President Obama signed the Patient Protection and Affordable Care Act (“Patient Protection Act”) and the Health Care and Education Reconciliation Act of 2010 (“Reconciliation Act”) into law on March 23, 2010 and March 30, 2010, respectively. The new legislation introduces revenue raisers that have far reaching tax planning implications, including additional Medicare taxes and codification of the economic substance doctrine.
Starting in 2013, the tax base for Medicare is broadened to include: (i) an additional tax of 0.9% on earned income in excess of $200,000 for individuals and $250,000 for married couples filing jointly, and (ii) a 3.8% “unearned Medicare contribution” tax equal to the lesser of 3.8% of “net investment income” or the excess of modified adjusted gross income over the threshold amount ($250,000 in the case of a joint return, $125,000 in the case of a married individual filing separately, and $200,000 in any other case). These amounts are not indexed for inflation.For transactions entered into after March 30, 2010, the Reconciliation Act codifies the judicial “economic substance doctrine.” As codified, the doctrine provides that transaction is treated as having economic substance only if (i) the transaction changes in a meaningful way (apart from Federal income tax effects) the taxpayer’s economic position, and (ii) the taxpayer has a substantial purpose (apart from Federal income tax effects) for entering into such transaction. Transactions that lack economic substance or fail to meet the requirements of any similar rule of law are subject to strict liability penalties of 20% or 40%, depending on the level of disclosure. In light of the steep penalties, the absence of a reasonable cause exception, and the vagueness of key language in the statute, this provision has generated substantial controversy.