One important goal of the Patient Protection and Affordable Care Act (PPACA) was to guarantee health insurance availability regardless of health status, eliminating rejections due to pre-existing conditions. The practical problem with such a guarantee is that some people may find it in their self-interest to avoid the expense of health insurance, waiting until they are really sick and buying it then. That shrinks the pool of premium payers, driving up the costs for those who do have insurance. The remedy to that problem is the individual mandate.
Beginning in 2014, most Americans will have to demonstrate to the IRS that they have adequate health insurance. Failure to have adequate health insurance triggers an additional income tax payment to the government. The law called the payment a penalty. Chief Justice Roberts called it a tax in order to join a majority of U.S. Supreme Court Justices sustaining the constitutionality of the PPACA. The initial penalty is relatively low, but it very roughly doubles and redoubles as shown in the table below. The penalty is the greater of a flat fee or a percentage of family income above the income tax filing threshold. A penalty payment is owed for each uninsured adult in a family, and a half penalty is owed for each child under age 18, but the flat fee is capped at three times the base penalty. That corresponds to two adults and two minor children. After 2016 the penalty is adjusted annually for inflation.

“Family income” for purposes of the percentage penalty is the taxpayer’s modified adjusted gross income (MAGI) plus the MAGI of any other family members for whom the taxpayer claims an exemption, plus any tax-exempt interest received during the tax year. Social Security benefits not included in gross income are not counted.
Example. Assume a single taxpayer has $50,000 of MAGI and that the filing threshold is $10,000. The excess income is $40,000, so the 1% penalty in 2014 comes to $400, and the 2% penalty in 2015 would be $800. Those would be payable, as they are higher than the flat fee. Generally, the annual penalty will be capped at an amount equal to the national average premium for qualified health plans that have a “bronze” level of coverage available through the state exchanges.

Exemptions

There are nine statutory exemptions from the enforcement of the penalty imposed by the individual mandate:
Religious conscience. Members of religious sects recognized as opposed to insurance. The Social Security Administration administers a process for identifying and recognizing these religious organizations. Members will need to apply for an exemption certificate from a Health Insurance Marketplace.
Health care sharing ministry. Members of recognized health care sharing ministries.
Indian tribes. Members of federally recognized Indian tribes.
Incarceration. Those who are currently incarcerated.
Not lawfully present. Persons who are not U.S. citizens or U.S. nationals, or who are aliens not lawfully present in the U.S.
Not required to file tax returns. Those whose income falls below the income tax filing threshold. The threshold is a function of filing status, age, and types and amounts of income. Thresholds are expressed in terms of gross income. In 2012 the filing threshold for single taxpayers under age 65 was $9,750, and for married couples filing jointly (both under age 65), it was $19,500.
Short coverage gap. The penalty imposed by the individual mandate applies on a monthly basis. Someone who changes jobs and has a coverage gap of less than three consecutive months is excused from the penalty. A month of coverage is any month in which the taxpayer had health insurance coverage for a single day.
Hardship. A Health Insurance Marketplace, also known as an Affordable Insurance Exchange, may issue hardship certificates to those unable to obtain coverage.
Unaffordable coverage options. If the available coverage requires premium payments in excess of 8% of household income, it is considered unaffordable, and the taxpayer does not have to buy it.
In general, an exemption from the individual mandate will be claimed as part of filing a federal income tax return.

Senior citizens

The individual mandate applies to senior citizens, but Medicare qualifies as minimum essential coverage. Each month of Medicare participation counts toward the mandate.

Enforcement

The requirement to have health insurance begins on January 1, 2014, and will be reported to the IRS on 2014 Forms 1040 in early 2015. Much could change before then. The Obama administration already has announced that it won’t enforce the employer mandate in 2014, and there is political pressure to extend that waiver to individuals also. IRS enforcement tools have been deliberately limited by the PPACA. Specifically, the IRS is only authorized to withhold the penalty under the individual mandate from a taxpayer’s income tax refunds, which are received by roughly half of all taxpayers each year. If a taxpayer has no refund due, then current law would result in a de facto avoidance of the penalty under the individual mandate. Last year the Congressional Budget Office estimated that by 2016 about 11 million taxpayers would be subject to the individual mandate and about 6 million would choose to pay the penalty, raising $7 billion in revenue.
However, anecdotal evidence suggests that taxpayers likely will alter the way in which they withhold for taxes in order to ensure that they do not owe taxes at the end of the year, or come as close to zero as possible, in order to avoid the penalty associated with the individual mandate. In this way, taxpayers could obtain health insurance at a moment’s notice when sickness arises (due to the PPACA’s prohibition against denials due to pre-existing conditions) rather than carrying escalating premium insurance during periods of health. One of the goals of the PPACA was to dilute the insurance pool with healthy individuals who normally do not access their care, thereby reducing premium costs across the board. If a large number of normally healthy individuals avoid the penalty under the individual mandate by under-withholding, the costs for premiums will increase rather than decrease for those remaining on the insured rolls.

© 2014 M.A. Co. All rights reserved.
Any developments occurring after January 1, 2014, are not reflected in this article.

Providing support without jeopardizing benefits

Parents and grandparents of a child with a lifelong disability, such as autism, have a special estate planning challenge. On the one hand, they want to provide the financial support that the child never may be able to provide for himself or herself. On the other hand, they want to protect the child’s eligibility for the full range of government support programs, including health care.

Distributing assets outright to to a special needs person is likely to result in a disqualification for government benefits. Completely disinheriting the child is not a good idea, because government benefits alone may not be enough. Giving property to other family members with the “understanding” that it will be used for the benefit of the special needs person may work for some families, but there are risks. For example, such assets will be vulnerable to creditors, including potential ex-spouses should there be a divorce.

The better course, for many families, is to establish a “third-party” special needs trust. A “first-party” special needs trust is one established for oneself, with one’s own assets. The assets of first-party trusts must be used to repay state Medicaid agencies that have paid for medical services. No such requirement applies to third-party trusts that are created for others.

This is a complicated area of law, and the rules vary from state to state, so the advice of a lawyer well-versed in special needs trusts will be essential.

Funding the trust

A special needs trust has to be fit into the estate plan as a whole. Very often the parents of a special needs child will provide that child with an enhanced share of the estate. For example, if there are three children, the estate may be divided 40-30-30, or 50-25-25.
Another approach is to divide the estate equally but supplement the provision for the special needs child with a life insurance policy, perhaps a second-to-die policy if both parents are living. This can be an affordable way to be confident that the special needs trust will be funded at an adequate level for the child’s entire life.

Choosing the trustee

In general, a family member should not be the sole trustee of a special needs trust. A professional trustee or a corporate trustee, such as a bank trust division or a trust company, is a better choice. The trustee will be given sole and absolute discretion in making distributions. Therefore, the trustee needs to be familiar with the legal requirements of special needs trusts and with government benefit programs. Investment management skills are a must if the trust is intended to last for many years. It’s also important that the trustee be free of conflicts of interest, which someone who is a remainder beneficiary of the trust would have.

To provide guidance for the trustee, the parents should prepare a letter that explains the purposes of the trust and the needs of the child. This can cover the child’s likes, dislikes, needs and preferences, and other information that will be essential to make the trust plan a success. Special needs organizations have prepared samples of such “letters of intent” to provide a starting point for parents taking this path.

© 2014 M.A. Co. All rights reserved.
Any developments occurring after January 1, 2014, are not reflected in this article.

You’ve just finish filing this year’s tax return. With a sense of relief, you set aside a copy of your return and your supporting documents. But what do you do with them then?

Of course, the first step is to keep your tax records in a safe, convenient place. You may need to refer to them for any number of reasons—for example, for future filings or when you are seeking credit. Then, too, you’ll need easy access if you face an audit from the IRS.

The following suggestions will help you compile the best and most complete records.

What to keep
First, there are the basic records that you will want to have on hand. Records of your income: Form(s) W-2, Form(s) 1099 and bank statements. Expense records should include sales slips, invoices, receipts, cancelled checks or other proofs of payment.
Among the investment records that you’ll want to keep are the following: brokerage statements, mutual fund statements, Form(s) 1099 and Form(s) 2439 (Notice to Shareholder of Undistributed Capital Gains). Keep year-end account summaries and deposit receipts for any IRA or Keogh contributions.
Your records should enable you to determine your basis in an investment and whether you have a gain or loss. Records should show the purchase price, sales price and commissions paid. They also may show any reinvested dividends, stock splits and dividends, load charges and original-issue discounts. If you have real estate investments, you’ll need to keep copies of all the regular and extraordinary expenses associated with the properties.

How long to keep it
According to the Tax Code, you are required to keep copies of your tax return and all support as long as they may be needed for the administration of any provision in the law. Typically, that means for as long as the IRS has the right to assess additional tax on your return, or you have the right to amend your return to claim a credit or refund (“the period of limitations”).
There are several periods of limitations. One is a three-year period that applies generally. Another is a six-year period that applies when you don’t report income that you should and that income is more than 25% of the gross income shown on your return. If the return is fraudulent, or you fail to file a required return, there is no limit as to when the IRS can require you to provide it with information.

Recordkeeping for homeowners
Determining your basis (cost) in your home will be extremely important in order to figure the gain or loss when you sell your home (or to calculate depreciation if you use part of your home for business purposes).
Therefore, your records should enable you to determine your basis as well as any adjustments to your basis. Your records should show the original purchase price of your home and settlement or closing costs. They also may show any casualty losses incurred, insurance reimbursements for casualty losses and postponed gain from the sale of a previously owned home.

Be sure to keep a file of bills on what improvements you’ve made to your home each year. Generally, the costs of improvements—changes that add value to your home, prolong its life or adapt it to new uses—may be added to the basis in your home. Repairs and general fix-up costs may not.

© 2014 M.A. Co. All rights reserved.
Any developments occurring after January 1, 2014, are not reflected in this article.

Upper-income taxpayers have many new levies to worry about and plan for this year. Some of these arose from the compromise over the expiration of the “Bush tax cuts”; others were enacted with the Affordable Care Act, but were given delayed effective dates. Taken together, these provisions could greatly raise the reward for effective tax planning.
When the stakes are this high, it’s better not to wait until year-end to start your tax planning moves. Here we look at just one issue.

Net investment income

This year there is a 3.8% tax on net investment income above $200,000 ($250,000 for marrieds filing jointly). The tax applies to the lesser of net investment income or the amount by which modified adjusted gross income (MAGI) exceeds the threshold amount. Here’s how it works for three singles.
Example 1. Bob has $100,000 in salary and $75,000 of net investment income. No tax is due, as his MAGI didn’t cross the threshold.
Example 2. Carol has $350,000 in salary, no net investment income. The 3.8% tax does not apply if there is no investment income.
Example 3. Ted has $300,000 of net investment income, no salary. The amount over the threshold, $100,000, is subject to the new tax, so he’ll owe $3,800 on the excess, in addition to any other taxes on the investment income.

What’s in and what’s out:
What is net investment income anyway? Here’s the breakdown:

Income sources that aren’t subject to the new tax may push a taxpayer into the taxable area. For example, a major IRA distribution in a single year might move a taxpayer over the threshold.
Example 4. Alice has $200,000 of net investment income. So far, no 3.8% tax, because she’s below the taxable threshold. Now Alice decides to withdraw $50,000 from her traditional IRA. The withdrawal itself isn’t taxed, but it does push $50,000 of her net investment income into the taxable area.
Tax planners have come up with a number of strategies to keep exposure to the tax on net investment income under some control. For example, investing for growth instead of income gives the taxpayer a measure of control over timing the realization of income. Distributions from Roth IRAs are exempt from the tax, as is municipal bond income. Most important, spot check for exposure to the tax throughout the year, so as to avoid painful surprises at tax filing time.

© 2014 M.A. Co. All rights reserved.
Any developments occurring after January 1, 2014, are not reflected in this article.