The document discusses taxes impacting employers and individuals under the Affordable Care Act that will take effect in 2013 and 2014. For employers in 2013, it outlines requirements for withholding the additional 0.9% Medicare tax on high-income employees, reporting the value of health coverage on W-2s, and limiting health flexible spending accounts to $2,500. It also discusses that employers will no longer be able to deduct retiree prescription drug costs covered by federal subsidies after 2012. For 2014, it explains the shared responsibility payment excise tax that may be assessed if large employers do not provide affordable and adequate health coverage to full-time employees. For individuals in 2013, it summarizes the new 3.8%

1. Subject: ACA Taxes Impacting Employers and Individuals
Date: November 27, 2012
The 2012 election has come and gone. The Federal government remains predominately status
quo, with Democrats controlling the White House and the Senate, and the Republicans controlling
the House. While there is much to be hashed out relating to continued implementation of the
Affordable Care Act (ACA), continued implementation is probably the operative phrase. To that
end, following are brief discussions of important upcoming matters, both for employers and
individuals.
Table of Contents
Taxes Impacting Employers
2013
0.9% Medicare Tax Withholding Requirement 2
W-2 Reporting 3
Health Flexible Spending Account Limits 4
Retiree Prescription Drug Coverage Subsidy 4
2014
Shared Responsibility Payment 5
Taxes Impacting Individuals
2013
3.8% Medicare Contribution on Net Investment Income 7
0.9% Medicare Tax on Wages and Self-Employment Income 12
Health Flexible Spending Account Limits 13
Increase in Floor for Medical Expense Itemized Deduction 13
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Taxes Impacting Employers
2013
0.9% Medicare Tax Withholding Requirement
Employers need to be prepared to make payroll adjustments for 2013 for this employee-only
Medicare tax withholding change. Individuals with wages above $200,000 ($250,000 for married
couples filing jointly) will be subject to an additional 0.9% Medicare tax beginning in 2013. For
married taxpayers filing jointly, the additional Medicare tax will be based on their combined wages,
complicating the withholding process for some employers.
The employer must begin withholding the additional Medicare tax in the pay period in which the
employee's wages exceeds $200,000, regardless of the employee's filing status. As a result, the
employee may be subject to the additional Medicare tax withholding even if the couple ultimately
doesn't owe the tax because their combined wages are less than $250,000. In this situation, the
extra Medicare tax withholding would be reflected as a tax payment on the couple's individual tax
return and could be used to offset their income tax liability or be refunded.
Situations may also occur where a couple is subject to the additional Medicare tax and has not had
any additional withholding because neither spouse exceeded $200,000 in wages. For example, if a
married couple filing jointly each earned $180,000 in wages, they would owe a combined $990 in
additional Medicare taxes ($360,000 in combined wages less $250,000 multiplied by 0.9%), even
though neither of them was subject to the additional withholding. In this instance, the additional
Medicare tax would be included in the calculation of their tax liability on their individual income tax
return. The additional Medicare tax is a tax for purposes of the underpayment of estimated tax
penalty. Therefore, couples in this situation will need to factor the additional Medicare tax into their
estimated tax payments or income tax withholding to avoid penalties.
An employee who anticipates being subject to the 0.9% Medicare tax cannot request that the
employer withhold the additional Medicare tax before the employee crosses the $200,000
threshold, nor can he request additional withholding specifically for the 0.9% Medicare tax. He can,
however, request additional income tax withholding on Form W-4 which will be applied against all
taxes reflected on his individual income tax return (including the additional Medicare tax).
Employers are not required to notify employees before withholding the additional Medicare tax.
Employers may want to ensure that their highly compensated employees are aware of the
additional Medicare tax, however, in case they need to adjust their withholding on Form W-4. Some
of those employees may also be subject to the new 3.8% Medicare tax on investment income and
may desire to adjust their withholding for that tax as well.
The 0.9% Medicare tax is in addition to the regular Medicare tax rate of 1.45% of wages but is only
assessed on the employee. The employer still owes only the 1.45% Medicare tax on the
employees' wages. The employer calculates wages for purposes of the additional Medicare tax in
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the same manner in which it calculates wages for purposes of the existing Medicare tax. For
example, non-cash fringe benefits or non-qualified deferred compensation that are subject to the
current Medicare tax also would be subject to the 0.9% Medicare tax if total wages exceed the
wage thresholds.
Before the end of the year, employers should check with their payroll service providers to ensure
that their systems are prepared to withhold the 0.9% Medicare tax when required.
W-2 Reporting
Employers who issue 250 or more Form W-2s will be required to report certain information about
their employees' health benefits on their 2012 W-2s issued in January, 2013. This additional
reporting was optional for the 2011 reporting year W-2s. Employers who issue fewer than 250 W-
2s are exempt from this requirement for 2012 and until further notice.
The value of the health care coverage is to be reported on Box 12 of the Form W-2 with the code
DD. Generally, the value of both the employer's and the employee's contributions toward the
benefits is included. Employers are not required to issue W-2s to retirees, former employees, etc.
who would not otherwise receive a W-2 except to report the health benefits.
Only certain types of benefits are required to be reported on the W-2, and the reporting of some
benefits is optional. A partial list of some of the more common types of benefits is below. For a
complete list, see Form W-2 Reporting of Employer Sponsored Health Care on the IRS website.
Do
Not
Coverage Type Report Report Optional
Major medical X
Dental or vision plan not integrated into another medical or health
plan X
Dental or vision plan which gives the choice of declining or electing
and paying an additional premium X
Health Flexible Spending Accounts (FSA) funded by salary-reduction
amounts X
Health FSA value for the year in excess of employee’s cafeteria plan
salary reductions for all qualified benefits X
Health Savings Account (HSA) contributions (employer or employee) X
Archer Medical Savings Account contributions (employer or
employee) X
Hospital indemnity or specified illness (insured or self-funded), paid
through salary reduction (pre-tax) or by employer X
Domestic partner coverage included in gross income X
Accident or disability income X
Long-term care X
Liability insurance X
Workers' compensation X
Payment/reimbursement of health insurance premiums for 2% S
corporation shareholder-employee, included in gross income X
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Employers may calculate the reportable cost of coverage in a number of ways. If the employee is
covered under the employer's insured group health plan, the simplest method would be by using the
premiums charged for that employee's coverage. Otherwise, the employer can use the method for
calculating the applicable COBRA premium (less the 2% administration fee) or, if the employer
subsidizes the COBRA premium or charges the employee based on the prior year COBRA
premium, it can use a modified COBRA premium method whereby the employer makes a good faith
estimate of the COBRA premium.
For complete details and a Q&A on what must be reported on the W-2 and how to calculate it, refer
to IRS Notice 2012-9.
Health Flexible Spending Account Limits
The amount that can be contributed to a health flexible spending account (FSA) is limited to $2,500,
effective for plan years beginning on or after January 1, 2013. The limit does not apply to
dependent care assistance, adoption care assistance or amounts applied toward the employee's
health insurance premiums. The $2,500 limit will be indexed for inflation beginning with 2014 plan
years.
Cafeteria plans and FSA plans will need to be amended to reflect the $2,500 limit. Generally, plan
amendments to cafeteria plans and FSA plans must be made on a prospective basis (in advance of
the effective date of the change). The IRS has provided relief from this requirement for FSA
changes; employers have until December 31, 2014 to amend their FSA plans retroactive to the first
plan year beginning on or after January 1, 2013. However, plans must be administered in
accordance with the change beginning on the first day of the first plan year beginning on or after
January 1, 2013.
If an employee is eligible for multiple FSAs offered by employers of a controlled group or affiliated
service group, the employee is limited to one $2,500 limit. If the individual is employed by unrelated
employers, however, he would be entitled to the $2,500 limit under each FSA (if eligible). Spouses
are each eligible to make a $2,500 salary reduction contribution, even if the spouses are employed
by the same employer (assuming that the plan allows it).
If the plan provides a grace period after the plan year-end (e.g.,. 2 ½ months) where unused salary
reduction contributions can be carried over and applied during the grace period, the carryover
amount does not count against the $2,500 limit for the subsequent plan year. The $2,500 limit
applies only to salary reduction contributions and not to employer non-elective contributions (i.e.,.
flex credits). If an employer provides flex credits that employees may elect to receive as cash,
however, those flex credits are treated as salary reduction contributions.
For additional guidance on how to implement the $2,500 limit on health FSA contributions, refer to
IRS Notice 2012-40.
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Retiree Prescription Drug Coverage Subsidy
Prior to January 1, 2013, employers are allowed by the Medicare Modernization Act of 2003 to a
tax-free subsidy of 28 percent of the costs they incur to provide a prescription drug benefit program
to their retirees. Employers are also permitted to deduct any outlays made with these subsidies to
provide retiree drug coverage for income tax purposes. This law was intended to provide relief by
reducing the coverage gap, known as the "doughnut hole," for individuals in the Medicare Part D
program.
Under ACA, employers will still receive the tax-free subsidy after 2012, but they will no longer be
able to deduct on their federal tax returns the cost of the prescription drugs to the extent reimbursed
by the federal subsidy.
Employers should not underestimate the impact of this provision. A Towers Watson study
concluded that U.S. companies could be facing losses of as much as $14 billion if they don’t shift
their employees off of drug subsidy plans. In addition, between 1.5 million and 2 million retirees
would have their drug coverage terminated because employers would be forced to shift them into
Medicare Part D coverage. While the government has estimated that the increased corporate taxes
would be close to $4.5 billion, they have failed to also estimate the cost of those retirees coming
onto the Medicare rolls and off of employers’ benefit plans.
For more information, see IRS Code § 139A, which was amended by PPACA § 9012.
2014
Shared Responsibility Payment
Large employers will have some difficult decisions to make between now and 2014 as the prospect
of the euphemistically named "shared responsibility payment" looms on the horizon. The shared
responsibility payment is a nondeductible excise tax assessed on large employers who do not
provide affordable and adequate health coverage to their full-time employees.
Beginning in 2014, large employers (generally those with more than 50 full-time employees or
equivalents) must provide minimum essential coverage at an affordable rate to all full-time
employees (defined as those who work at least 30 hours per week) in order to avoid the excise tax.
This may require:
• Offering coverage to previously excluded full-time employees,
• Increasing the percentage of total costs covered,
• Increasing the portion of the premiums paid by the employer, and/or
• Offering additional benefits.
"Minimum essential coverage" constitutes 60% of the total benefit costs of a health plan that
provides "essential health benefits." Essential health benefits include: ambulatory patient services;
emergency services; hospitalization; maternity and newborn care; mental health and substance use
disorder services; prescription drugs; rehabilitative services and devices; laboratory services;
preventive and wellness services; and pediatric services. Coverage is provided at an "affordable
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rate" if the employee's contribution, including salary reduction amounts, does not exceed 9.5% of
household income, currently based on the cost of single coverage. For purposes of determining
whether coverage is provided at an affordable rate, employers can rely on an employee's Form W-2
Box 1 wages.
For employers who do not offer coverage to all full-time employees, the excise tax is equal to
$2,000 multiplied by the number of full-time employees less 30 (assuming at least one is eligible for
a federal subsidy, such as a premium assistance credit or cost-sharing assistance, and participates
in an Exchange). For employers who offer coverage to all full-time employees, but the coverage is
not affordable or does not provide minimum value, the excise tax is equal to $3,000 multiplied by
the number of full-time employees eligible for a federal subsidy and participating in an Exchange.
The total excise tax, however, cannot exceed $2,000 multiplied by the number of full-time
employees less 30.
A large employer, for purposes of the excise tax, is an employer who employed an average of at
least 50 full-time employees on business days during the preceding calendar year. For purposes of
determining if it is a large employer, an employer must also include, in addition to its full-time
employees, a number of full-time equivalent employees determined by dividing the aggregate
number of hours of service of employees who are not full-time employees for the month, by 120.
Employers are exempt from the excise tax if its workforce exceeds 50 full-time employees for 120
or fewer days during the calendar year and the employees in excess of 50 employed during the
120-day period are seasonal workers.
Controlled groups of corporations, partnerships and proprietorships under common control, and
affiliated service groups are treated as one employer for purposes of determining whether an
employer exceeds the 50 full-time employee threshold. In addition, for purposes of calculating the
$2,000 excise tax, only one 30-employee reduction is allowed for all persons within a multi-
employer group. The 30-employee reduction is allocated among these persons ratably based on
the number of full-time employees employed by each person.
As previously mentioned, a full-time employee is one who on average works 30 or more hours per
week. While making that determination for traditional full-time employees is simple, classifying
employees who work variable hours or seasonal employees is considerably more complicated. The
IRS provides a "look-back/stability period" safe harbor which allows employers to make the full-time
determination by looking back at an employee's actual hours worked over a certain period of time
(the "look-back period") and then categorizing that employee accordingly for a certain period (the
"stability period") regardless of the actual hours the employee works during that period. A variation
of this safe harbor that examines hours worked during an initial measurement period may be
applied to new employees.
Employers who do not currently cover all full-time employees should estimate what excise tax, if
any, they will owe based on their current health plan structure. Then they will need to perform a
cost-benefit analysis that compares the cost of expanding coverage as necessary to avoid the
excise tax to the cost of leaving the current plan structure intact and paying the excise tax.
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Employers should also explore what other changes it can make to its health plan that would
mitigate the cost of expanding coverage to more employees. For example, employers may be able
to reduce the overall cost of the health plan by increasing co-pays and co-insurance percentages,
increasing the employees' share of the premiums or eliminating certain benefits. Any such changes
should be carefully considered, however, as overly-aggressive changes could cause the plan to
violate the "minimum essential coverage", "minimum value" or "affordable rate" standards. These
types of changes may also cause the health plan to lose its grandfathered status which could
subject the plan to additional requirements.
Taxes Impacting Individuals
2013
3.8% Medicare Contribution on Net Investment Income
Historically, Medicare tax has only been assessed on earned income. Beginning in 2013,
individuals, trusts and estates with income over certain levels will be subject to a 3.8% Medicare tax
(referred to as the "Medicare contribution") on net investment income.
For individuals, the Medicare contribution tax is equal to 3.8% multiplied by the lesser of:
• Net investment income, or
• Modified adjusted gross income (AGI) in excess of $200,000 ($250,000 for married couples
filing jointly).
Modified AGI is equal to AGI plus the foreign earned income exclusion, if applicable.
For trusts and estates, the Medicare contribution tax is equal to 3.8% multiplied by the lesser of:
• Undistributed net investment income, or
• AGI in excess of the amount at which the highest tax bracket begins.
For 2013, the highest tax bracket for trusts and estates is projected to begin at around only $12,000
of income. Trusts and estates that don't distribute the majority of their net investment income will
need to prepare for significant tax increases in 2013 and beyond. The 3.8% Medicare tax generally
would not apply to simple trusts, since by definition they distribute all income to the beneficiaries, or
to grantor trusts, since they are generally disregarded for income tax purposes. Of course, the
3.8% Medicare tax could apply to the beneficiaries or grantor, respectively.
For purposes of the 3.8% Medicare tax, net investment income generally is the sum of the following
items in excess of properly allocable deductions:
• Gross income from interest, dividends, annuities, royalties and rents;
• Other gross income from any passive trade or business or trade or business of trading in
financial instruments or commodities, and;
• Net gains attributable to the disposition of property.
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Investment income does not include:
• Investment income that is excludable from taxable income (e.g., municipal bond interest,
excluded gain from sale of personal residence);
• Qualified retirement plan distributions; and
• Income from the active trade or business of a partnership or LLC, S corporation or sole
proprietorship in which the individual materially participates.
If an individual disposes of his interest in an S corporation or partnership in which he materially
participates, the gain or loss from the disposition of that interest is only taken into account to the
extent of the gain that the individual would have recognized had the entity sold all of its assets for
fair market value immediately before the disposition.
The calculation of the 3.8% Medicare contribution tax is illustrated in the following case study:
Case Study – 3.8% Medicare Contribution Tax
Assume that Joe, a single taxpayer, has the following sources of income in 2013:
Interest income from various corporate bonds and bank $10,000
accounts
Tax-exempt interest income from various municipal bonds $8,000
Qualified dividend income from various mutual funds and stock $12,000
investments
Net long-term capital gains from the disposition of various $40,000
mutual funds and stock investments
Regular IRA distribution $100,000
Net rental income from a building that Joe owns $15,000
Distributive ordinary trade or business income from an LLC in $20,000
which Joe does not materially participate
Distributive net Section 1231 gain from the same LLC $10,000
Distributive ordinary trade or business income from an S $60,000
corporation in which Joe materially participates
Distributive net Section 1231 gain from the same S corporation $50,000
Net investment income for purposes of the 3.8% Medicare contribution tax is calculated as follows:
Interest income from various corporate bonds and bank $10,000
accounts
Qualified dividend income from mutual funds and stock $12,000
investments
Net long-term capital gains from the disposition of investments $40,000
Net rental income $15,000
Ordinary trade or business income from LLC in which Joe does $20,000
not materially participate
Net Section 1231 gain from the LLC $10,000
Net investment income $107,000
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Net investment income does not include the tax-exempt interest income, the IRA distribution or the
income from the S corporation in which materially participates.
Joe's modified adjusted gross income is calculated as follows:
Interest income from various corporate bonds and bank $10,000
accounts
Qualified dividend income from mutual funds and stock $12,000
investments
Net long-term capital gains from the disposition of investments $40,000
Regular IRA distribution $100,000
Net rental income $15,000
Ordinary trade or business income from the LLC $20,000
Net Section 1231 gain from the same LLC $10,000
Ordinary trade or business income from the S corporation $60,000
Net Section 1231 gain from the same S corporation $50,000
Modified AGI $317,000
The 3.8% Medicare contribution tax is calculated as follows:
Modified AGI $317,000
Less Threshold $200,000
Modified AGI in Excess of Threshold $117,000
Lesser of Net Investment Income and Modified AGI in Excess of $107,000
Threshold
Medicare Tax Rate 3.8%
Medicare Contribution Tax $4,066
Taxpayers facing the 3.8% Medicare contribution tax should consider a number of the strategies
below to mitigate the tax. These strategies may also be helpful if individual income tax rates
increase in the coming years.
Convert to a Roth IRA in 2012
While regular IRA distributions are not subject to the 3.8% Medicare tax, they are subject to regular
income taxes and thus are included in a taxpayer's modified AGI for purposes of calculating the
amount subject to the Medicare tax. Converting to a Roth IRA prior to 2013 will remove all future
IRA distributions from the modified AGI computation which could yield a smaller amount that is
subject to the Medicare tax. For example, in the case study above, had the IRA distribution been
from a Roth IRA, modified AGI would have only been $217,000, meaning that only $17,000 would
have been subject to the 3.8% Medicare tax. The additional Medicare tax would have been only
$646 instead of $4,066.
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This strategy won't benefit everyone. If modified AGI less the threshold amount will consistently
exceed net investment income even without the taxable IRA distributions, removing the IRA
distributions from the modified AGI calculation won't produce any benefit.
Taxpayers who could benefit from this strategy should consider converting to a Roth IRA in 2012 so
that the Roth IRA conversion amount doesn't increase modified AGI in 2013 or beyond for purposes
of the Medicare tax.
Realign Investment Portfolio and Time Gain/Loss Realization
The 3.8% Medicare tax on net investment income gives taxpayers incentive to shift their investment
portfolios to investments that don't produce current taxable income. Such investments may include
growth-oriented stocks that don't pay regular dividends, tax-exempt municipal bonds, or whole-life
insurance contracts with an investment feature. To the extent that current holdings will need to be
liquidated to effect this investment shift, taxpayers may want to liquidate those investments in 2012
so that resulting capital gains are taxed at 15% and aren't subject to the 3.8% Medicare tax.
Taxpayers should also consider timing the realization of capital gains and losses to minimize net
investment income (and modified AGI) in 2013. Taxpayers holding securities in a long-term gain
position may want to realize those gains in 2012 before the Medicare tax goes into effect.
Conversely, taxpayers holding securities in a loss position may want to defer realizing those losses
until 2013 to ensure that they offset capital gains that would be subject to the Medicare tax.
Taxpayers must be confident that they will have capital gains in 2013, however, since only $3,000
of capital losses in excess of capital gains can be deducted in one year. Excess capital losses may
be carried forward to offset capital gains in future years.
Taxpayers who are selling securities to generate gains and losses but who wish to retain the
investments must consider the wash sale rules. Securities sold at a loss cannot be reacquired
within 30 days before or after the date of the sale, otherwise the loss will be disallowed. Securities
sold at a gain, however, can be reacquired at any time.
While the potential taxes from an investment strategy should be analyzed in light of the Medicare
tax, it is only one of many factors that an investor should consider when making investment
decisions. The overall return that an investment yields, the income it produces and the investor's
risk tolerance are just some of the other factors in any investment decision.
Shift Investments to Children
A taxpayer may be able to lower his family's overall effective tax rate by shifting some investments
to his children. The 3.8% Medicare tax will be avoided on income from investments given to
children with modified AGI below the $200,000 or $250,000 threshold. The "kiddie tax" generally
will tax at the parents' marginal tax rates the investment income of children under age 19 or full-time
students under age 24. The kiddie tax rules, however, do not apply to the 3.8% Medicare tax. If
the adult children are not subject to the kiddie tax rules, they may also benefit from the income
being taxed at a lower marginal tax rate.
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Parents may not want to give their children control over a significant amount of investments.
Several vehicles can help alleviate these concerns, such as the use of certain trusts or a family
limited partnership. Taxpayers must consider the gift tax implications of any transfers of assets to
their children. Taxpayers can transfer up to $13,000 of investments ($26,000 if split with a spouse)
to each child without any gift tax concerns in 2012. With the $5 million lifetime gift exemption
expiring at the end of 2012, this is an opportune time to shift investment assets to one's children
without incurring a current gift tax liability.
Make Real Estate Professional Election
Rental real estate activities are passive by definition and therefore are subject to the 3.8% Medicare
tax. A real estate professional who spends more than 750 hours and more than 50% of his
business activities in a rental real estate activity may treat that activity as non-passive and therefore
exempt from the 3.8% Medicare tax. Real estate professionals generally will not spend the
requisite amount of time on one rental real estate activity, but they may make an election to group
several activities together for purposes of applying these tests. Investors in real estate who may be
able to group activities together to satisfy the 750 hour and 50% tests should consider making that
election to exempt the income from those activities from the 3.8% Medicare tax. Keep in mind that
such an election would eliminate the ability to use any real estate losses to offset other passive
income in calculating the 3.8% Medicare tax, as well.
Look for Passive Losses
Taxpayers with significant amounts of passive investment income may want to explore new
investments that are projected to generate passive losses. Real estate investments would be the
most likely suspect. Of course, taxpayers must consider the overall quality of the investment and
not invest in an activity solely to generate tax losses.
If taxpayers are looking for investments to generate passive losses, they should avoid publicly
traded partnerships (PTPs). Losses generated by PTPs can only offset income from the same
activity.
Reconsider Installment Sales
Installment sales spread the gain recognition from the sale of qualified property over multiple years
as the proceeds are received on the seller-financed installment note. While installment sale
treatment is usually taxpayer friendly, future tax rate increases can diminish or even eliminate its
benefits.
A taxpayer who sells investment property on an installment basis in 2012 may benefit by electing
out of installment sale treatment and recognizing all of the income in the year of sale. When
contemplating this strategy, the taxpayer must consider whether he can pay all of the tax in the
current year without borrowing money, given that he will not have the installment sale proceeds at
his disposal. The cost of borrowing money may offset any tax savings from avoiding the Medicare
tax.
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A taxpayer who holds an installment note from 2011 or earlier cannot elect out of installment sale
treatment, but can explore ways to trigger the remaining income recognition. For example, selling
the installment note to a related party for fair market value generally will trigger the remaining
income. If the installment note is held within an S corporation, distributing the note to the
shareholders will trigger the income recognition as well.
While a taxpayer may want to avoid or terminate an installment sale prior to 2013, once 2013
arrives, the taxpayer will benefit from installment sale treatment on any new sales. Not only will
installment sale treatment match the income recognition with when payments on the note are
received, but by spreading the income over multiple years, modified AGI for purposes of the
Medicare tax calculation will be minimized.
0.9% Medicare Tax on Wages and Self-Employment Income
Individuals with wages and/or net self-employment income above $200,000 ($250,000 for married
couples filing jointly) will be subject to an additional 0.9% Medicare tax beginning in 2013. For
individuals with self-employment income, the 0.9% Medicare tax is in addition to the regular
Medicare tax rate of 2.9% on net self-employment income. The 0.9% Medicare tax does not qualify
for the one-half of self-employment tax deduction on page one of Form 1040.
For wage earners, employers will begin withholding the additional Medicare tax in the pay period in
which the employee's wages exceeds $200,000, regardless of the filing status. As a result, the
employee may be subject to the additional Medicare tax withholding even if the couple ultimately
doesn't owe the tax because their combined wages are less than $250,000. In this situation, the
extra Medicare tax withholding would be reflected as a tax payment on the couple's individual tax
return and could be used to offset their income tax liability or be refunded.
Situations may also occur where a couple is subject to the additional Medicare tax and has not had
any additional withholding because neither spouse exceeded $200,000 in wages. For example, if a
married couple filing jointly each earned $180,000 in wages, they would owe a combined $990 in
additional Medicare taxes ($360,000 in combined wages less $250,000 multiplied by 0.9%) even
though neither of them was subject to the additional withholding. In this instance, the additional
Medicare tax would be included in the calculation of their tax liability on their individual income tax
return.
The additional Medicare tax is a tax for purposes of the underpayment of estimated tax penalty.
Therefore, couples in this situation will need to factor the additional Medicare tax into their
estimated tax payments or income tax withholding to avoid penalties. An employee cannot request
that the employer withhold additional amounts specifically for the 0.9% Medicare tax. He can,
however, request additional income tax withholding on Form W-4 which will be applied against all
taxes reflected on his individual income tax return (including the additional Medicare tax). If the
employee may also be subject to the new 3.8% Medicare tax on investment income (discussed
above), he may desire to adjust his withholding for that tax as well.
An employee-shareholder of an S corporation currently is not subject to self-employment tax on
trade or business income that passes through to him from the S corporation. The employee-
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shareholder could reduce the 0.9% Medicare tax by decreasing his salary and reporting additional
trade or business flow-through income. The employee-shareholder's compensation must be
reasonable based on the services he performs and he should evaluate the impact that reducing
compensation could have on maximizing retirement plan contributions.
Health Flexible Spending Account Limits
The amount that can be contributed to a health flexible spending account (FSA) is limited to $2,500,
effective for plan years beginning on or after January 1, 2013. The limit does not apply to
dependent care assistance, adoption care assistance or amounts applied toward the employee's
health insurance premiums. The $2,500 limit will be indexed for inflation beginning with 2014 plan
years.
If the plan provides a grace period after the plan year-end (e.g.,. 2 ½ months) where unused salary
reduction contributions can be carried over and applied during the grace period, the carryover
amount does not count against the $2,500 limit for the subsequent plan year.
Employees who have traditionally contributed more than $2,500 to their health FSAs may want to
reevaluate certain decisions during their health plan enrollment period. For example, employees
who have historically chosen a higher deductible or declined dental or vision coverage may want to
reconsider those decisions since the FSA contributions are limited, especially since employee
contributions toward medical, dental and vision insurance premiums are not subject to the FSA
limitations.
Increase in Floor for Medical Expense Itemized Deduction
Historically, qualified medical expenses were deductible as an itemized deduction on Schedule A of
Form 1040 to the extent that the qualified expenses exceeded 7.5% of the taxpayer's adjusted
gross income (AGI). Beginning in 2013, the 7.5% floor will increase to 10% for most taxpayers.
For many taxpayers, the 7.5% floor already was high enough to preclude them from benefiting from
the medical expense deduction. For example, a taxpayer with AGI of $100,000 would only benefit
from the medical expense deduction to the extent qualified medical expenses exceed $7,500.
Beginning in 2013, that threshold would increase to $10,000. Expenses that are reimbursed by
insurance or paid for with pre-tax dollars are not eligible for the deduction.
Taxpayers who are age 65 or older by the end of the tax year are exempt from the increase in the
AGI floor until 2017. For married couples, only one spouse needs to be age 65 by the end of the
tax year for the couple to be exempt from the increase in the AGI floor, even if the couple files
separate tax returns. A taxpayer who incurs significant qualified medical expenses and who will
turn age 65 between 2013 and 2017 may want to defer paying medical expenses incurred toward
the end of the year until the year in which he turns age 65 in order to benefit from the lower AGI
floor.
November 27, 2012 CBIZ Tax Bulletin Page 13

14. CBIZ Special Edition Tax Bulletin
Taxpayers subject to the alternative minimum tax (AMT) may not feel the effects of the increase in
the AGI floor. The medical expense AGI floor for AMT purposes historically has been 10% and will
continue as such, even for those taxpayers age 65 and older.
The information contained herein is not intended to be legal, accounting, or other professional advice, nor are
these comments directed to specific situations. The information contained herein is provided as general
guidance and may be affected by changes in law or regulation.
The information contained herein is not intended to replace or substitute for accounting or other professional
advice. Attorneys or tax advisors must be consulted for assistance in specific situations. This information is
provided as-is, with no warranties of any kind. CBIZ shall not be liable for any damages whatsoever in
connection with its use and assumes no obligation to inform the reader of any changes in laws or other
factors that could affect the information contained herein.
As required by U.S. Treasury rules, we inform you that, unless expressly stated otherwise, any U.S. federal
tax advice contained herein is not intended or written to be used, and cannot be used, by any person for the
purpose of avoiding any penalties that may be imposed by the Internal Revenue Service.
November 27, 2012 CBIZ Tax Bulletin Page 14