A good friend of MANA too close to the health care debate to allow his name to be used has provided us with this summary of the implications for our members who are sole proprietors. Please note: MANA does not dispense legal or accounting advice, always consult your lawyer and accountant in any matter concerning your legal, accounting, or tax situation, or health care insurance or benefits.

Many manufacturers’ representatives are sole proprietors for the purposes of federal tax law. They file a Schedule C on which they report their business income and expenses along with their individual Form 1040 tax return. With S Corporations and partnerships, sole proprietorships are part of the group typically referred to as “pass-through” entities. This means income taxes are not paid at the business entity level but on the owner’s personal tax return. The terms “independent contractor” and “self-employed” are sometimes used to describe them for federal laws.

For the federal health care reform law, the Patient Protection and Affordable Care Act (PPACA), these sole proprietors are basically considered as any other individual under the law. In that regard, the matter the United States Supreme Court had under consideration — the individual mandate — was of direct interest. If the Court had decided it was not constitutional, the sole proprietor would not have had to acquire health insurance for her or himself. Since the Court decided the mandate was constitutional, the sole proprietor is required to have health insurance coverage in 2014 — unless the sole proprietor is covered otherwise or is exempt (there are certain narrow categories of individuals such as those who do not have health care because of religious beliefs who are exempt.)

Individuals must obtain “minimum essential coverage” for health insurance for themselves and dependents. The requirement begins in 2014 with a $95 minimum penalty for failing to obtain the coverage. The minimum penalties increase to $325 in 2015 and to $695 in 2016. If household “modified adjusted gross income” exceeds specified levels, the penalty is greater.  The percents of household income are 1.0 percent in 2014 (so an individual making more than $9,500 would pay more than the minimum flat amount as a penalty in 2014), 2.0 percent in 2015, and 2.5 percent for 2016 and thereafter.

There is a cap on the minimum penalty per family of no more than 300 percent of the minimum penalty (e.g. $95 x 300 percent = $285 for 2014), regardless of the size of the family. Children under 18 are assessed at half the minimum penalty. If the cost of lowest available plan exceeds 8 percent of income there is no penalty for not having coverage, and there are hardship and religious exclusions.

Where can a sole proprietor obtain coverage? PPACA requires the States to create “exchanges.” While the establishment of the Exchanges is a complex topic, four points are essential to understanding the importance for sole proprietors:

  • States are required to establish American Health Benefit Exchanges by 2014.
  • Individuals may obtain their coverage through these Exchanges.
  • The plans cannot deny coverage.
  • Most subsidies for individuals are tied to coverage through the Exchanges.

If individuals obtain their coverage through an Exchange, they may be eligible for a premium tax credit. There is a sliding scale based of a percent of the Federal Poverty Level (FPL). The lower your income, the bigger the subsidy (or looking at it the other way, the less of your income you are required to pay for obtain coverage). Individuals and families with household income of up to 400 percent of FPL would not be required to spend more than a specified percent of their income on premiums. Individuals and families will receive a credit so that families at the 400 percent FPL will have to pay no more than 9.5 percent of their incomes.  (The 2009 Poverty Guidelines for the 48 Contiguous States and the District of Columbia for one person in the family — $10,830, for two — $14,570, for three — $18,310, or for 4 — $22,050 and so forth). Therefore, a family of four with household income of $88,000 (400 percent of $22,050) would be eligible for a premium tax credit.

The sole proprietor, as she or he can do under current law, can deduct the cost of the health care insurance, on her or his tax return.

Other Taxes

It should be noted that there are two additional tax increases coming that were enacted to help “pay” for health care reform. By their nature, they can have an impact on sole proprietors.

Hospital Insurance Trust Tax

The law increases the Medicare Hospital Insurance (HI) trust portion) of the payroll tax to 2.35 percent from 1.45 percent (i.e. a 0.9 increase) on wages or self-employment income over $200,000 for individual return and $250,000 for a joint return. There is no limit on the amount of wages or self-employment income that is subject to the tax (unlike the social security portion of the FICA tax, which has a wage cap). This is an increase in the employee’s share only.  The employer will continue to pay to its 1.45 percent rate share on the employee’s wages.  In the case of the self-employed, they will pay “only” the additional 0.9 percent. The increase takes effect in 2013.

Unearned Income Medicare Contribution Tax

Since the HI applies only to earned income, the new law establishes a new “Unearned Income Medicare Contribution” (UIMC) tax. This is calculated separately from the HI tax and would apply to “net investment income” which is 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). The rate is 3.8 percent. The UIMC tax on net investment income would not apply if modified adjusted gross income is less than $250,000 in the case of a joint return, or $200,000 in the case of a single return. The UIMC tax takes effect in 2013.

Sole Proprietor as Employer

It should be noted that while the vast majority of sole proprietors are “a business of one,” some sole proprietors do have employees too. If the number of employees were 50 or more then the employer mandate would apply. Very few sole proprietors have that many employees. If a sole proprietor has10 or fewer full-time employees and with average taxable wages of $25,000 or less there is a credit to encourage the business to offer health care insurance to its employees. The self-employed individuals, including partners and sole proprietors, two percent shareholders of an S Corporation, and five percent owners of the employer are not treated as employees for purposes of this credit. There is also a special rule to prevent sole proprietorships from receiving the credit for the owner and their family members.