Vernoia, Enterline + Brewer, CPA LLC

Posts tagged ‘HCERA’

Landmark health care decision; now what?

On June 28, the U.S. Supreme Court issued its long-awaited landmark decision on the Patient Protection and Affordable Care Act (PPACA) and its companion law, the Health Care and Education Reconciliation Act (HCERA). In a 5 to 4 decision of historic proportions, the nation’s highest court upheld the law – except for a certain Medicaid provision involving state funding.  Key to the Court’s approval of President Obama’s signature health care law was the finding that the linchpin individual mandate was constitutional.  The requirement under the individual mandate that individuals pay a penalty if they fail to carry minimum essential health insurance coverage was declared within the Constitution based upon Congress’s power to tax.

The Supreme Court’s decision preserves all of the far-reaching tax provisions and health insurance reforms that were part of the overall health care reform legislation as passed in 2010. In coming months, lawmakers and legal scholars will examine all of the nuances of the Court’s highly complex decision.  More immediately, individuals and businesses are concerned about what steps they need to take next.

Role of taxes

To a large extent, the Obama administration’s health care law is driven by tax provisions, to provide the carrot, the stick and adequate funding in alternating quantities. The role played by taxes in the new health care provisions is also underscored by the predominate part that the IRS will play in its administration.

Under the health care law, a number of tax provisions are scheduled to take effect in 2013 and beyond. The court’s decision allows the numerous tax provisions within the health care laws to move forward on schedule. Some important provisions have already taken effect; others will take effect in 2013 and 2014. One provision, the excise tax on high-cost employer-sponsored coverage, will not take effect until 2018.

Main provisions/effective dates

PPACA and HCERA include the following tax provisions (not a complete list):

  • Small employer Sec. 45R credit, effective for tax years beginning in 2010 – the government will provide a credit of 35 percent of health insurance premiums to small employers (25 percent for tax-exempt organizations. The credit expires after 2015.
  • Economic substance doctrine, effective after March 30, 2010 – the economic substance test was codified as a two-prong test, requiring that the transaction change the taxpayer’s economic position in a meaningful way, and that the taxpayer has a substantial business purpose for the transaction.
  • Over-the-counter limitations for health accounts, effective for tax years beginning after December 31, 2010 – health accounts, such as flexible spending arrangements, health reimbursement arrangements, health savings accounts, and Archer Medical Savings Accounts, can only reimburse expenses for medicine and drugs if the item is a prescription drug (or insulin).
  • Indoor tanning services excise tax, effective on or after July 1, 2010 – amounts paid for indoor tanning services are subject to a 10-percent excise tax. Tanning salons must collect the tax and pay it quarterly.
  • Itemized deduction for medical expenses, effective for tax years beginning after December 31, 2012 – the threshold for deducting medical expenses as an itemized deduction is raised from 7.5 percent to 10 percent of adjusted gross income.
  • Additional 0.9% Medicare tax, effective after December 31, 2012 – an additional 0.9 percent Medicare tax is imposed on wages and self-employment income of higher-income individuals: individuals – above $200,000; married filing jointly – above $250,000; married filing separately – above $125,000.
  • 3.8% Medicare contribution tax, effective after December 31, 2012 – a 3.8 percent Medicare tax is imposed on unearned income for higher-income individuals, including interest, dividends, annuities, royalties, rents and other passive income.
  • Medical device excise tax, effective for sales after December 31, 2012 – a 2.3 percent excise tax is imposed on sales of certain medical devices by manufacturers, producers and importers. Retail items such as eyeglasses are excluded from the tax.
  • Employer shared responsibility, effective after December 31, 2013 – the “employer mandate”: an applicable large employer (50 or more full-time employees) must make a payment if any full-time employee can receive the premium tax credit. The payment is required if the employer does not offer minimum essential coverage, or offers coverage that is not affordable.
  • Branded prescription drug fees, effective for calendar years beginning after December 31, 2010 – an annual fee imposed on manufacturers and importers with receipts from branded prescription drug sales.
  • Sec. 36B premium assistance credit, effective for tax years ending after December 31, 2013 – lower-income individuals who obtain health insurance coverage through an insurance exchange may qualify for the credit, unless they are eligible for other minimum essential coverage.
  • Excise tax on high-dollar insurance, effective for tax years beginning after December 31, 2017 – employer-sponsored health coverage whose cost exceeds a threshold amount ($10,200 for self-on coverage; $27,500 for other coverage) will be subject to a 40-percent excise tax.

Looking ahead

Employers, taxpayers – indeed everyone – must prepare for sweeping changes in health care in coming years.  Many of the provisions in the PPACA have already been implemented or are in the process of being implemented.  Other provisions, as the above list indicated, are scheduled to take effect after 2012.  The Supreme Court’s upholding of the PPACA clears the way for full implementation of the new law (unless a future Congress votes to repeal the law, which at this point would be an uphill battle). Our office will keep you posted of developments and the steps you need to take in the coming months.

IRS instructs auditors on economic substance doctrine

A transaction may comply with a literal reading of the Tax Code but result in unreasonable tax consequences that are not intended by the tax laws. To combat these transactions, the IRS has used for many years a doctrine known as the economic substance doctrine.  Congress codified the doctrine in 2010 and recently the IRS issued instructions to examiners explaining how to apply the codified doctrine.

Economic substance

In recent years, the IRS has successfully used the economic substance doctrine to fight abusive tax shelters.  These cases involved, among other things, corporate owned life insurance, limited liability companies, and other entities. According to the IRS, these entities and the transactions they entered into were designed solely for tax avoidance purposes and lacked economic substance. The IRS scored some significant victories using the economic substance doctrine against tax shelters.


The economic substance doctrine was developed by the courts over the past 70 years. Because it was judicially created, courts applied the doctrine in different ways. There was no national standard in applying the doctrine. In some cases, the differences among the courts of appeal were subtle; in other cases, they their interpretations of the doctrine varied widely.

Codification was promoted as a way to standardize application of the doctrine. Congress codified the economic substance doctrine in the Health Care and Education Reconciliation Act (HCERA).  The codified doctrine applies to transactions entered into on or after March 30, 2010 (the date of enactment of HCERA).

Congress codified the economic substance doctrine as follows: In the case of any transaction to which the economic substance doctrine is relevant, the transaction shall be treated as having economic substance only if the transaction changes in a meaningful way (apart from federal income tax effects) the taxpayer’s economic position; and the taxpayer has a substantial purpose (apart from federal income tax effects) for entering into such transaction.

Congress also approved tough penalties.  There is a strict liability penalty of 20 percent (40 percent for undisclosed transactions) of any underpayment attributable to the disallowance of claimed tax benefits by reason of the application of the economic substance doctrine or failing to meet the requirements of any similar rule of law.


Almost immediately after HCERA became law, taxpayers asked the IRS how it intends to enforce the codified economic substance doctrine. The IRS issued a notice (Notice 2010-62) and a directive for its examiners (LMSB-20-0910-024) in September 2010.  The IRS followed up that initial guidance with a new directive on July 15, 2011.

The IRS explained that latest directive lays out a step-by-step inquiry examiners should make to determine if it is appropriate to apply the economic substance doctrine. The IRS also reiterated that any decision to apply the doctrine must be approved by senior agency personnel.

First, an examiner should evaluate whether the circumstances in the case are those under which application of the economic substance doctrine to a transaction is likely not appropriate.  Second, an examiner should evaluate whether the circumstances in the case are those under which application of the doctrine to the transaction may be appropriate.  Third, if an examiner determines that the application of the doctrine may be appropriate, the guidance provides a series of inquiries an examiner must make before seeking approval to apply the doctrine.  Fourth, if an examiner and his or her manager and territory manager determine that application of the economic substance doctrine is merited, guidance is provided on how to request senior manager approval.

The directive also advised examiners that the enhanced penalties under HCERA are limited to the application of the economic substance doctrine. Until more guidance is issued, the IRS will not impose these enhanced penalties due to the application of any “similar rule of law” as authorized by HCERA.

Measured approach

Looking ahead, it appears the IRS intends to take a measured approach in applying the codified economic substance doctrine. Senior IRS officials have indicated that the agency will be careful in applying the codified doctrine. Of course, guidance in this area is very limited at this time. Our office will keep you posted of developments. If you have any questions about the economic substance doctrine, please contact our office.