The Patient Protection and Affordable Care Act (PPACA) added a new section in the Internal Revenue Code that requires individuals to obtain healthcare coverage. The new section, IRC 5000A, states that every applicable individual must obtain minimum essential coverage for themselves and their dependents or pay a tax penalty.  This section becomes effective January 1, 2014 and coverage will be reported starting with the 2014 tax year.

Applicable individuals are subject to the requirements to obtain and maintain healthcare coverage for each month that the individual is subject to the mandate. Dependents must also have appropriate coverage each month. The healthcare mandate extends to all applicable individuals, with the exception of members of a healthcare sharing ministry, persons with a religious exemptions, illegal aliens, and prisoners.

Minimum Coverage

Minimum coverage is necessary to meet the healthcare mandate. The types of healthcare plans that meet the minimum coverage include Medicare, Medicaid, Children’s Health Insurance program (CHIP);  Healthcare plans for active military, veterans, and civilian Department of Defense workers, as well as the Peace Corps health plan; an eligible employer-sponsored plan; a group healthcare plan or health insurance coverage that an individual is already enrolled in (grandfathered); coverage purchased through a state-sponsored healthcare exchange; and other plans that the Secretaries of the Treasury and Health and Human Services recognize.

Certain medical benefits do not qualify on their own as minimum coverage. These benefits are generally referred to as “accepted benefits” and are not sufficient to meet the minimum coverage requirements of the healthcare mandate. This includes insurance for accident or disability income; general liability, auto, or supplemental insurance; workers compensation; coverage for on-site medical clinics, or other similar types of coverage where medical benefits are secondary in nature.

Limited-purpose coverage also does not meet the minimum coverage requirements. This includes specific coverage insurance like dental, vision, or long-term care. Insurance for special illness or disease also does not qualify, nor does supplemental coverage to Medicare, or other plans.

Shared Responsibility Payments

Failure to maintain coverage subjects the taxpayer to a tax penalty for some or all of the months that minimum coverage is not maintained. The penalty is called a “shared responsibility payment.”The taxpayer’s penalty will be reflected in the tax year the coverage was not maintained. As with most tax matters, there is joint and several liability for the penalty with married taxpayers filing jointly.

The penalty for a taxpayer who does not maintain minimum essential coverage is based on three factors: 1) the flat dollar amount penalty; 2) the percentage of income penalty; and 3) the average national cost for the “bronze-level” minimum essential coverage that is available to the taxpayer.

The flat dollar penalty is the lesser of 1) the applicable dollar amount of $95 per adult in the household ($48 for children under 18) for applicable individuals who did not maintain coverage for the full 12-month period of the year; or 2) three times the applicable dollar amount of $95. Note, that dollar amounts are expected to increase in subsequent years.  Rates for 2015 are scheduled at $325/$163; and 2016 are schedule at $695/$348.

The percentage of income penalty is based on the modified adjusted gross income (MAGI) of the household. Household income includes the MAGI of all members of the household, including dependents that are required to file a return. In 2014, the percentage is 1.0%, and increases to 2.0%, and 2.5% respectively in 2015 and 2016.

The penalty is the lesser of 1) the flat dollar amount penalty or the percentage of income penalty, whichever is greater; or 2) the national average costs for a “bronze level” qualified plan on the state exchanges during the tax year for the taxpayer and any family members for whom coverage should have been maintained for the full tax year.

EXAMPLE:

A husband, wife and two minor children have household income of $60,000 in 2014. Their flat dollar amount penalty would be $286 ($95+95+$48+$48). Their percentage of income would be 1.0% of 60,000, or $600. The cost of “bronze level” coverage was $12,000. The penalty would be the lesser the cost of coverage or the greater of the flat dollar amount or percentage of income. In this case, the percentage of income was higher than the fixed dollar penalty. The penalty would be $600, because it is less than the cost of the healthcare coverage.

Penalty Exceptions

There are some exceptions to the shared responsibility payment penalties. Penalties do not apply when the individual’s household income falls below the filing threshold. When coverage is unaffordable – when the cost of healthcare is greater than 8% of household income, there is no penalty. There is an exception for native Americans who are members of an Indian tribe, under the definition of IRC 45(c)(6). There is an exception for short periods without coverage, generally no more than 3 months in a calendar year. There is also an exception for hardship in obtaining required coverage on their state exchange.  It should also be noted that the taxpayer is responsible for a penalty with respect to any dependent that is claimed on their return. Additionally, any time in residence outside of the U.S. is deemed as time with essential minimum coverage.

Cost Limitations

The new healthcare reform law provides for subsidized healthcare to certain lower income individuals. Individuals who purchase coverage through a healthcare exchange are entitled to receive a premium assistance credit (PAC), which will be a refundable income tax credit available on a sliding scale basis for taxpayers with household incomes between 100 and 400% of the federal poverty level guidelines. Taxpayers above 400% of the federal poverty guideline do not qualify for PAC. Households with incomes under 133% of the federal poverty guideline will generally be covered under Medicaid.

Healthcare will be marketed by exchanges in four different levels – Bronze (60%), Silver (70%), Gold (80%), and Platinum (90%). In each case, the insurance will cover the percentage level of medical costs, and the taxpayer will pay the balance.  The refundable PAC will be paid directly to the health insurance plan.

The PAC is tied to the “second lowest cost of the silver plan,” which is also referred to as the applicable benchmark plan. The applicable benchmark plan is generally self-only coverage for single taxpayers without dependents or family coverage for taxpayers with a spouse and or dependents. In order to qualify for the PAC, taxpayers who are married at the end of the year must file jointly.

 Premium Assistance Credit (PAC)

For purposes of the PAC, household income includes tax exempt interest, foreign Income excluded under IRC section 911, and any social security or railroad retirement benefits excluded from gross income under IRC section 86.

The poverty guidelines are published annually in the Federal Register by the Department of Health and Human Services, and range from $11,700 for a one member household to $38,890 for an eight member household. There are additional amounts for families above 8. Families with incomes between 100% and 400% of the poverty level are eligible for the PAC.

EXAMPLE:

The federal poverty level for a family of four is $23,050. Thus, families of four with household income of $92,200 or less are eligible for the PAC.

The Premium Assistance Credit is determined on a sliding scale based on income and an applicable percentage, or contribution rate toward healthcare insurance. The taxpayers household income is multiplied by the applicable percentage to arrive at the amount of refundable PAC the taxpayer will receive to be used toward the purchase of healthcare. The qualifying taxpayer’s applicable percentage of income represents the maximum amount the taxpayer will be required to pay for healthcare.

EXAMPLE:

A family of four earns $92,200 – 400% the federal poverty level.  The applicable percentage is 9.5%. of $92,200, or $8759, which represents the maximum premium payment the family must make toward the benchmark plan. Assuming the benchmark plan (2^nd lowest Silver plan) is $15,000, the premium assistance credit is $6241.

Administration

The premium assistance credit (PAC) will be paid as an advance credit. When the taxpayer goes to the state exchange to purchase coverage, the exchange will calculate the taxpayer’s PAC. The taxpayer will pay the cost of the desired insurance less the amount of the PAC. When the taxpayers file their return at the end of the tax year, the return will include a reconciliation of the exchange-calculated PAC and the actual PAC that will be calculated and shown on the return. Any amount of the state exchange-calculated PAC paid to the insurance plan in excess of the actual PAC will be recovered as an additional tax liability on the taxpayer’s return. There may be some relief from the additional tax liability for taxpayers with incomes below 400% of the poverty level.

When the individual mandate becomes effective beginning January 1, 2014, initial eligibility for the PAC and any advance payments of the credit to state exchanges will be based on the taxpayer’s household income two years prior to enrollment. Taxpayers will also update their eligibility information or request a redetermination of their tax credit eligibility if there is a change in marital status, a decrease in income of more than 20%, or the receipt of unemployment income.

The PPACA also has a provision to limit the amount of out of pocket expenses paid by the insured. This includes deductibles, co payments  qualified medical expenses, and coinsurance. For 2014, this overall out-of-pocket limitation mandated by PPACA is the same as the limit on out-of-pocket expenses for high-deductible health plans (HDHP). The out of pocket limit is calculated on a sliding scale based on the federal poverty income guidelines and the out of pocket limitation ratios.

EXAMPLE:

A family of four earns $92,200 – 400% the federal poverty level.  Their out of pocket limitation would be 2/3 the maximum out of pocket for HDHP, estimated at $13,000 for 2014. Thus, the maximum out of pocket would be 2/3 of $13,000 or $8667.

The individual mandate is complicated to explain in its entirety. It introduces a lot of complicated terminology. This article is intended to give a better picture of the PPACA system, but obviously lacks the detailed charts to understand individual scenarios. Before the PPACA can be implemented, states need to develop healthcare exchanges and the HHS secretary must develop procedures to administer subsidies, and deal with cost-sharing reductions with employer provided coverage. Surely this benefit program will evolve as administration begins.