Problems Arise in Implementing Obamacare on 2014 Income Tax Returns

The Affordable Care Act is an extremely large and complicated law.  Not only are there technical legal issues that are still being resolved, but there are also many compliance problems that have arisen in connection with preparing 2014 individual income tax returns.  The year 2014 is the first time taxpayers must have health insurance for each month of the year or face a tax penalty.  The year 2014 is also the first time that health insurance exchanges operated and provided premium tax credits to offset the cost of health insurance for lower to moderate income taxpayers.  Just like when serious problems arose with the government’s website when it first started, several problems affecting 2014 income tax returns have arisen.

Incorrect Information Reported by Health Insurance Exchange Marketplaces

On February 20^th the government announced that it sent incorrect Forms 1095-A to 800,000 people who enrolled in the Federal exchange.  The form incorrectly used 2015 premium information instead of 2014 information.  Corrected forms will be sent in March.  The form is used to compute the proper amount of the premium support tax credit.  If too much credit is claimed it must be repaid.  If too little credit was received it can be claimed on the tax return.  The government estimates that some people who have already filed their 2014 income tax returns using the erroneous information will have received too much credit while others will have received too little, expecting to roughly break even.  Therefore the government said that amended tax returns are not required, in an attempt to avoid additional compliance costs to the affected taxpayers, although taxpayers may file amended returns if they wish.

Payback of Excess Premium Support Credits

According to an announcement by H&R Block, 52% of their customers are required to repay part of their tax credit subsidies used to purchase health insurance on the exchange.  The average payback is $530 which is treated as an additional tax on the income tax return.  This has been a surprise to many of their customers who were counting on higher refunds.

Estimated Tax Payment and Late Payment Penalty Relief

The IRS issued Notice 2015-9 where it announced penalty relief for taxpayers who must repay excess premium support credits and who have a balance owing on their tax returns.  Many taxpayers are now realizing that they must repay excess credits if they understated their estimate of 2014 income when they applied for premium tax credits.  The government is heading off complaints by granting relief from late payment and estimated tax payment penalties if the taxpayer can’t pay the tax due by April 15, 2015.  In order to qualify for the relief, taxpayers must file their tax return on time showing the amount of the excess credit, and they must not otherwise be delinquent with their prior tax filings and payment obligations.  The Notice indicates that IRS computers will bill the late payment penalty and that the taxpayer must respond to the billing notice with the phrase, “I am eligible for the relief granted under Notice 2015-9 because I received excess advance payment of the premium tax credit.”  To obtain relief from the estimated tax payment penalty, which is computed as part of the 2014 tax return, taxpayers should check box A in Part II of Form 2210, complete page 1, and include a statement with the form:  “Received excess advance payment of the premium tax credit.”  Interest will still be charged on amounts paid after April 15^th.

IRS Decides not to Put Small Businesses out of Business (at least through June 30, 2015) for Certain Health Insurance Violations

Remember when Pres. Obama said that if you liked your health insurance plan you can keep it?  Even though small businesses are not subject to the employer mandate, many provide health insurance benefits for their employees.  Many small employers have historically permitted their employees to choose their own individual health insurance policies, and then either directly paid the premium or reimbursed all or part of the monthly premium to their employees.  Small businesses that continued this practice into 2014 are in trouble.  This arrangement has been permitted for decades under the income tax law.  Now comes the Affordable Care Act (ACA) mandating certain marketplace health insurance reforms.  Beginning in 2014, it is against the law for employers to continue these premium payment plans for their employees.  The violation subjects the small employer to a $100 per day per employee penalty!  That’s right.  A small employer is exposed to a $36,500 annual penalty for each employee whom they assisted in purchasing an individual health insurance policy.  Somehow small businesses were supposed to know that these “employer payment plans” violated the law on January 1, 2014.  January and early February 2015 have been a time of high anxiety for small businesses and their accountants who have been trying to figure out how to correct the problem without financially ruining the business, and without causing the employees to pay income taxes on tax-free benefits!  Now the government has come to rescue us from their own rules by issuing IRS Notice 2015-17.

The Notice provides for a “transition” period through June 30, 2015, by which time small employers must cease providing financial assistance for their employees' purchase of individual health policies.  Instead, the employer must either offer a group health insurance plan, or use the SHOP Marketplace (known as Avenue H in Utah) to permit employees to select plans that are grouped together as an overall qualifying group plan.  Alternatively, the small employer can just raise their employees’ wages (with no mandate to spend the wage increase on health insurance) and get out of the business of helping employees pay health insurance premiums.  But this approach is very tax inefficient.  An employer’s payment of group health insurance premiums can be made income tax free to the employees, but a wage increase is fully taxable.  The Notice also provides special rules for employees of S corporations who own more than 2% of the employer’s stock.

The Notice provides that the $100 a day penalty will not apply for 2014 or through June 30, 2015, but it will begin to apply on July 1, 2015.  Again, this issue deals with small employers (those with less than 50 full-time equivalent employees) who are not subject to the employer mandate but who nevertheless choose to assist employees in obtaining individual health insurance.  These employers must help their employees in the way the government says to do it or else they risk being penalized out of business!

IRS Finally Does the Right Thing: Eases Application of the Tangible Property Regulations for “Small” Taxpayers

On Friday, February 13, 2015, the IRS issued Revenue Procedure 2015-20 to simplify the application of the tangible property regulations (TPRs, sometimes called the “repair regs”) for small taxpayers.  Accountants and industry organizations told the IRS months ago that its implementation rules were too onerous and impractical for small taxpayers to follow.  Now in the middle of tax season the IRS provides relief, but only after tax preparers and taxpayers have already spent many hours of effort trying to make the old rules work.

What is a “small” taxpayer?  A small taxpayer has either less than $10 million of assets on the first day of the 2014 tax year OR has average annual gross receipts of $10 million or less for the three prior tax years.  These tests are applied separately for each separate and distinct trade or business of the taxpayer.  Special rules exist for taxpayers having less than three full prior tax years.  Gross receipts include gross sales less sales returns and allowances, all receipts for services, investment income, but only the gains from the sale of investments and property used in a trade or business (other than inventory). 

The IRS eased two major problems.  First, the TPRs do not have to be retroactively applied to past tax years.  It was ridiculous for the government to require taxpayers to apply today’s tax rules to all previous tax years.  Second, the 8-page Form 3115 (plus attachments) is not required to be completed to tell the IRS that its TPRs are now being complied with.  However, the IRS says this simplification comes at a cost.  The IRS says that there is no audit protection for years earlier than 2014.  Because small taxpayers can use the “cut-off” method and just start complying with the TPRs in 2014, the IRS states that it can still require compliance in past years in the event of an audit.  Most small taxpayers will ignore this threat and avoid the costs and hassles of retroactively applying the rules and filing multiple Forms 3115.

The IRS points out that any tax benefits that would have come from retroactive application of the TPRs won’t be available unless the small taxpayer does in fact retroactively apply the TPRs and file Form 3115.  One example is the “late partial disposition election.”  This “election” is made by filing Form 3115 for prior dispositions of components or structural parts of assets.  For example, for a building, the tax code does not allow for separate depreciation of building components or systems.  Therefore, the building cost is often recorded on the depreciation schedule as a lump-sum number.  The IRS is now permitting the deduction of the undepreciated cost of the portion of the building previously disposed, such as a roof.  When a new roof was put on in the past, the cost of the old roof was not broken out from the building cost and written off.  Now, the IRS is permitting this write-off, and to do so, Form 3115 must be filed with an estimate of the cost of the old roof.  Doing so is an election and not a requirement.  A second example of lost tax benefits if there is no retroactive application of the TPRs deals with prior capitalized repairs that would clearly be deductible under the TPRs.  Filing a Form 3115 allows a current deduction for any remaining undepreciated capitalized cost.  In addition, if the capitalized repairs are not written-off, there is a chance the IRS would deny future depreciation deductions by asserting that the repairs should have been expensed in the prior year and that there is no legitimate asset to depreciate.