Plan now to avoid surprises from the Affordable Care Act when filing 2014 taxes

2014 was the first year Americans had access to health insurance options through the Affordable Care Act (the “ACA”). With this new access to insurance came the obligation to purchase it or face new tax consequences. If you opted not to buy health insurance in 2014, you may be faced with a penalty when you file your 2014 tax returns. Even if you did buy insurance through one of the insurance marketplaces, you may have new tax forms to complete and some surprises when it comes to your refund or tax bill.

For most taxpayers, the impact on their tax filing will be minimal, requiring those who were covered to simply check a box indicating they had insurance throughout the year. Those who received subsidies to purchase insurance and who later had increases in their 2014 salary may be required to pay back some of that subsidy. Those whose salary decreased may receive a larger than expected refund.

As these provisions are new to everyone, there may be confusion for taxpayers and tax preparers alike. Unfortunately, due to recent budget cuts, the IRS expects to be able to speak with only half of the people who call in for assistance.

While gearing up for the 2014 tax season, it’s helpful to understand some the most important provisions of the ACA:

  • 1. Exemptions: The ACA provided some exemptions that allow taxpayers to opt out of purchasing insurance without any penalties, including hardship, affordability and religion. There are different methods for applying for an exemption depending on the type of exemption you are requesting. To learn more, go to: https://www.healthcare.gov/fees-exemptions/apply-for-exemption/
  • 2. Penalties: Those who do not qualify for an exemption, were insured for only part of the year, or remain uninsured will be required to pay a penalty called “The Individual Shared Responsibility Payment.” The penalty is set to increase over the coming years, so compare not to see if it is more beneficial for you to pay the penalty or buy insurance. The Tax Policy Center has designed a calculator to help you determine your penalty is you opt to remain uninsured: http://taxpolicycenter.org/taxfacts/acacalculator.cfm.
  • 3. Reconciling: Those who purchased subsidized insurance on the exchanges received an advance on a tax credit. At the time of requesting the subsidy for insurance in 2014, the amount of the subsidy was calculated based on the taxpayer’s 2012 income. The amount of the subsidy granted will be reconciled in the taxpayer’s 2014 filing using the taxpayer’s actual 2014 income and that will affect the taxpayer’s refund or bill. Changes in an individual’s personal circumstances, such as divorce, marriage or a new child can also impact those numbers.
  • There’s still time to plan. Taxpayers facing a loss in premium subsidies because of an increase in income can reduce their income to qualify for the credits. For example, they can contribute to an IRA by April 15, 2015, for the 2014 tax year.

    Update on estate planning – what should you gift now?

    Estate planning remains stuck in limbo. That is, after 2012, the $5 million credit for gift and estate taxes goes away and we could be back at a $1 million credit. Also, the generation skipping tax limit now at $5 million would decrease. Finally, the portability of estate tax exemptions between spouses expires, meaning that the survivor can no longer use any credit amount not used by the first spouse, which would allow more to pass on estate tax free.
    So far, Congress has taken no action. Many expect the 35% rate and a credit of at least $3 million to be the law for 2013 on. However, Congress failed to fix the estate tax for 2010 so nothing is certain.

    Planning: This means you need to review your estate plan, especially your gifting strategies, and act now to take advantage of the higher gift tax credit. You can gift up to $5 million of assets free of gift tax now, or $10 million for married couples. The benefit is that all future income and appreciation on these gifts is removed from your estate. The downside is that the gifts are irrevocable, so you must be certain that what you pass on now you will not need later.
    You always want to select assets that you expect will grow in value. If the assets decline, the strategy is frustrated. An example of what could go wrong is gift of a home at peak values that is now worth far less.

    Remember that you have the annual gift tax exclusion allowing you and your spouse can each give $13,000 per year to any individual without eating away at your gift and estate tax credit. And note: any payments made to colleges or hospitals for the benefit of another person are not counted at all. (No gift tax return is required for these excluded amounts.)

    How do you effectively structure the gift? Here are some examples:
    • Family limited liability company (FLLC): With real estate or business assets, you can transfer minority interests in the FLLC to children or grandchildren. You retain control and the amount you gift is discounted because the minority interests lack control and lack marketability. You will need an appraisal for the value and the discount.
    • Dynasty trust: This type of trust is designed to pass assets on multiple generations. Distributions can be made to the first generations, but they never actually receive a final amount – they rely on the trustee for any amounts to be distributed to them.
    • Grantor retained annuity trust (GRAT): This trust transfers assets to children after a specified term while retaining a fixed annuity. The amount you gift is discounted, because children do not receive it until the end of the term. If the amount transfers, you succeed in transferring a discounted amount that becomes worth much more to the next generation.
    • Qualified Personal Residence Trust (QPRT) Like the GRAT, your children receive your house in the future, so the value of the gift made now is discounted. You can even stay in the house after that term, but you have to pay rent, which is in effect another gift.

    One note of caution: some have expressed the concern that if Congress does not act, the IRS could try to take back the excess in some fashion. Be sure to consult with your estate tax advisor before taking any moves.
    We added gifting as a “to do” on the Finance Health Day page .

    Tax planning and 2011 estate tax law

    While we await more details, recent action by Congress has the Bush tax cuts continuing for two more years, making the 2010 to 2011 tax planning straight forward – much like past years.

    The new law provides relief on the AMT, no reduction in deductions and other benefits, which we plan to review in greater detail.

    Also, it appears that, rather than return to a $1 million unified credit for estate taxes, at least a $3.5 million, if not a $5 million, credit and perhaps as low as a 35% tax rate will be the law next year.

    Until we have more, please consider this summary of Tax planning: 2010 tips and traps, and 2011 changes

    For 2010, some old provisions return and some new changes require action now:

    2010 conversion to a Roth IRA has no income limit and two years to pay the taxes (please see to convert or not to convert).

    Certain advantages in 2009 are lost for 2010 (see tax planning 2009 tips and traps and 2010 changes):
    • AMT patch falls back;
    • Casualty and theft loss limits fall back;
    • Educator and tuition and fees deductions against adjusted gross income are not available;
    • Deduction of state and local sales taxes ends;
    • Exclusion of $2,400 of unemployment income ends; and
    • Exclusion of income from qualified distributions from IRAs to charities ends.

    However, some still apply in 2010:
    • New home buyer credit (through the extended date)
    • Energy Credit for solar power, fuel cells and certain energy efficient improvements are Schedule A deductions. There are two types of credit depending on what improvements were made to your home and taking the deductions requires you to have documentation.
    • A tax refund can be used to buy U.S. Series I bonds.
    • Note that a dependent child’s income is taxed when it exceeds $1,900.
    • Educator’s Expense

    Note that not all states accept the IRS changes, so the information and outcome could be different.

    As we said before, tax planning involves a multi-year view to optimize what you end up paying.

    You should also review your mortgage when you review tax information.

    Roth IRA, to convert or not to convert?

    The answer depends on your tax rate now and expected tax rate when you plan to take withdrawals. Also, you should consider this only if you can cover the taxes with funds from outside of your IRAs, otherwise you are forfeiting the tax deferral on those funds.

    For example, someone with a low tax rate now, from large losses, large deductions or low income, may have less in taxes to pay now so that the rate of tax is less than what it could be in the future, making converting a wise financial move.

    As a separate matter, the taxes can be paid over two years, however, if you expect a higher rate for 2011, the interest you earn will not make it worth waiting.

    Someone with high taxes now, or in the AMT, would be a bad candidate for converting.

    If you are considering this and want more analysis, we created a tool for that purpose so let us know.

    Tax planning: 2009 tips and traps, and 2010 changes

    Tax law changes for 2009 will require you to submit more information to your tax preparer to ensure that you get the most of tax credits and deductions. If the person working on your tax returns does not have all the proper information, you could pay too much or your return could be rejected.

    Here is an overview of tax changes to consider when gathering your information:

    * Making Work Pay Credit (“MWPC”), is a $400 credit to offset a reduction in withholdings enacted early in 2009. It is phased out for higher income and offset by the Economic Recovery Payment, described below. You could end up owing taxes if the credit does fully offset the reduction in withholdings (affects 2009 and 2010).
    * Economic Recovery Payment (“ERP”) is a payment received as part of your social security benefits (for 2009 only), and affects the MWPC so that failing to report it could result in your tax return being rejected. The payment itself is not taxable.
    * Government Retiree Credit (“GRC”) is for those not receiving social security, but affects the MWPC (2009 only). The new Schedule M reconciles the MWPC, ERP and GRC so you need all the information.
    * First Time Home Buyer’s Credit is a $8,000 credit that applies to first time buyers purchasing between certain dates and requires a paper filing (electronic filings will not get the credit). If you buy the home in 2010, you have the option of amending your 2009 taxes for the credit. Note that this credit gets repaid over time on future tax returns beginning in 2010.
    * Tax credit for long term home owners buying a new home, between certain dates, also requires a paper filing to avoid being rejected.
    * American Opportunity Tax Credit (an expanded Hope Credit) allows use of the credit for two year more years than the Hope Credit, covering junior and senior years of college when the Hope Credit was not available.
    * New Vehicle Purchase sales tax deduction (2009 only) is an additional Schedule A item, so long as your are not taking the general sales tax deduction.
    * Energy Credit for solar power, fuel cells and certain energy efficient improvements are Schedule A deductions. There are two types of credit depending on what improvements were made to your home and taking the deductions requires you to have documentation.
    * The Cash for Clunkers voucher is not considered income (2009 only).
    * A tax refund can be used to buy U.S. Series I bonds.
    * There is an AMT patch which helps for 2009, but falls back for 2010.
    * There is an increased casualty and theft loss limit that helps for 2009.
    * Note that a dependent child’s income is taxed when it exceeds $1,900.
    * The Tuition and Fees Deduction applies to 2009.
    * Unemployment Compensation has $2,400 excluded from taxable income (2009 only).
    * Educator’s Expense enhanced for 2009.

    Note that not all states accept the IRS changes, so the information and outcome could be different.

    For 2010, some old provisions return and some new changes require action now:

    * 2010 conversion to a Roth IRA has no income limit and two years to pay the taxes (please see To convert or not traditional IRA to Roth IRA).
    * Certain changes lost for 2010 worth repeating (see What to watch out for in 2010 – investing, taxes and more):
    * AMT patch falls back;
    * Casualty and theft loss limits fall back;
    * Educator and tuition and fees deductions against adjusted gross income are not available;
    * Deduction of state and local sales taxes ends;
    * Exclusion of $2,400 of unemployment income ends; and
    * Exclusion of income from qualified distributions from IRAs to charities ends.
    * The estate tax still has not been enacted retroactively, as expected (see Estate Planning – will we have a new tax law in time).

    As we said before, tax planning involves a multi-year view to optimize what you end up paying (please see More Strategies – Three Year Planning…., Tax Credits and all Continued, and What to watch out for in 2010 – investing, taxes and more)

    Let us know if you have questions or comments. Thanks,

    Steven