The two massive and controversial recently enacted health-care reform bills, “Patient Protection and Affordable Care Act” and “Health Care and Education Reconciliation Act of 2010,” contain a number of new rules, such as penalties for individuals who choose to remain uninsured, tax credits and other incentives for employers participating in new insurance pools, penalties for larger employers that do not provide insurance (or provide insurance deemed inadequate or unaffordable), and a voucher system for certain lower income employees who choose not to be covered by their employer’s health plan. Health-care reform also includes more than $400 billion in new taxes on both employers and individuals.

The new laws’ supporters predict that an estimated 3.6 million small business owners will qualify for tax credits for health care beginning this year, receiving almost $40 billion in assistance over the next decade. A large percentage of the 26 million small business employees currently uninsured also will receive help.

What impact will this massive overhaul of health care have on your insulation business?

The Small Business Health Tax Credit (2010)

The new law provides $40 billion in tax credits—direct reductions of the operation’s tax bill—for small insulation contractors and businesses to help them offer their employees health insurance coverage, if they choose to do so. According to lawmakers, more than 60 percent of small employers—more than 4 million firms—will be eligible for these credits.

The Internal Revenue Service (IRS) is already encouraging small businesses to explore and, if qualified, claim the new small business health insurance coverage credit. The credit was created for eligible small businesses to either maintain their current health insurance coverage or to begin offering health insurance coverage to their employees.

Effective January 1, 2010, small insulation contractors and other employers offering health insurance to employees as part of their compensation and contributing at least half of the total premium cost will qualify for the tax credit. The employer must have no more than 25 “full-time equivalent” employees (FTEs), and the employees must have annual FTE wages that average no more than $50,000.

Small employers (those with no more than 25 employees and average wages below $50,000 annually) are eligible for a federal general business tax credit up to 35 percent of the amount spent on health insurance for their employees. However, only employers with no more than 10 employees and average wages below $20,000 per year are eligible for the full 35 percent amount.

On January 1, 2014, this rate increases to 50 percent. The wage limits would be indexed to the Consumer Price Index for Urban Consumers for years beginning in 2014.

Self-employed insulation contractors and other professionals, including partners and sole proprietors, 2-percent shareholders of an S corporation, and 5-percent principals in an incorporated business, are not treated as employees for purposes of the Small Employer Health Insurance Credit. In fact, a special rule prevents sole proprietors from receiving the credit for themselves or their family members.

Self-employed contractors can, of course, deduct the cost of health insurance for themselves and their spouses and dependents. Thus, if an S corporation pays accident and health insurance premiums (under a plan established by the S corporation) on behalf of a more-than-2-percent shareholder who is also its employee and who must include the value of the premiums in his or her gross income, the shareholder is permitted to deduct the cost of the premiums paid on his or her behalf.

Penalty for Remaining Uninsured

Starting in 2014, the new law will require nearly all Americans to have health insurance through an employer, a government program, or buying it directly. That year, new insurance markets will open for business, health plans will be required to accept all applicants, and tax credits will start flowing to millions of people, helping them pay the premiums.

Those who continue to go without coverage will have to pay a penalty to the IRS, except in cases of financial hardship. Fines vary by income and family size. For example, a single person making $45,000 would pay an extra $1,125 in taxes when the penalty is fully phased in, in 2016.

Employer Responsibilities

Prior to the passage of this reform, there was no federal requirement that employers offer health insurance coverage to employees or their families. The new law imposes penalties on some businesses for not providing employees coverage (so-called “pay or play”).

Fortunately, most small insulation businesses will not have to worry about the provision because employers with fewer than 50 employees are not subject to the “pay or play” penalty. The new law exempts all small businesses with fewer than 50 employees from the employer responsibility requirements that begin in 2014. This means, according to lawmakers, that 96 percent of all firms in the United States—or 5.8 million out of 6 million total businesses—will be exempt from the requirement to provide health coverage for employees.

For those that are not exempt, the penalty for any month would be an excise tax equal to the number of full-time employees over a 30-employee threshold during the applicable month (regardless of how many employees are receiving a premium tax credit or cost-sharing reduction), multiplied by one-twelfth of $2,000.

“Free Choice” Vouchers

After 2013, employers offering minimum essential coverage through an eligible employer-sponsored plan, and paying a portion of that coverage, would be required to provide qualified employees with a voucher whose value could be applied to the purchase of a health plan through a soon-to-be-established Insurance Exchange.

Qualified employees would be those who do not participate in the employer’s health plan, whose required contribution for employer-sponsored minimum essential coverage exceeds 8 percent but does not exceed 9.5 percent of household income, and whose total household income does not exceed 400 percent of the poverty line for the family. The value of the voucher would be equal to the dollar value of the employer contribution to the employer-offered health plan.

Health Insurance Exchanges

Beginning in 2014, the new law creates state-based Health Insurance Exchanges to make health insurance affordable and accessible for small businesses and the self-employed. With the option of joining a large “pool,” small employers will have access to the same type of quality, affordable coverage that only large firms currently have. Employees of small businesses will be able to do one-stop comparison shopping for an affordable insurance plan that offers lower rates, stable pricing from year to year, and a choice of quality plans.

Those employed by small businesses but who do not receive insurance through their employer and are on the Exchange will have access to sliding-scale tax credits to help pay their premiums. Effective in 2014, for those with access to the Exchange, sliding-scale tax credits are provided to individuals and families up to 400 percent of poverty level. The tax credits phase out completely for an individual with $43,320 and a family of four with $88,200 in income.

Additional Tax on High Wage Earners

To help pay for making health insurance affordable for small businesses and the middle class, the new law includes an increase in taxes for high earners. Specifically, for tax years beginning after December 31, 2012, the hospital insurance (HI) tax rate will be increased by 0.9 percentage points on an individual taxpayer earning over $200,000 ($250,000 for married couples filing jointly). These figures are not indexed for inflation. Also added to the withholding levy is “unearned income.”

The Unearned Income Surtax

Beginning in 2013, a 3.8-percent surtax called an “Unearned Income Medicare Contribution” will be placed on the net investment income of anyone earning over $200,000 ($250,000 for a joint return). Net investment income includes interest, dividends, royalties, rents, gross income from a trade or business involving passive activities, and net gain from disposition of property (other than property held in a trade or business). It should be noted that income “actively” earned by anyone running a small, closely-held business is exempt because it is not “passive” income.

New Limit on Health Plan Contributions

Insulation contractors and other small business owners, as well as their employees, have long used flexible spending accounts (FSAs), medical savings accounts (MSAs), and health savings accounts (HSAs) to pay for medical expenses with pretax dollars. An HSA goes along with a high-deductible insurance policy and gives individuals a tax deduction for money saved that can later be used for health-care expenses. An FSA has similar tax advantages, but contributions to it are deducted from an employee’s salary, and money in the account must be used by the end of the year.

The new law modifies the definition of qualified medical expenses for health FSAs and HSAs to conform to the definition used for the medical expense itemized deduction (excluding over-the-counter medicines, unless prescribed by a health-care professional) beginning in 2011. The law also caps health FSA contributions at $2,500 per year after 2012, which is indexed annually for inflation after 2013.

The additional tax on non-qualified distributions made from HSAs is increased from 10 percent to 20 percent; on non-qualified distributions from Archer MSAs, the tax bite increases from 15 to 20 percent.

New Reporting Responsibilities

For tax years beginning after December 31, 2010, employers will have to disclose the value of the benefit they provide for each employee’s health insurance coverage on the employee’s annual W-2 form. Next year, anyone paying unincorporated suppliers of equipment, property, supplies, and services more than $600 a year will have to file an information report with each provider and with the IRS.

Simple Cafeteria Plans

To encourage more employers to offer tax-free benefits to their employees, including those related to health insurance coverage, the new law relaxes cafeteria plan rules by carving out a safe harbor from the nondiscrimination requirements for cafeteria plans for qualified small employers.

A cafeteria plan enables employees to choose from a menu of employer-sponsored benefits. For tax years beginning after 2010, a Simple Cafeteria Plan can be established. This plan will be subject to eased participation restrictions so small employers could provide tax-free benefits to their employees. Best of all, a Simple Cafeteria Plan can include self-employed individuals as qualified employees.

Are You Ready?

In 2014, contractors and other businesses employing more than 50 workers will be required to provide health coverage, and most people will be required to have health insurance. The tax on high-cost “Cadillac” health insurance policies—those with annual premiums in excess of $10,200 for individual coverage and $27,500 for family coverage—will not go into effect until 2018. The increase in Medicare payroll taxes begins in 2013, while the tax credits available to small employers for health-care-related expenses start in 2010.

In one of its first steps to carry out the new health-care law, the White House announced it is establishing a temporary insurance pool where uninsured people with medical problems can buy coverage at reduced rates. Federal health officials say the program will be available from late June of this year until January 1, 2014, when private insurers will be required to accept all applicants without varying premiums on account of a person’s medical condition.

Overall, the $940 billion health-care overhaul subsidizes coverage for uninsured Americans, financed by Medicare cuts to hospitals and fees or taxes on insurers, drug makers, medical-device companies, those earning more than $200,000 a year, and employers. Many of the changes in the new law’s more than 2,400 pages, such as requiring most people to have health insurance and employers to provide coverage, will take at least 2 years to go into effect. Will you and your insulation business be ready?

Disclaimer: This discussion is generalized in nature and should not be considered a substitute for professional advice. Readers are advised to contact counsel before embarking on any of the options discussed in this article.