How Will You Report The ObamaCare Subsidy On Your Tax Return?

It is called the “premium assistance tax credit,” and it refers to the subsidy that people will receive under the ObamaCare individual mandate. It will begin in 2014, and it is supposed to make insurance more affordable for people under 400% of the federal poverty line (FPL). I am not really sure how the politicians came up with 400%, as many if not most of us would agree that 4 times the poverty line is nowhere near poverty. For example, if you are married and have a child, 400% of the FPL is $78,120. That picks up a lot, if not the majority, of people in the Cincinnati area. 

OBSERVATION: I did not realize that Washington views the average Cincinnatian as impoverished and in need of their help.  How did we ever survive this blight before?

Starting next year, you have to address your health insurance, either by receiving it through work, remaining on your parent’s policy, buying it in the private marketplace or on the public exchange. If you don’t, tax advisors are supposed to calculate a tax penalty when preparing your 2014 taxes in April 2015. If you do, then tax advisors may have to go through a separate calculation to determine whether the government paid too much or too little subsidy toward your health insurance. As a tax advisor, I say … whoopee. You would think the government could at least put me on its 401(k) plan for doing its yeoman work.

So how do you calculate whether the government paid too much or too little? That is our topic this week.

We will need two tables to do this. The first is the FPL table by household size.

The second table provides the phase-out of the subsidy as one’s income increases through the FPL table.

When you and I meet in April 2015, I will know your 2014 adjusted gross income (AGI), which starts off this exercise. A good definition of AGI is the amount of money you made before you deduct your house, taxes, contributions and kids. I will then have to make some adjustments to it, if you have certain items on your return:

·        I will add tax -exempt interest

·        I will add the untaxed portion of your social security

·        If you worked overseas I will add the exempted portion of your salary

You now have something called modified adjusted gross income (MAGI).

Let’s say that you are married, have a toddler and your MAGI is $55,000. You have a modest home, an older car and are living the dream. 

The table tells me that you are under 400% of the FPL (which is $78,120 for a family of 3), so we next talk about your health insurance. You tell me that you do not have insurance at work. Your wife is staying at home and being a mom. You went and bought a health policy on the public exchange. You purchased an Anthem bronze plan costing $715 per month. That $715 however was before the subsidy, to which we will return in a moment.

We now have your actual 2014 income, and we have to settle-up with the government. If you were under-subsidized, you will get a check. If you were over-subsidized, you have to return the money. 

NOTE: The subsidy is being paid directly to the insurer. You never see this check. It is very possible that you never even paid attention to the subsidy amount, as you were focusing only on your out-of-pocket.

At MAGI of $55,000, you are at 282% of the FPL ($55,000/$19,530). We now go to the next table. There is a sliding scale between 250% and 300% FPL, going from 8.05% to 9.5% of MAGI. You are somewhere in the middle, so we have to do some math:

            282 – 250 = 32

            32/50 = 64%

            9.5% - 8.05% = 1.45%

            1.45% * 64% = 0.93%

            8.05% + 0.93% = 8.98%

Your premiums are limited to 8.98% of your MAGI. As we said, your income was $55,000. That means your share of the premiums caps-out at $4,939.

How much was your subsidy? Total annual premiums were $8,580 ($715 * 12 months). Your cap is $4,939. The difference is $3,641, or $303 per month. If your subsidy was less than $303/month, I have good news for you. If it was more, then I have bad news, as you will be writing the government a check.  How do we know the subsidy? There will be a new tax form – Form 1095-A- that will be issued about the same time as your W-2. You will have to bring that form to me when preparing your taxes.

There are limits on how much you have to repay the government:

·        If you are below 200% of the FPL, the most you have to pay back is $600

·        Between 200% and 300% the maximum is $1,500

·        Between 300% and 400% the maximum is $2,500

The $600/$1,500/$2,500 limits are for a family. It is one-half that amount if you are single.

By the way …. IF your MAGI exceeds 400% FPL, then you have to repay ALL the subsidy with your tax return.

The above limits ($600/$1,500/$2,500) do not apply if the government owes you. This could happen if your income dropped significantly, such as your employer moving you to part-time.

You may have read that the White House delayed the employer reporting for one year. It will now start in 2015 (for 2014), rather than 2014 (for 2013). The White House believes that it has limited the potential for fraud because of the requirement to settle-up the individual mandate when filing the individual income tax return. You can see their point.

I am very uncomfortable with this action, however. Since when does a White House get to decide which laws it wants to enforce and which laws it does not? What if the next president decides to “suspend” the corporate tax for a year? This White House is creating precedence for that White House to do so.

What we have now are three categories of health consumers:

(1) Over 400%: you pay full boat. The exchanges and subsidies mean nothing to you.

(2) Between 133% and 400% of the FPL: you may be subject to the above, depending upon your insurance situation at work.

(3) Below 133%: you are likely enrolled in Medicaid and pay no premiums at all. This however will vary by state, as many states did not participate in the Medicaid expansion under ObamaCare.

You cannot deduct the portion of your health insurance that is being subsidized. However, since the medical deduction threshold is increasing to 10% (from 7.5%) of AGI, it is highly unlikely that you will ever deduct medical expenses again, unless you have exceptional circumstances. 

And there is how the government intends that people will settle up their ObamaCare if they qualify for a subsidy. Seems reasonable, as in I-haven’t-been-in-the-real-world-and-earned-a-real-paycheck-for-many-years-now and how-hard-can-it-be-to-build-a-website sort of way.

After all, what could possibly go wrong?

Why Would a 100+ Year-Old Ohio Company Move To Ireland?

Consider the following statements:

• Eaton Corp acquired Cooper Industries for $13 billion, the largest acquisition in the Cleveland manufacturer's 101-year history.
• Cooper Industries is based in Houston and incorporated in Ireland.
• Eaton Corp incorporated a new company in Ireland - Eaton Corp., plc.
• Eaton Corp will wind up as a subsidiary of Eaton Corp. plc.
• The new company will have about 100,000 employees in 150 countries. It will have annual sales in excess of $20 billion.

This transaction is called an inversion. Visualize it this way: the top of the ladder (Eaton Corp) now becomes a subsidiary – that is, it moved down the ladder. It inverted.

 

To a tax planner this is an “outbound” transaction, and it brings onto the pitch one of the most near-incomprehensible areas of the tax code – Section 367. This construct entered the Code in the 1930s in response to the following little trick:

1. A U.S. taxpayer would transfer appreciated assets to a foreign corporation in a tax haven country. Many times these assets were stocks and bonds, as they were easy to sell. Believe it or not, Canada was a popular destination for this.
2. The corporation would sell the assets at little or no tax.
3. The corporation, flush with cash, would merge back into a U.S. company.
4. The U.S. taxpayer thus had cash and had deftly sidestepped U.S. corporate tax.

OBSERVATION: It sounds like it was much easier to be a tax planner back in the 1930s.

The initial concept of Section 367 was relatively easy to follow: what drove the above transactions was the tax planner’s ability to make most or all the transactions tax-free.  To do this, planners primarily used corporations. This in turn allowed the planner to use incorporations, mergers, reorganizations and divisives to peel assets away from the U.S.  Congress in turn passed this little beauty:

            367(a)(1)General rule.—

If, in connection with any exchange described in section 332, 351, 354, 356, or 361, a United States person transfers property to a foreign corporation, such foreign corporation shall not, for purposes of determining the extent to which gain shall be recognized on such transfer, be considered to be a corporation.

Congress said that – if one wanted to play that appreciated-stock-to-a-Canadian-company game again - it would not permit the Canadian company to be treated as a corporation. As the tax-free status required both parties to be corporations, the game was halted. There were exceptions, of course, otherwise legitimate business transactions would grind to a halt. Then there were exceptions to exceptions, which the planners exploited, to which the IRS responded, and so on to the present day.

By 2004 the planners had gotten very good. Congress passed another law – Section 7874 – to address inversions. It introduced the term “surrogate foreign corporation,” which – as initially drafted – could have pulled a foreign corporation owned by foreign investors with no U.S. operations or U.S. history into the orbit of U.S. taxation. How?

Let’s look at this horror show:

7874(a)(2)(B)Surrogate foreign corporation.—

A foreign corporation shall be treated as a surrogate foreign corporation if, pursuant to a plan (or a series of related transactions)—

7874(a)(2)(B)(i) 

the entity completes … the direct or indirect acquisition of substantially all of the properties … held directly or indirectly by a domestic corporation or substantially all of the properties … of a domestic partnership,

7874(a)(2)(B)(ii) 

after the acquisition at least 60 percent of the stock … is held by former shareholders of the domestic corporation by reason of holding stock in the domestic corporation,

7874(a)(2)(B)(iii) 

after the acquisition the …entity does not have substantial business activities in the foreign country … when compared to the total business activities of such expanded affiliated group.

How can this blow up? Let me give you an example:

• Foreign individuals form a domestic U.S. corporation (Hamilton U.S.) under the laws of Delaware.
• Hamilton U.S. makes a ton of money (not relevant but it makes me happy).
• All shareholders of Hamilton U.S. are either nonresident aliens or a foreign corporation (Hamilton International) also owned by the same shareholders.
• The shareholders have never resided nor have any other business interest in the U.S.
• Hamilton International was formed outside the U.S. and has no other business interest in the U.S.
• The shareholders decide to make Hamilton U.S. a subsidiary of Hamilton International.
• The shareholders have a Board meeting in Leeds and transfer their shares in Hamilton U.S. to Hamilton International. They then head to the pub for a pint.

Let’s pace this out:

• Hamilton U.S. would be subject to U.S. taxation on its operations, as the operations occur exclusively within the U.S. This result is not affected by who owns Hamilton U.S.
• We will meet the threshold of 7874(a)(2)(B)(i) as a foreign corporation acquired substantially all (heck, it acquired all) the properties of a domestic corporation.
• We will meet the threshold of 7874(a)(2)(B)(ii) as more than 60% of the shareholders remain the same. In fact, 100% of the shareholders remain the same.
• We will meet the threshold of 7874(a)(2)(B)(iii) as the business activities are in the U.S., not in the foreign country.

We now have the possibility – and absurdity – that Hamilton International is a “surrogate foreign corporation” and taxable in the U.S. Granted, in our example this doesn’t mean much, as Hamilton International’s only asset is stock in Hamilton U.S., which has to pay U.S. tax anyway. Still, it is an example of the swamp of U.S. tax law.

Let’s get back to Eaton.

Why would Eaton make itself a subsidiary of an Irish parent?

It is not moving to Ireland. Eaton will retain its presence in northern Ohio, and Cooper will remain in Houston. Remember that business activities in the United States will be taxable to the U.S., irrespective of the international parent. What then is the point of the inversion? The point is that more than one-half the new company will be outside the U.S., and the international parent keeps that portion away from the IRS. Remember also that Ireland has a 12.5% tax rate, as opposed to the U.S. 35% rate.

There is another consideration. Placing Eaton in Ireland allows the tax planners to move the treasury function outside the U.S. What is a treasury function? It is lingo for the budgeting, management and investment of cash. Considering that this is a $20 billion company, there is a lot of cash flow. Treasury is a candidate for what has been called “stateless” income.

           

There is more. Now the development of patents and intellectual property can now be sitused outside the United States. By the way, this is a key reason why virtually all (if not all) pharmaceutical and technology companies have presence outside of the United States. It is very difficult to create intellectual property in the U.S. and then move it offshore. How does a tax advisor plan for that? By never placing the intellectual property in the U.S.

           

And the point of all this: Eaton has estimated that the combined companies would realize annual tax savings of about $160 million by 2016.

In 2002, Senator Charles Grassley, then the top Republican on the Finance Committee, called inversion transactions “immoral.”  That ironically was also the year that Cooper Industries inverted to Bermuda, and it later moved to Ireland. The Obama administration has proposed disallowing tax deductions for companies moving outside the United States. Nothing has come of that proposal.

The U.S. policy of worldwide taxation goes back to the League of Nations, when the U.S. thought that advanced nations would eventually move to its side. That did not happen, and with time, many nations moved instead to a territorial system. The U.S. is now the outlier. Our tax policy now presumes irrational economics. I am not going to advise a client to pay more tax just because Senator Grassley thinks they should. 

I will take this step further: many tax planners believe that it may be malpractice NOT to consider placing as much activity offshore as reasonably possible. There is more than a snowball’s chance that I could be sued for advising a client as the Senator wants.

I am glad that Eaton kept its jobs in Ohio. It is unfortunate that it had to go through these gymnastics, though.

Why Is The IRS Looking At Restaurant Tips (Again)?

I recently visited one of our clients. He owns a restaurant/bar. That is a tough business under the best of circumstances.  It is a business where almost all your profit comes from paying attention to the nickels and dimes.

Is there anything new out there, he asked?

We talked about the IRS’ recent interest in employee tips and gratuities. What is the difference?

• A tip is an amount determined by the patron

• A service charge is an amount agreed upon by the restaurant and patron

The IRS has long defined a tip as:

1. Paid free from compulsion
2. Determinable by the customer
3. Not dictated by the restaurant/employer
4. The recipient of which is identified by the customer

You may know that restaurant employees are paid a lower minimum wage, as a substantial part of their income is expected to come from tips. The employees are supposed to report their tips to the restaurant, which in turn withholds the employee’s share of the taxes. The restaurant also pays employer FICA on the base wages and tips.

The IRS has long believed that there exists substantial noncompliance with tip reporting by restaurant employees, and it has rolled out a number of “programs” over the years with the intent of increasing compliance. I have been through several of these, and my conclusion is that the IRS just wants money, even if it takes a work of fiction to get there. For example, if the IRS feels that the cash tip rate is too low, they will simply propose a higher rate, and call upon the restaurant (which then means me) to prove otherwise. Failure to do so means the restaurant is writing a tidy check for those actual taxes on proposed tips.

It is unfortunately too common that a server will be under-tipped if he/she is serving a large party. As a defense mechanism, many restaurants have imposed a service charge policy (also known as an auto gratuity or “auto-grat”) on that table or tables. The policy has worked fine for years.

But not for the IRS. They have recently clarified that they don’t believe auto-grats count as a tips, as the customer does not have the option of changing the amount or directing who is to receive it. I have to admit, the IRS has a point. However, are they making things worse by pressing the point? Let’s go through a few issues:

• The auto-grat will be on the server’s paycheck, rather than cashed out at the end of the shift. This is not a big deal in the scheme of things – except perhaps to the server.

• Restaurants are allowed to claim a tax credit for employer FICA paid on tips in excess of the amount necessary to get a server to minimum wage.

a.     Reduce the amount considered to be tips and you reduce the credit available to the restaurant.

b.     Meaning more tax to the restaurant.

• An auto-grat is considered revenue to the restaurant. Tips are not. States with a gross revenue tax – such as Ohio with its CAT – will now tax those auto-grats.

a.     Meaning more tax to the restaurant.

• Following on the same vein as (3), the customer will pay more sales tax, as the auto-grat is included in sales.

a.     Meaning more tax to the customer.

• How does one (I don’t know: say my accounting firm) figure out what rate of pay to use if the employee works overtime?

a.     Remember, service charges are resetting the base rate of pay.

b.     What if they server works tips and auto-grat tables over the course of one shift? Do they have one rate of pay or two? How would you even calculate this?

• Let’s throw a little SALT (State And Local Tax) into the mix: some states do not follow the federal definitions. For example, New York will consider auto-grats to be considered tips if they are separately stated on the receipt or invoice. New Jersey and Connecticut follow this line also.

a.     The good thing is that auto-grats will not be subject to New York sales tax.

b.     The bad thing is the accounting required to figure this out.

How long do you think it will be before the attorneys eviscerate some restaurant chain for violations of FLSA and overtime regulations? Remember, a service charge can change a server’s base pay, something a tip cannot do. On the other hand, the odds of overtime under the current economy are pretty low.

What about discrimination? How long before someone sues for being scheduled insufficient/excessive service -charge/non-service-charge shifts?

You know what I would do? I would do away with service charges altogether. I am not bringing that tiger to the party. Tips only at my restaurant.

Is it good for the servers? Since when does any of this care whether it is good for the employee?

It is about one thing: more money to the IRS. There may have been a time when I would have been sympathetic to the government’s position, but in this day of credit and debit cards, I am cynical about how much “unreported” income there is left to squeeze out of this turnip. I am also concerned that some restaurants may impose a service charge and then keep a portion of it for themselves rather than pass it along in full to the servers and others.  I am unhumored by the IRS, but I would be beyond unhumored by a restaurant that did that to its employees.