President Obama signed The Patient Protection and Affordable Care Act (“the Act”) into law on March 23, 2010. Separately, on March 25, 2010, the Senate and House passed the Health Care and Education Reconciliation Act of 2010 (“the Reconciliation Act”) amending many provisions of the Act. The Reconciliation Act was signed into law by President Obama on March 30, 2010. The tax provisions contained in this major health care overhaul are the subject of a series of Insight articles. The focus of this Insight is the new restrictions on cafeteria plans and reimbursements.
Beginning in 2013, the Act imposes a limit of $2,500 per taxable year on employee salary reductions for coverage under a cafeteria plan Flexible Spending Arrangement (“FSA”). Current law does not impose a limit on salary reductions into an FSA, but many employers impose a limit on annual contributions ($5,000 is a common limitation). Accordingly, any FSA plan that either has no limit, or that has a limit in excess of $2,500 (indexed for inflation after 2013), will have to be amended to maintain qualified benefit status under the cafeteria plan rules beginning in 2013.
In addition to the $2,500 cap on salary reduction contributions into a plan, the Act contains a provision that will prohibit the cost of over-the-counter medications from being reimbursed through an FSA, HRA, HSA or Archer MSA plan, unless the medicine is prescribed by a physician. This provision is effective for expenses incurred after December 31, 2010. Thus, many employers will need to amend their plans and policies beginning in 2011 with respect to over-the-counter medications (more paperwork?).
Congress believes that FSAs are a cause of wasteful health care spending by encouraging people to overuse the health care system near year’s end since they can’t rollover unused balances from one plan year to the next. Therefore, people tend to buy things they do not need, and to see doctors when they do not need to. Simply translated, Congress intends the provisions to be revenue raisers. The changes will raise revenue by reducing the amount of money people can set aside on a pre-tax basis meaning that they pay more tax on their salaries and wages.
Many people use FSA accounts to pay for high ticket items such as vision and dental work on a pretax basis. Therefore, these folks should consider accelerating these services into 2011 and 2012 if their benefits will be reduced and limited by the new law beginning in 2013.
Itemized Deduction for Medical Expenses
The Act increases the threshold for claiming an itemized deduction for unreimbursed medical expenses for regular tax purposes from 7.5% to 10% of the taxpayers’ AGI. The Act does not change the 10% of AGI threshold for alternative minimum tax (“AMT”) purposes.
The new law generally applies for taxable years beginning after December 31, 2012. However, for taxpayers or spouses who 65 or over in 2013 through 2016, the 7.5% threshold remains in effect for them until 2017.
Penalty increase on nonqualified Health Savings Account (“HSA”)
The new law also increases the penalty on withdrawals from HSAs and Archer MSAs not used for qualified medical expenses from 10 to 20% for years after 2010.
It appears that many of the tax changes affecting individuals are designed to raise revenues to help pay for health care reform and to reduce demand on the health system by forcing more individuals to pay for health care with after tax dollars. Plan accordingly if your cafeteria plan will have to allow for reduced benefits beginning in 2013.
We encourage you to bookmark our web page dedicated to Health Care Reform for periodic updates.
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This advice is not intended or written to be used for, and it cannot be used for, the purpose of avoiding any federal tax penalties that may be imposed, or for promoting, marketing or recommending to another person, any tax related matter.