By Kathleen Kingsbury
(Reuters) - For many Americans, the health reform law passed in 2010 will forevermore tie their health to their taxes.
And even though the big changes required by the Patient Protection and Affordable Care don't start until 2014, the tax impact starts now.
"We're undergoing some of the biggest changes to the tax code in 20 years," said Meg Sutton, senior adviser for tax and healthcare services at tax preparation firm H&R Block Inc. "People need to start understanding how it will impact them."
For starters, beginning in January 2014, every American will be required to have health coverage, and many will qualify for government help to pay for it. Whether or not you do will depend on the income you report to the Internal Revenue Service on your 2012 tax return.
Fewer than one-in four Americans understood that when H&R Block did a survey last fall, but an estimated 26 million people could be affected when they begin to turn to new health exchanges to buy their coverage for next year. Block is making a point of counseling their clients on whether they will qualify for subsidies.
Some people who are on the border may be able to reduce their 2012 income by making a last-minute retirement account contribution, for example, so they can get the extra help.
CARROTS AND STICKS
The new law's individual mandate depends on income-dependent subsidies and penalties to make it work.
This will primarily affect people who don't have insurance or buy their own and are likely to look to new state exchanges for their policies. When they choose their plans, they will receive tax credits if the cost of the coverage is deemed too high relative to their income.
Those who don't buy coverage for 2014 will face penalties of $95 or 1 percent of household income, whichever is greater. That will increase each year to $695, or 2.5 percent, in 2016.
Subsidies will be available for families who earn as much as 400 percent of the federal poverty rate - roughly $45,000 for an individual or $92,000 for a family of four. For example, a family of four making $70,000 could expect a government tax credit of $5,504, which would cover about 45 percent of its insurance costs. That's according to the Kaiser Family Foundation's Health Reform Subsidy Calculator.
GETTING INCOME RIGHT
Some taxpayers may run into trouble this year by underestimating their income and receiving a larger subsidy than they are ultimately eligible for, says Mark Steber, chief tax officer for Jackson Hewitt. "They will owe a large payment back to the IRS" down the road.
The formula for calculating subsidy eligibility adds some foreign income and tax-exempt interest income to adjusted gross income, so people may have little taxable income but still make too much to qualify for the subsidies. There's another wrinkle: Even if you do everything right in 2012, you could end up owing some subsidy back on your 2014 taxes if you earn more then. But you won't have to worry about that until 2015.
Make no mistake, though — the government wants to sweeten the pot for those buying insurance on their own as much as it can. Self-employed workers can still deduct the cost of their policies. And while workers may start seeing how much their companies are spending for their healthcare on their 2012 W-2 forms, that amount won't be considered taxable income.
WRITE-OFFS WILL GET TOUGHER
The tax code will get less generous when it comes to writing off healthcare expenses other than insurance. The 2012 tax year is the last one for which medical costs over 7.5 percent of adjusted gross income (AGI) can be deducted. Starting in 2013, that figure jumps to 10 percent. (An exception is individuals or spouses who turn 65 before the end of 2013, who will retain the 7.5 percent floor through the 2016 tax year.)
Finally, all employees will also find contributions to pre-tax health flexible-spending accounts capped at $2,500 this year. Working spouses, however, can each open an FSA with their respective employers, which would allow them to put aside a total of $5,000.
NEW TAXES, TOO
Other provisions of the Affordable Care Act will add to some taxpayers' burdens.
High-income earners now pay an additional 0.9 percent Medicare payroll tax on income over $200,000 for individuals and $250,000 for couples. That comes on top of the previous Medicare tax of 1.45 percent.
Also starting in 2013, high earners pay a 3.8 percent Medicare tax on interest, dividends, capital gains, rent and royalty income.
And while employers have been withholding the extra payroll taxes from high-earning workers since January 2013, some people will now have to file estimated taxes as well, says Mark Raschiatore, partner at accounting firm CliftonLarsonAllen.
Those who have high investment income, or couples who together earn more than $250,000 but aren't having the extra 0.9 percent taken out of their paychecks should consider paying extra taxes quarterly to the IRS, lest they end up owing extra - and penalties when they file their 2013 taxes.
There is a lot to learn. Most filers should use the next several months to educate themselves on — and budget for — changes ahead in 2014, says Sutton. It'll be good preparation for reading all the small print on health exchanges.
(The author is a Reuters contributor. This is part of a five-story package on tax planning that runs from March 12 to March 14.)
(Editing by Chelsea Emery, Linda Stern and Prudence Crowther)