesses the process of boosting employee paychecks may take longer.

As of today. February 21, 2018 this is where small businesses stand on he issues:

  • Form W4 for 2017 is obsolete bu can be used until February 28, 2018 per IRS Notice 2018-14
  • IRS has not yet issued a new Form W4 for 2018. (A draft version published cannot actually be used yet because it is missing important information). Obviously employers will not have time to have the new forms. when issued, executed and in use by March 1, 2018.
  • Revised 2018 withholding tables are available so employers should be clear on their legal requirement to withhold payroll taxes.

Payroll accountants and their software platforms are generally proficient in these matters so the only problems I expect are among those relatively few ‘do-it-yourself’ manual payroll operations.


While this article focuses on employer actions and responsibilities, I  strongly recommend that individual taxpayers prepare an estimate of 2018 taxes based on the new law to accurately plan for payroll tax withholding.


I am pleased to discuss this issue as it relates to your small business.

Small Business Employee Benefits Made Easy!

Small business employee benefits are managed much more effectively when the business owner has a basic working knowledge of the components that make the plan successful. This bog post lists those basic components.

  1. Understand the purpose of the employee benefit plan – Usually the goal, at least the starting point goal, is to provide benefits that are tax-deductible as a business expense and tax-free to the employee. If not for this tax advantage, there would be little incentive for employers to be involved. Each employer has a unique and specific goal and so the employee benefit plan is designed to match that goal.
  2. Understand what is not the purpose of an employee benefit plan – No longer do employers provide a ‘one size fits all’ and ‘take it or leave it’ benefit plan design. Today’s employee benefits are designed to extract and maximize the benefits and efficiencies of consumer-driven choices.
  3. Communication – Good communication is the key to a successful employee benefit plan. All of the stakeholders – the employer, employees, spouses and dependents of employees, plan administrator, claim administrator, insurer, and payroll company must feel comfortable that they have a reliable source of information. A reputable benefit plan adviser makes all the difference.
  4. Documentation – Employer resolutions, Enrollment forms, Plan Documents and summary plan Descriptions are typically required. A non-attorney typically provides these sample documents but cannot provide legal advice. The employer is encouraged to seek independent legal advice on all business documents.
  5. Claim accounting – Nowadays this is typically handled via secure portal, email or text message, at the option of the employee. The result is an approved claim report that is sent to payroll processing.
  6. Payroll processing – Most employee benefit transactions between the employer and the employe are handled through a payroll processing service. Once the benefits accounts are set up properly within the payroll system, this process usually flows smoothly. Typically the payroll processor sends reports back to the employer for general accounting purposes.
  7. Tax filings – some employee benefit plans require year-end filings either singularly or as a data inclusion on another form like a W2. Again, this process flows effortlessly within a properly set up payroll and benefits administration system.

Freedom Benefits is prepared to make all the details flow effortlessly. Just give a call to discuss your own small business employee benefit plan. 

One page summary of Freedom Benefits

Yesterday an inspiring business adviser Sara Rosenberg of Powermatch, wrote a social media post that said that every business should have a one page summary that answers four questions: (1) The problem you solve, (2) A very brief description of your process (3) How you are different than everyone else that does what you do, (4) The results that happen when someone hires you. This is a powerful idea but one that I have not ever considered, So I spent some time and came up with this that flows exactly in the 4 part format she suggests. Next I’ll work on polishing and simplifying the wording and checking on a few compliance issues.

Here is the draft text of the one page summary as of now:

Slash your taxes now!

How it works

Freedom Benefits helps your small business slash wage taxes and move more of your earnings to long term wealth building accounts with the benefit plans used by larger firms. Our small business employee benefit plans are integrated with your payroll system to take advantage of IRS-sanctioned accounting methods and tax-favored employee benefit plans. Plans are now redesigned for 2018 to maximize savings under the Tax Cuts and Jobs Act.

First, your small business meets with the planner to elect the benefits to be offered and selects the employer’s financial contribution, if any, that the business will make toward the cost of these voluntary benefit programs. Some options like a Health Reimbursement Arrangement, if elected, and administrative costs are paid by the employer. The employer’s cost is always controlled and limited by what the employer elects to contribute.

Then employees may elect to pay with Voluntary Salary Reduction for Insurance Premium Payments, Flexible Spending Account, Health Savings Account, and Dependent Care Assistance Plan components. Popular savings plans including a 401(k) Plan, Simplified Employee Pension, IRA and Thrift Savings Plan are available to help employees keep more of what they earn. New for 2018: employees may now elect to participate in a Home Office Expense Reimbursement, Travel Expense Reimbursement and Commuting Expense Reimbursement Plan and an Employee Work Expense Reimbursement Plan. The Plan Advisor works with each employee individually to plan the benefit combination that works best. Participation is completely voluntary.

Why we are different

Our service is based on building long term relationships that are aligned with supporting the financial goals of the business and your individual employees. We deliver big firm executive service to small businesses. Freedom Benefits is powered by the experience of Tony Novak, CPA, MBA, MT, an employee benefits adviser with more than 30 years helping small businesses nationwide. Success is ensured by our unique pricing policy that limits the plan cost to a fraction of the tax savings that you achieve.

Results

You will see immediate wage tax savings adding up to thousands of dollars per employee in combined employer and employee savings. The savings will begin to show in your first payroll report after implementation. Employees will enjoy a better understanding of their benefit options and see more accumulating by year end as an additional benefit. The sooner you start, the greater the savings in 2018.

HEALTH   *   RETIREMENT   *   DEPENDENT CARE   *   EMPLOYEE BUSINESS EXPENSE

The draft PDF version:

freedom benefits page

Summary of the Tax Cut and Jobs Act

(Reportedly by Kathy Pickering – Executive Director, The Tax Institute, December 20, 2017, reproduced here after it was widely circulated on social media where I found it). Some portions related to small business employee benefit plans are highlighted.

Three highlights you need to know:

Virtually all taxpayers are impacted by the changes in the tax reform legislation
Those who itemize will have fewer expenses to deduct and a higher standard to cross
Changes to child-related tax benefits impact families
In the weeks to come, we’ll dive into each of these sections and help you identify how you will be impacted on your 2018 return.

How does tax reform affect you?

Virtually all taxpayers are impacted by changes in the tax reform legislation. Find out what could be changing on your return.

Congress just passed the Tax Cuts and Jobs Act (TCJA). Next, it will go to President Trump to be signed into law. The TCJA makes changes that affect all kinds of taxes – individual, corporate, partnership and other “pass through” business entities, estate, and even tax-exempt organizations. This article looks at tax changes for individuals.

Most changes take effect on January 1, 2018. Tax returns filed during the spring of 2018 (for the 2017 tax year) are generally not affected. But knowing about these changes now will help taxpayers plan and understand how the TCJA could impact their take-home pay and their 2018 tax refund.

Tax brackets and tax rates change for most taxpayers

Most tax filers will pay tax using a new tax bracket and tax rate structure. However, the tax rates remain progressive, meaning tax rates rise as income increases.

In comparison to previous tax brackets and tax rates, the new rates due to the Tax Cuts and Jobs Act are slightly lower and the brackets are generally slightly broader.

Rates under the TCJA Pre-TCJA rates
10%, 12%, 22%, 24%, 32%, 35%, 37% 10%, 15%, 25%, 28%, 33%, 35%, 39.6%
View the 2018 tax rates and brackets for each filing status

Under the 2017 tax brackets and rates, a single taxpayer with $40,000 of taxable income would be in the 25% tax bracket and would have a tax liability of $5,739.

Under the 2018 tax brackets and rates, a single taxpayer with $40,000 of taxable income would be in the 22% tax bracket and would have a tax liability of $4,740.

Going forward, the brackets will be adjusted based on a different inflation measure – the Chained Consumer Price Index for All Urban Consumers (C-CPI-U) – that is expected to grow more slowly than the previous inflation measure.

While most taxpayers will pay less, some taxpayers will pay a slightly higher tax rate under the TCJA. This is most likely to impact an upper-middle class individual with a marginal tax rate of 35%, up from 33%.

Tip: Tax brackets, rates and credits play a big part in how much tax a taxpayer will pay, but the amount of taxable income plays perhaps an even bigger role.

Personal and dependent exemptions are eliminated

In 2017, taxpayers claimed a personal exemption for themselves, their spouse (if married filing jointly) and each qualifying child or qualifying relative. Each exemption reduced taxable income by over $4,000 in 2017. Under the TCJA, personal and dependent exemptions are eliminated from 2018 through 2025.

In 2026, taxpayers can claim personal and dependent exemptions again.

Child tax credit increased through 2025

Through 2025, the TCJA increases the maximum child tax credit from $1,000 to $2,000 per qualifying child. The refundable portion of the credit increases from $1,000 to $1,400. That means taxpayers who don’t owe tax can still claim a credit of up to $1,400. The higher child tax credit will be available for qualifying children under age 17, as under current law.

Also, the child tax credit begins to phase out for taxpayers with modified adjusted gross income (MAGI) of over $200,000 or $400,000 (MFJ). This phaseout more than doubles the phaseout range under current law. Taxpayers can’t claim a child tax credit for a child who does not have a Social Security Number (SSN) by the due date of the return.

In 2026, the child tax credit will change to the rules used in 2017, with a maximum credit of $1,000 per qualifying child, and lower phaseouts.

New credit for non-child dependents available through 2025

The TCJA allows a new $500 nonrefundable credit for dependents who do not qualify for the child tax credit. Taxpayers can claim this credit for children who are too old for the child tax credit, as well as for non-child dependents. There is no SSN requirement to claim this credit, so taxpayers can claim the credit for children with an Individual Tax Identification Number (ITIN) or an Adoption Tax Identification Number (ATIN) if they otherwise qualify.

Taxpayers cannot claim the credit for themselves or their spouse (if MFJ).

In 2026, the credit for non-child dependents will no longer be available.

Standard deduction increases through 2025

The standard deduction will increase. In 2018, the standard deduction amounts will be:

$12,000 (single)
$18,000 (head of household)
$24,000 (married filing jointly)
Because of the increase and because of changes to the rules for itemized deductions, many taxpayers who previously itemized deductions will now claim the standard deduction instead. This means they may not have to file Schedule A. However, taxpayers may want to continue to track their expenses so they have the information to make the comparison and choose the tax benefit with the bigger value.

Many itemized deductions eliminated, limited or modified

 

Before the tax reform bill takes effect, about 30% of taxpayers itemized deductions on Schedule A, instead of taking the standard deduction associated with their filing status. However, the TCJA has a large impact on itemized deductions, as several itemized deductions have been eliminated or modified.

 

Fully eliminated

Miscellaneous itemized deductions subject to the 2-percent floor
Employee business expenses
Tax preparation fees
Investment interest expenses
Personal casualty and theft losses (except for certain losses in certain federally declared disaster areas)
Limited

State and local income taxes (SALT) or state and local sales tax, plus real property taxes, may be deducted, but only up to a combined total limit of $10,000 ($5,000 if MFS)
Home mortgage interest has several modifications:
Interest on a home equity loan is no longer deductible
Interest on a new home mortgage is limited to interest paid on a maximum of $750,000 ($375,000 if MFS) of a new mortgage taken out after December 14, 2017.
Taxpayers with a mortgage taken out before December 15, 2017 can continue to claim home mortgage interest on up to $1 million ($500,000 if MFS) going forward; the $1 million ($500,000 if MFS) limit continues to apply to a refinanced mortgage incurred before December 15, 2017.
Modified

Charitable contributions: The deduction for charitable contributions is expanded so that taxpayers may contribute up to 60% of their adjusted gross income, rather than up to 50%.
Gambling losses remain deductible, but only to the extent of gambling winnings. The definition of losses from wagering transactions is modified.
Medical expenses remain deductible. For 2017 and 2018, medical expenses are deductible to the extent they exceed 7.5% of AGI. In 2019, the threshold will increase to 10% of AGI.
The overall limit on itemized deductions (often called the Pease limit) is also eliminated by tax reform under President Trump.

Most of the changes to itemized deductions will remain in place through 2025. In 2026, itemized deductions will generally follow the rules in place before the TCJA.

Many “Above-the-line” deductions eliminated, limited or modified

 

As with itemized deductions, many “above-the-line” adjustments have also been eliminated or limited:

Fully eliminated

Alimony deduction for payments made under orders executed after December 31, 2018. For new orders, the TCJA no longer allows payors to deduct alimony payments or requires the recipient to report income for alimony received. (Payments under existing orders are grandfathered and may continue to be deducted by the payor and should be reported as income by the recipient.)
Tuition and fees deduction expired under previous law and was not renewed by the TCJA.
Domestic production activities deduction (DPAD)
Mostly eliminated

Moving expenses are disallowed (except for the expenses of active members of the military who relocate pursuant to military orders).

Stays the same

Educator expense deduction (K-12 educators can deduct up to $250 per year for unreimbursed classroom supplies.)
Student loan interest of up to $2,500 can be deducted by qualifying taxpayers for interest paid on student loans.
Health savings account (HSA) deduction
IRA deduction
Deductions for self-employed taxpayers (SE tax, SE health insurance, SE qualified retirement plan contributions)
Some education benefits remain the same, others modified

Taxpayers can continue to claim the American Opportunity Credit, a credit of up to $2,500 per year for the first four years of college education, and the lifetime learning credit, a credit of up to $2,000 per year for qualifying education expenses.

 

Taxpayers can continue to use savings bonds for education, educational assistance programs provided by employers, 529 plans and Coverdell education savings plans to save for college. Some scholarships and tuition waivers can continue to be treated as tax-free if certain conditions are met.

 

529 plans can now be used for K-12 expenses.

Plans can distribute up to $10,000 each year for tuition incurred for enrollment or attendance at a public, private, or religious elementary or secondary school.
The $10,000 limit for elementary and secondary school is applied on a per-student limit.

Taxpayers whose student loans are cancelled because death or total and permanent disability may be eligible to treat the cancellation of debt as tax-free.

Health care penalty eliminated

The penalty for failure to obtain health insurance coverage (the “individual mandate”) will be eliminated beginning in 2019. Taxpayers who did not have coverage in 2017 or 2018 will continue to owe a penalty for those years, unless they qualify for an exemption.

Self-employed taxpayers may claim a new deduction for qualified business income

Self-employed taxpayers can deduct up to 20% of qualified business income from a sole proprietorship, partnership, or S corporation. There are a few limitations placed on the deductions, but many small businesses will be able to benefit.

Example: A self-employed taxpayer has taxable income of $60,000. All of the income is from the business. The qualified business income deduction is $12,000 ($60,000 × 20%).

Taxpayers may benefit by adjusting withholding and estimated taxes

Because of all the changes made by the TCJA, taxpayers should consult their tax professionals for next steps.

Tax professionals can help with Form W-4 planning by verifying they have the correct income tax withholding set up with their employer.

Taxpayers who are self-employed and others who make quarterly estimated tax payments should check with a tax professional and determine whether they need to adjust their estimated payments.

Taking the time to make changes now will help ensure a smooth transition from year to year and eliminate refund surprises.

The new world of financial planning for small businesses

Financial planning has turned upside down this week for small business owners and most are still spinning to get a grip on the topic. Details of the new Republican road map will emerge over time but it t already clear that unprecedented opportunity to save money through proactive financial planning.

The most immediate areas of change and opportunity are:

  1. federal income taxes – significant tax reductions will be available for the most profitable businesses. These whose tax planning was restricted by the Alternate Minimum Tax will get a new lease on possible tax savings.
  2. employee benefits – fewer regulations will lead to more opportunity for creativity and savings. Freedom Benefits expects to re-introduce a wide range of cost-saving options that were retired with the passage of the Affordable Care Act in 2010.
  3. payroll taxes – adjustments will be needed for most firms and their employees. Fortunately today’s online tools reduce the cost while simultaneously improving the reliability of payroll services.

Tax free treatment of amounts received through health plans

The tax treatment of amounts received through accident and health plans is governed by Section 105 of the Internal Revenue Code. The treatment is relatively simple; the only common difficulty comes from the distinctions in treatment between insured and uninsured health plans. The tax code is reproduced below.

There is a minor typographical error in this section of the tax code. The text in (h)(7)(b) is missing a closing parentheses,

26 USC § 105 – Amounts received under accident and health plans

(a) Amounts attributable to employer contributions
Except as otherwise provided in this section, amounts received by an employee through accident or health insurance for personal injuries or sickness shall be included in gross income to the extent such amounts
(1) are attributable to contributions by the employer which were not includible in the gross income of the employee, or
(2) are paid by the employer.
(b) Amounts expended for medical care
Except in the case of amounts attributable to (and not in excess of) deductions allowed under section 213 (relating to medical, etc., expenses) for any prior taxable year, gross income does not include amounts referred to in subsection (a) if such amounts are paid, directly or indirectly, to the taxpayer to reimburse the taxpayer for expenses incurred by him for the medical care (as defined in section 213(d)) of the taxpayer, his spouse, his dependents (as defined in section 152, determined without regard to subsections (b)(1), (b)(2), and (d)(1)(B) thereof), and any child (as defined in section 152(f)(1)) of the taxpayer who as of the end of the taxable year has not attained age 27. Any child to whom section 152(e) applies shall be treated as a dependent of both parents for purposes of this subsection.
(c) Payments unrelated to absence from work
Gross income does not include amounts referred to in subsection (a) to the extent such amounts—
(1)constitute payment for the permanent loss or loss of use of a member or function of the body, or the permanent disfigurement, of the taxpayer, his spouse, or a dependent (as defined in section 152, determined without regard to subsections (b)(1), (b)(2), and (d)(1)(B) thereof), and
(2)are computed with reference to the nature of the injury without regard to the period the employee is absent from work.
[(d) Repealed. Pub. L. 98–21, title I, § 122(b),Apr. 20, 1983, 97 Stat. 87]
(e) Accident and health plans
For purposes of this section and section 104—
(1)amounts received under an accident or health plan for employees, and
(2)amounts received from a sickness and disability fund for employees maintained under the law of a State or the District of Columbia,
shall be treated as amounts received through accident or health insurance.
(f) Rules for application of section 213
For purposes of section 213(a) (relating to medical, dental, etc., expenses) amounts excluded from gross income under subsection (c) or (d) shall not be considered as compensation (by insurance or otherwise) for expenses paid for medical care.
(g) Self-employed individual not considered an employee
For purposes of this section, the term “employee” does not include an individual who is an employee within the meaning of section 401(c)(1) (relating to self-employed individuals).
(h) Amount paid to highly compensated individuals under a discriminatory self-insured medical expense reimbursement plan
(1) In general
In the case of amounts paid to a highly compensated individual under a self-insured medical reimbursement plan which does not satisfy the requirements of paragraph (2) for a plan year, subsection (b) shall not apply to such amounts to the extent they constitute an excess reimbursement of such highly compensated individual.
(2) Prohibition of discrimination
A self-insured medical reimbursement plan satisfies the requirements of this paragraph only if—
(A)the plan does not discriminate in favor of highly compensated individuals as to eligibility to participate; and
(B)the benefits provided under the plan do not discriminate in favor of participants who are highly compensated individuals.
(3) Nondiscriminatory eligibility classifications
(A) In general
A self-insured medical reimbursement plan does not satisfy the requirements of subparagraph (A) of paragraph (2) unless such plan benefits—
(i)70 percent or more of all employees, or 80 percent or more of all the employees who are eligible to benefit under the plan if 70 percent or more of all employees are eligible to benefit under the plan; or
(ii)such employees as qualify under a classification set up by the employer and found by the Secretary not to be discriminatory in favor of highly compensated individuals.
(B) Exclusion of certain employees
For purposes of subparagraph (A), there may be excluded from consideration—
(i)employees who have not completed 3 years of service;
(ii)employees who have not attained age 25;
(iii)part-time or seasonal employees;
(iv)employees not included in the plan who are included in a unit of employees covered by an agreement between employee representatives and one or more employers which the Secretary finds to be a collective bargaining agreement, if accident and health benefits were the subject of good faith bargaining between such employee representatives and such employer or employers; and
(v)employees who are nonresident aliens and who receive no earned income (within the meaning of section 911(d)(2)) from the employer which constitutes income from sources within the United States (within the meaning of section 861(a)(3)).
(4) Nondiscriminatory benefits
A self-insured medical reimbursement plan does not meet the requirements of subparagraph (B) of paragraph (2) unless all benefits provided for participants who are highly compensated individuals are provided for all other participants.
(5) Highly compensated individual defined
For purposes of this subsection, the term “highly compensated individual” means an individual who is—
(A)one of the 5 highest paid officers,
(B)a shareholder who owns (with the application of section 318) more than 10 percent in value of the stock of the employer, or
(C)among the highest paid 25 percent of all employees (other than employees described in paragraph (3)(B) who are not participants).
(6) Self-insured medical reimbursement plan
The term “self-insured medical reimbursement plan” means a plan of an employer to reimburse employees for expenses referred to in subsection (b) for which reimbursement is not provided under a policy of accident and health insurance.
(7) Excess reimbursement of highly compensated individual
For purposes of this section, the excess reimbursement of a highly compensated individual which is attributable to a self-insured medical reimbursement plan is—
(A)in the case of a benefit available to highly compensated individuals but not to all other participants (or which otherwise fails to satisfy the requirements of paragraph (2)(B)), the amount reimbursed under the plan to the employee with respect to such benefit, and
(B)in the case of benefits (other than benefits described in subparagraph (A) paid to a highly compensated individual by a plan which fails to satisfy the requirements of paragraph (2), the total amount reimbursed to the highly compensated individual for the plan year multiplied by a fraction—
(i)the numerator of which is the total amount reimbursed to all participants who are highly compensated individuals under the plan for the plan year, and
(ii)the denominator of which is the total amount reimbursed to all employees under the plan for such plan year.
In determining the fraction under subparagraph (B), there shall not be taken into account any reimbursement which is attributable to a benefit described in subparagraph (A).
(8) Certain controlled groups, etc.
All employees who are treated as employed by a single employer under subsection (b), (c), or (m) of section 414 shall be treated as employed by a single employer for purposes of this section.
(9) Regulations
The Secretary shall prescribe such regulations as may be necessary to carry out the provisions of this section.
(10) Time of inclusion
Any amount paid for a plan year that is included in income by reason of this subsection shall be treated as received or accrued in the taxable year of the participant in which the plan year ends.
(i) Sick pay under Railroad Unemployment Insurance Act
Notwithstanding any other provision of law, gross income includes benefits paid under section 2(a) of the Railroad Unemployment Insurance Act for days of sickness; except to the extent such sickness (as determined in accordance with standards prescribed by the Railroad Retirement Board) is the result of on-the-job injury.
(j) Special rule for certain governmental plans
(1) In general
For purposes of subsection (b), amounts paid (directly or indirectly) to the taxpayer from an accident or health plan described in paragraph (2) shall not fail to be excluded from gross income solely because such plan, on or before January 1, 2008, provides for reimbursements of health care expenses of a deceased plan participant’s beneficiary.
(2) Plan described
An accident or health plan is described in this paragraph if such plan is funded by a medical trust that is established in connection with a public retirement system and that—
(A)has been authorized by a State legislature, or
(B)has received a favorable ruling from the Internal Revenue Service that the trust’s income is not includible in gross income under section 115.

Other resources:

Tax changes triggered by federal health reform law

 

A summary of tax issues related to employer-provided health benefits

Taxation of employer-provided health benefits is often a misunderstood topic especially in the years after implementation of the Affordable Care Act market reform provisions. Yet the fundamental tax treatment of health plans and health benefits has not changed in decades.

Four key factual issues now control the tax treatment of employer-provided health benefits under U.S. law:

  1. Whether the health benefit was provided through insurance or outside of insurance,
  2. If provided through insurance, whether the insurance was ACA compliant, exempted, or non-compliant,
  3. Whether the employer’s health plan meets legal requirements. (I used to write “whether an employer plan exists” but now presume that all employer-provided health benefits are part of a “plan” for tax purposes,
  4. Whether the benefit involved employee contributions as a salary reduction.

There are different components of tax law to consider that affect employer-provided health benefits including:

  1. Deductibility of the expense by the employer under IRC Section 162 (ordinary business expenses). Almost all employee health plan expenses do qualify as an ordinary tax-deductible business expense for the employer.
  2. Taxability of benefits to the employee, as determined by IRC Section 3121 (definition of wages). In the past almost all employer-provided health benefits were received tax-free by the employee but this is no longer presumed to be the case following implementation of the Affordable Care Act.
  3. Excise taxes imposed on non-compliant employer health plans under IRC Section 4980D. This is the new ‘hot issue’ for employers in 2014 following implementation of the Affordable Care Act. Many employer health plans are subject to a new 10% excise penalty, a few will be subject to much higher penalty amounts.
  4. Taxation for FICA and FUTA and state income taxes. This tax treatment may be different than the tax treatment for federal income taxes.

There are many resources available for tax advisers and business owners. A few are listed here:

IRS – Publication 15-B

IRS – Employer Health Care Arrangements

Freedom Benefits – Small business health plan compliance checklist 

Novak, Tony – Taxation of health insurance

Novak. Tony – 18 Things Small Businesses Must Know About Health Reimbursement Arrangements (HRAs)

 

How to calculate small business excise taxes under IRC 4980D

The preparation of 2015 small business tax returns will require the self-assessment and calculation of a new tax triggered by the Patient Protection and Affordable Care Act (PPACA). Beginning with the filing of the 2015 federal income tax return in early 2016 taxpayers and professional tax preparers are required to recognize when this tax applies and the calculate the appropriate excise tax for their small business clients under Section 4980D of the Internal Revenue Code.

Background

This section of tax law was introduced under the PPACA in 2010. This provision of the law became effective January 2014 but IRS issued a delay in enforcement applicable to small business employers that expired June 30, 2015. After that date, the excise tax must be self-assessed and included in the tax liability for the firm’s 2015 tax return. Larger employers were already subject to the excise tax penalty for 2014.

While several authors have published legal commentary on this section of PPACA, there are no known sources of practical help for tax practitioners who need to recognize and calculate the tax liability under this new section of the tax code.

No official estimates are published on the number of small businesses affected by this new provision of tax law but I roughly estimated it to be in the tens of thousands nationwide based on anecdotal indications of the portion of small business firms engaging in one of the two trigger mechanisms discussed below. If we add the number of firms in violation of other tax provisions for health plans then the number of affected taxpayers would likely rise much higher.

Recognizing the tax liability

The first step for the tax practitioner is recognizing when this tax applies. This posed a significant potential stumbling block because the tax return preparer may not recognize a non-compliant small business health plan.

There are two situations that trigger this tax: 1) payment of individual health insurance and 2) reimbursing out-of-pocket medical expenses under an arrangement that is not integrated with an employer-provided group health insurance policy. The tax preparer must be able to recognize each of these  situations that triggers a tax.

Neither of these triggers should create a penalty against one employee business. Small businesses are particularly vulnerable when they hire their first employee so the tax preparer should review 4980D issues with a self-employed client before they make a hiring decision. One person C corporation owners with high out-of-pocket medical costs, in particular, may be well-advised to consider using a contractor like a virtual assistant rather than hiring an employee. This alternate strategy may make it possible to continue using individual health insurance and a Health Reimbursement Arrangement without adverse consequence.

No change to taxation of underlying transactions

There is nothing in this tax code section or any other part of the PPACA that changes the underlying tax treatment of health insurance or uninsured health benefits as discussed in my other article here. Instead, the new law adds an additional layer of tax on top of existing law without changing the underlying law.

This is important point to consider because some tax practitioners think that by changing the tax treatment of the underlying transactions then the 4980D excise tax can be avoided. For example, some small business accountants report that they changed a the reimbursement for individual health insurance from pre-tax to after-tax bonus in an attempt to avoid triggering the excise tax. The proverbial “two wrongs do not make a right” applies here. In this example, the insurance reimbursement is now being reported improperly and the business is still not in compliance with 4980D.

Method of Calculation

There are two primary methods of assessing the excise tax: 1) the statutory tax of $100 per employee per day and, for qualifying employers, 2) a reduced penalty of 10% of the employer’s health care costs.

The larger excise tax penalty – $100 per employee per day – appears straight forward at first consideration, there are unresolved issues that may impair accurate calculation. Assuming that we are preparing the 2015 full year tax return and the violation existed for the entire year then the tax is $36,500 per employee. Presumably employees who did not participate in the employer health plan or reimbursement are exempted from the penalty but we have no authoritative proof.

Qualifying for the reduced penalty

Considering the potential for greatly reduced taxes, we presume there will be great interest in qualifying for the tax for unintentional violations.

The lesser excise tax penalty for unintentional violations of 10% of health care expense may be substantially lower, we have no guidance on the availability or applicability of this reduced penalty. Specifically, a self-assessment of the reduced penalty raises serious preparer questions. How can the violation be unintentional if the preparer recognizes it? And what if the violation continues past the tax filing deadline where a 4980D excise tax is self-assessed, wouldn’t that be prima facia evidence that the violation is not unintentional? How can the preparer know about the violation and simultaneously claim that the violation was unintentional?

This discussion is incomplete due to a lack of information at the time of the article’s publication.

Minimum penalty on audit

IRC 4980D (3)(a)(ii) has a minimum penalty of $2,500 if a de minimis violation is uncovered during audit. This appears to be a way for the Service to settle cases without arguing that a small unintentional violation reduces liability to almost nothing. This provision of the law appears to suggest that small business employers are potentially liable for even the smallest violations.

Avoiding preparer penalties

It seems clear that this new tax opens the door for substantial underpayment tax penalties for the small business employer and their tax preparers.  Preparers should take these additional steps during the preparation of a 2015 small business tax return to avoid substantial underpayment penalties:

1) Review the businesses health plan documents. In some cases the preparer may discover that required plan documents do not exist. Lack of required plan documents is a separate tax violation completely outside of the scope of this article. See my article here for other common problems with HRA documents and plan design.

2) Examine the integrated insurance policy. Is it a group type insurance? Is it issued in the name of the employer? Does it meet minimum requirements of a qualified plan under ACA?

3) Review individual health insurance payment transactions. If the business has any interaction with individual health insurance payment transactions, be certain that the IRS would not classify the transactions as an employer payment arrangement. Review the employment contract, if applicable, or documentation of bonuses that might be used to pay for individual insurance. If an employer is making or facilitating the payment of individual health insurance then make sure that the employee has the right to receive cash instead of insurance.

4) Consider whether the business meets the one employee business exemption for individual insurance or the church plan exemption. IRS has clarified that a business will not be penalized simply because individual health insurance was the only available option. This exemption some but not all of the requirements of the provisions of 4980D. While issued regulations address the case of the single employee business, they do not address the case where there is more than one employee but only one is eligible for health insurance. In this latter case, the only insurance option is still individual health insurance but current regulations do not clarify an exemption from the excise tax. Church health plans are also exempt from the excise tax.

Tax preparers who are not familiar with health insurance and employee benefits documents are well advised to obtain a professional review and opinion before making a determination of whether excise taxes under 4980D should be included on the small business tax return for 2015.

This discussion of tax preparer liability is incomplete because additional information was not available at the time of the article’s publication. Ideally, some tax preparer checklist or action framework could be developed to minimize the possibility of tax preparer liability.

Finally, because this is a new area of tax compliance for small businesses we should recognize that additional information is likely to emerge.

Changes to 2014-2015 tax penalties for small business health plans

On February 18, 2015 the IRS released Notice 2015-17 that delays some of the tax penalties included in the Affordable Care Act related to businesses that pay for or reimburse certain types of employee medical costs under conditions not allowed by the Affordable Care Act. The notice is important to businesses that paid or reimbursed the cost of individual health insurance in 2014 or those who reimbursed employees for out-of-pocket medical expenses outside of an insurance plan over the past year.

Freedom Benefits previously estimated that more than 1 million small businesses were in violation of one of more provisions of the law and the size of potential excise tax penalties (up to $36,500 per employee for 2014 alone) was enough to bankrupt many small firms. Under the IRS guidance issued today the application of penalties for small businesses is delayed until June 30, 2015. It is important for small businesses to review and update their non-compliant health plans over the next four months. Freedom Benefits offers a do-it-yourself compliance checklist or a professional review with sample plan documents that are intended to meet the new requirements.

In summary, the tax penalty for past violations in small business employee health plans is gone. Businesses must bring their health plans into compliance by June 30, 2015 in order to avoid tax penalties for 2015 an beyond.

What is a simple cafeteria plan?

Simple cafeteria plans were created as part of the Affordable Care Act of 2010 to make it easier for small businesses to meet the applicable tax requirements for this type of employee benefit plan.

To qualify for a simple cafeteria plan, the plan must meet all of the following criteria:

  1. Eligible Employer. To be an employer eligible to sponsor a simple cafeteria plan the employer must have employed an average of 100 or fewer employees on business days during either of the 2 preceding years.

Growing Employers. Special rules apply to a ‘growing employer’, in the event that its employee population exceeds 100 employees. The employer can continue to sponsor a simple cafeteria plan; however, in the year following a year in which the employer employs on average 200 or more employees on business days, the plan must be converted to a classic cafeteria plan.

Aggregation Rules. Related employers, as defined in IRC Section 52(a), Controlled Group of Corporations, or Section 52(b), Employees of Partnerships, Proprietorships, Etc., Which Are Under Common Control, must be combined in determining employer size. In addition, leased employees, as defined in IRC §§414(n) or (o), are counted in determining employer eligibility.

  1. Minimum eligibility and participation requirements. Simple cafeteria plans must meet minimum eligibility and participation requirements. Specifically, all employees who had at least 1,000 hours of service for the preceding plan year are eligible to participate. Each employee eligible to participate in the plan may, subject to terms and conditions applicable to all participants, elect any benefit available under the plan.

Excludable Employees. Certain employees may be excluded from the minimum eligibility and participation requirements; these include:

  • Employees who are under age 21;
  • Employees who have been employed for less than one year;
  • Employees covered by a collective bargaining agreement where health benefits have been the subject of good faith bargaining; and
  • Nonresident aliens with no U.S. source of income.
  1. Contribution requirement. The employer is required, without regard to whether a qualified employee makes any salary reduction contribution, to make a contribution to provide qualified benefits under the plan, on behalf of each qualified employee. Qualified employees are those employees who are neither highly compensated individuals or key employees, as defined by the cafeteria plan rules, and who are eligible to participate in the cafeteria plan.

There are two types of employer contributions, as follows:

  • The non-elective contribution is a uniform percent of compensation, but not less than 2% of the employee’s compensation for the plan year.
  • The matching contribution is an amount that equals or exceeds the lesser of:
  • Six percent of the employee’s compensation for the plan year; or
  • Twice the employee’s salary reduction contribution.

The contribution method selected must be the same for all qualified employees, and must be a true employer contribution, i.e., it cannot include a salary reduction contribution at all.

When a plan meets these criteria then it meets the non-discrimination requirements for a cafeteria plan. These requirements are less complex than the requirements imposed on other cafeteria benefit plans.

Other resources:

article: Taxation of small business health plans