Few people enjoy giving money to the IRS, but some types of taxes are viewed more unfavorably than others. Here are three worthy candidates vying for the title of most-hated tax.
Penalty Tax on Individuals without Health Insurance
As you probably know, the Affordable Care Act (ACA) imposes a penalty on individuals who fail to have so-called minimum essential health insurance coverage for any month of the year. This requirement is commonly called the “individual mandate,” and individuals must pay a penalty for noncompliance with the mandate.
You may be exempt from paying the penalty, however, if you fit into one of these categories for 2016:
- Your household income is below the federal income tax return filing threshold, which is generally $10,350 for singles, $20,700 for married joint-filing couples and $13,350 for heads of households.
- You lack access to affordable minimum essential coverage.
- You suffered a hardship in obtaining coverage.
- You have only a short-term coverage gap.
- You qualify for an exception on religious grounds or have coverage through a health care sharing ministry.
- You’re not a U.S. citizen or national.
- You’re incarcerated.
- You’re a member of a Native American tribe.
How much can the penalty cost? That’s a tricky question. If you owe the penalty, the tentative amount equals the greater of the following two prongs:
1. The applicable percentage of your household income above the applicable federal income tax return filing threshold, or
2. The applicable dollar amount times the number of uninsured individuals in your household, limited to 300% of the applicable dollar amount.
In terms of the percentage-of-income prong of the penalty, the applicable percentage of income is 2.5% for 2016 and beyond.
In terms of the dollar-amount prong of the penalty, the applicable dollar amount for each uninsured household member is $695 for 2016. This amount will be adjusted for inflation for 2017 and beyond. For a household member who’s under age 18, the applicable dollar amounts are cut by 50%.
The final penalty amount can’t exceed the national average cost of “bronze coverage” (the cheapest category of ACA-compliant coverage) for your household. For 2015, the national average cost for bronze coverage was $207 per person, per month or $1,035 per month for a family of five or more. Numbers currently aren’t available for 2016, but they’ll probably be somewhat higher. Meanwhile, the important thing to know is that a high-income person or household could owe more than 300% of the applicable dollar amount but not more than the cost of bronze coverage.
Important note: If you have minimum essential coverage for only part of the year, the final penalty is calculated on a monthly basis using pro-rated annual figures.
|Example: You’re unmarried and live alone. During all of 2016, you have no health coverage. Your income for the year is $100,000. Your tax return filing threshold for the year is $10,350. Assume the monthly national average premium for bronze coverage for one person is $215 for 2016, which amounts to $2,580 for the entire year (12 × $215).
In this example, the percentage-of-income prong for 2016 is $2,241. That’s 2.5% of the difference between $100,000 and $10,350.
The dollar-amount prong is $695.
The tentative penalty amount is $2,241 (the greater of $2,241 or $695).
In this example, the annual national average cost of bronze coverage is assumed to be $2,580 for one person who’s uncovered for all of 2016. Therefore, the final penalty amount for failing to comply with the individual mandate is $2,241 (the lesser of $2,241 or $2,580).
Penalty Tax on Employers that Pay Employee Health Insurance Premiums
The ACA also established a number of so-called “market reform restrictions” on employer-provided group health plans. These restrictions generally apply to all employer-provided group health plans, including those furnished by small employers with fewer than 50 workers.
The penalty for running afoul of the market reform restrictions is $100 per employee, per day. This penalty can amount to $36,500 per employee over the course of a full year. Even worse, the penalty can be assessed on employers who offer an employer payment arrangement in which the company’s health plan simply reimburses employees for premiums paid for individual health insurance policies or pays premiums directly on behalf of employees.
This penalty doesn’t apply to employer payment arrangements that have only one participating employee. Therefore, a business can still use such an arrangement to reimburse or pay for individual health policy premiums for one employee (such as the owner’s spouse) without triggering this expensive penalty.
Many S corporations have set up employer payment arrangements to cover individual health policy premiums for employees who also own more than 2% of the company stock. Under long-standing IRS rules, amounts paid under such plans are treated as additional wages that are subject to federal income tax but exempt from Social Security and Medicare taxes. Qualifying shareholder-employees can deduct the premiums on their individual federal income tax returns under the provision for self-employed health premiums. These plans are also exempt from the $100 per-employee-per-day penalty. But S corporation employer payment arrangements that benefit other employees are still exposed to the penalty.
Medicare Surtax on Net Investment Income
The 3.8% Medicare surtax on net investment income was also enacted as part of the ACA. Taxpayers who are hit with the net investment income tax (NIIT) can have a marginal federal tax rate as high as 43.4% (39.6% top federal income tax rate plus 3.8% NIIT). The NIIT can potentially affect anyone with consistently high income or anyone with a major one-time shot of income or gain, say, from selling some highly appreciated company stock or a highly appreciated personal residence. For purposes of the NIIT, net investment income includes the following after subtracting related expenses:
- Capital gains, including the taxable portion of gain from selling a personal residence and capital gains distributions from mutual funds,
- Interest, excluding tax-free interest (such as municipal bond interest),
- Most royalties,
- The taxable portion of annuity payments,
- Income and gains from passive business activities (in other words, activities in which you don’t spend a significant amount of time),
- Rental income,
- Gain from selling a passive ownership interest in a partnership, limited liability company, or S corporation, and
- Income and gains from the business of trading in financial instruments or commodities.
You’re exposed to the NIIT only if your modified adjusted gross income (MAGI) exceeds the applicable threshold of:
- $200,000 if you are unmarried,
- $250,000 if you are a married joint-filer, or
- $125,000 if you use married filing separate status.
The amount hit by the NIIT is the lesser of: 1) your net investment income, or 2) the amount by which MAGI exceeds the applicable threshold. MAGI is defined as regular adjusted gross income plus certain excluded foreign-source income net of certain deductions and exclusions. (Most individuals are unaffected by this addback, however.)
Focus on the Positive
There’s some good news about these three most-hated taxes: With thoughtful advance planning, they can often be avoided or significantly reduced. For more information about these taxes, consult your tax adviser.
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