The national health care reform bill -- the Patient Protection and Affordable

Care Act of 2010 (PPACA) -- became law on March 23, 2010 and will eventually

affect the daily lives and bank accounts of every American.

This includes federal employees who will see changes to their health care

benefits, most likely starting next January. While it is somewhat early to know

precisely what the full impact of PPACA will be, it is not too early to consider

some of the financial consequences for federal employees, along with some

possible financial planning strategies for managing these consequences.

Perhaps the most significant change for federal employees resulting from

PPACA is that adult children between the ages of 22 and 26 will be eligible for

federal insurance coverage, beginning in the next benefit plan year which begins

Jan. 1, 2011. Under current law, for federal employees who participate in the

Federal Employees Health Benefits Program (FEHBP), an unmarried dependent child

can be included as part of "self and family" coverage until the child becomes

age 22. Starting Jan. 1, 2011, an adult child can remain on the parent's FEHBP

plan (as part of "self and family" coverage) at no extra premium cost to the

parent. But to retain health insurance coverage through the FEHBP, the child

(using current FEHBP eligibility rules for children younger than age

22): (1) must be a tax dependent of the parent and unmarried; (2) be

younger than age 27; and (3) must not have access to, or be eligible to join, an

employer-sponsored group health insurance plan.  Please note: The

Office of Personnel Management  (OPM) has not issued final rules regarding

which 22 - 26 years old will be eligible for the FEHBP. Final eligibility rules

should be issued in early fall 2010. 

For employees or annuitants whose children become age 22 sometime during

2010, they will have to find an alternative health insurance plan for their

children until Jan. 1, 2011 when PPACA becomes law. Under the FEHBP, children

turning age 22 are automatically covered under FEHBP for an additional 31 days

past their 22nd birthday at no cost to the employee or annuitant. Once 31 days

have past, a federal employee can continue FEHBP coverage for their adult child

for up to 36 months through the Temporary Continuation of Coverage (TCC)

program. Though there is no federal contribution towards the premium, the

coverage policy is not subject to underwriting or pre-existing conditions

exclusions. The employee pays the full cost of the premium - this includes the

employee's portion, the employer's portion, plus a two percent administrative

charge. In other words, the employee pays for a dependent child 22 or older 102

percent of the total premium cost of a "self-only" FEHBP plan.

An alternative to the TCC is for an employee to search for an individual

health insurance policy for their child. This policy would be used on a

temporary basis until next January. Some private health insurance companies

offer what is called a "bridge" plan that provides health insurance for an

individual for between six to eight months, with a minimum of underwriting and

reasonable premium costs, especially for a 22 year old.

The year 2010 will be the last year employees can get reimbursed for

over-the-counter (OTC) drugs from their health care flexible spending accounts

(HCFSA), health savings accounts (HSAs), or health reimbursement arrangement

(HRA) without a prescription. Beginning Jan. 1, 2011, these plans can only

reimburse employees for prescribed drugs and insulin. Also, effective Jan. 1,

2013, annual employee contributions to HCFSAs will be capped at $2,500, which is

$2,500 less than the current $5,000 maximum.

Effective Jan. 1, 2011, employees under age 65 must pay an additional tax for

nonqualified distributions from an HSA. They will pay a 20 percent (rather than

the current 10 percent) tax on nonqualified HSA distributions.

Starting in 2013, PPACA could result in higher taxes for many federal

employees. The following is a summary of these higher taxes for those affected

individuals.

Additional Medicare Hospital Insurance (HI) Tax on High-Income

Taxpayers

Under current law, an employee is liable for a Medicare Hospital Insurance

(HI) tax equal to 1.45 percent of his or her wages. Beginning Jan. 1, 2013,

individuals with incomes above certain thresholds will pay an additional HI tax

of 0.9 per cent (Additional Medicare Hospital Insurance (HI) Tax on High-Income

Taxpayers). Under current law, an employee is liable for a Medicare Hospital

Insurance (HI) tax equal to 1.45 percent of his or her wages. Beginning Jan. 1,

2013, individuals with incomes above certain thresholds will pay an additional

HI tax of 0.9 per cent. For an employee, the additional 0.9 percent effectively

increases the HI tax from 1.45 percent to 2.35 percent. The 2.35 percent HI tax

will be imposed on salaries and wages exceeding $250,000 for married individuals

filing jointly. In determining the additional HI tax, the combined earnings of

both spouses are considered. The wage or salary base for determining the

additional tax for married individuals filing separate returns is $125,000 and

$200,000 for any other taxpayer. This additional HI tax is in a sense an

additional Medicare payroll tax imposed on "high wage" earners, a not so

uncommon occurrence for married federal employees in which both spouses are

working and could easily have combined wages exceeding $250,000.

"Unearned Income" Medicare Contribution Payroll Tax

The new legislation imposes a 3.8 percent "unearned income" Medicare tax on

individuals, estates, and certain trusts. For individuals, the tax is equal to

3.8 percent of the lesser of net investment income or the excess of modified

adjusted gross income (MAGI) over the threshold amounts mentioned above

($200,000 for single individuals, $250,000 for married individuals). Individuals

who are above these thresholds will pay an additional 3.8 percent tax on: (1)

income from interest, dividends, nonqualified annuities, royalties and rent; (2)

gross income from a business to which the tax applies, such as rental income

from a rental property; and (3) the net gain from the disposition of certain

property. The tax will not be imposed on CSRS and FERS annuities, military

pensions, TSP distributions and IRA distributions.
 
The overall

result is that the additional 3.8 percent tax will have an impact on federal

employees and annuitants who have significant and growing non-retirement

investment portfolios. To understand this tax increase and its effects, consider

the fact that dividends and long-term capital gains are currently (2010) taxed

at 15 percent. In 2011, high-earning individuals will see dividends taxed at

"ordinary", rather than "preferential" tax rates. This will result in an

increase to a maximum tax rate on ordinary dividends to 39.6 percent. Long-term

capital taxes could increase to 20 percent or more. With the additional 3.8

percent Medicare tax, taxes on dividends could nearly triple to 45 percent, from

the current 15 percent and to 39.6 plus 3.8 percent or 43 percent in the year

2013. For those employees and annuitants with large portfolios that are

generating dividends and capital gains, it may make sense to shift their

portfolios to investments generating tax-exempt or tax-deferred income, such as

municipal bonds or IRAs.

Itemized Deduction Limitation for Medical Expenses

Under current law, an individual is allowed an itemized deduction for regular

tax purposes for unreimbursed medical expenses to the extent that such expenses

in total exceed 7.5 percent of an individual's adjusted gross income (AGI).

Beginning in 2013, PPACA will increase the threshold for itemizing deductions

for unreimbursed medical expenses from 7.5 percent of AGI to 10 percent of AGI.

The thresholds for an individual or an individual's surviving spouse who becomes

age 65 before the end of the taxable year during 2013 through 2016 will remain

at 7.5 percent.

Other changes that will occur as a result of PPACA's

passage:

CLASS Act and Long-Term Care Insurance

Effective Jan 1, 2011, a new long-term care insurance program called the

"CLASS" (Community Living Assistance Services and Supports) will begin.

Employers, including the federal government, may begin collecting premiums as

early as Jan. 1, 2011. Intended as a voluntary ("opt-out" program offered by

employers, premiums will be paid entirely by employees. The programs will

provide individuals with specified limitations as cash benefits of $50 per day

or more in order to pay for long term care (LTC) expenses. There is no lifetime

limit on benefits, and persons with greater needs in terms of the basic

activities of daily living will receive higher benefits. No benefits will be

paid until an enrollee has paid premiums for at least five years and no earlier

than in 2016, and meets certain other requirements. The program may be a

substitute for the federal government's LTC program or LTC insurance from

private insurance companies, especially important for those individuals who

cannot qualify for the federal government's or a private insurance company's LTC

insurance.

Health Care Costs Reported on W-2

Effective Jan. 1, 2011, all employers - including the federal government -

must include on an employee's W-2 form the entire cost of employer-sponsored

health coverage. Generally, this refers to the total premium cost of health

insurance made available by an employer to an employee and that is excluded from

the employee's gross income. The requirement is applicable to W-2 forms to be

issued in early 2012 for tax years beginning Jan. 1, 2011. This reporting

requirement does not change the tax-free treatment of employer-provided health

coverage.

Excise tax on high-cost ("Cadillac") health insurance plans,

effective Jan. 1, 2018

The Cadillac tax goes into effect for all group plans, including self-insured

plans. The tax would be paid by the insurer in the case of a fully insured group

or the third party administrator in a self-insured arrangement, but would be

passed on directly to the employer. The new law establishes a 40% excise tax on

plans with values that exceed $10,200 for individual coverage and $27,500 for

family coverage, with higher thresholds for retirees over age 55 and employees

in certain high-risk professions. Transition relief would be provided for 17

identified high-cost states. The tax would be indexed annually for inflation

using the consumer price index. When determining the values of health plans,

reimbursements from FSAs, HRAs and employer contributions to HSAs will be

included. The value of stand-alone vision and dental plans will be excluded. In

addition the excise tax will not apply to accident, disability, long-term care,

and "after-taxed" indemnity or specified disease insurance coverage.

PPACA was signed into law by President Obama on March 23, 2010. A companion

package of "fixes" to PPACA, the Health Care and Education Reconciliation Act

(HCERA), was signed by the President on March 30, 2010. As noted above, many

provisions of the new law are effective in 2010, while others become law during

the years 2011 to 2018. In many instance, the legislation is applicable to group

plans, "for plan years beginning on or after" a particular date. Since many

group plans follow a calendar year, a provision that becomes legally effective

in one year may not actually be implemented by a group plan until the following

calendar year.

The following summarizes the timeline of the most significant changes

resulting from passage of the PPACA and HCERA. Some of these changes

will federal employees; some will not.

Provisions Effective in 2010

January 1, 2010

• $250 one-time payment for a Medicare beneficiary enrolled in Medicare Part D

  who   reaches the coverage gap of $2,830 for the year 2010 only.

uly 1, 2010

• 10% excise tax on indoor tanning services.

September 23, 2010

• Extension of health coverage to include adult children through age 26.

• No pre-existing condition exclusion for children under age 19.

• No lifetime limit on the dollar value of essential health benefits.

• Policies may not be cancelled if policyholder becomes sick.

• Certain preventive health care coverage are required.

Provisions Effective in 2011

January 1, 2011

• Employers required to report the total cost of employer-provided health care

  on an employee's W-2 form.

• Increase to 20% of the additional tax on nonqualified distributions from

  HSAs.

• Distributions from HSAs, HRAs, or Health Care FSAs for over-the-counter

  medicines are considered a "qualified" expense only if prescribed by a

  physician.

• Collection of premiums for CLASS long-term care program may begin.

Provision Effective in 2013

January 1, 2013

• 0.9% additional Hospital Insurance (Medicare) tax on high-income taxpayers.

• 3.8% "unearned income" Medicare contribution tax takes effect.

• Threshold for itemized deduction of unreimbursed medical expenses increases

  to 10%.

• $2,500 contribution limitation on Health Care FSAs under cafeteria

  plans.

Provisions Effective in 2018

January 1, 2018

• 40% excise tax on high-cost (Cadillac) health plans.

About the Author

Edward A. Zurndorfer is a Certified Financial Planner, Registered Health

Underwriter, Registered Employee Benefits Consultant and Enrolled Agent in

Silver Spring, MD and the owner of EZ Accounting and Financial Services, an

accounting, tax preparation and financial planning firm also located in Silver

Spring, MD.  He is an instructor at federal employee retirement

seminars throughout the country for the National Institute of Transition

Planning, Inc. and writes numerous columns and books on federal employee

benefits.

Revised:  06/18/10