The clock is ticking for millions of uninsured Americans who are grappling with a critical decision: Should they comply with the new federal mandate to purchase health insurance starting Jan. 1, 2014, or pay the tax instead?
The Affordable Care Act requires most people who can afford health insurance to buy coverage -- a provision known as the individual mandate -- or pay a penalty based on their taxable annual income and household size.
"People need to understand that taxes and health care are now connected," said Meg Sutton, senior advisor for tax and health care services at H&R Block. "Every individual and family should consider the personal impact of the Affordable Care Act no matter what decision they make about health insurance."
About 6 million Americans will choose to pay a penalty each year instead of purchasing health insurance, according to estimates from the Congressional Budget Office and the Joint Committee on Taxation.
Marilyn M. Niwao of the National Society of Accountants advises clients to consider their health risks (family history, lifestyle, health status) and financial risks (personal wealth, number of dependents) when determining whether to forego coverage. "It's an important decision that should be made carefully," she said.
Here's what you need to know about the tax penalty and how it works:
Avoiding the penalty
To avoid paying the tax, individuals must purchase health insurance that includes a minimum of 10 essential health benefits – such as hospitalization, maternity care, prescription drugs and more – and covers at least 60 percent of their medical costs. People who have coverage through their employers or are enrolled in government-subsidized health plans such as Medicare, Medicaid, the Children's Health Insurance Program or TRICARE don't need to worry about the tax.
Beginning October 1, millions of uninsured Americans with low and moderate incomes will be eligible for tax credits (to help pay premium costs) and government subsidies (to help pay out-of-pocket expenses) when they purchase health insurance in the new online marketplaces created by the law. In addition, millions of the nation's poorest residents will be newly eligible for Medicaid in the states that have agreed to expand the federal-state health program for people with low incomes, as proposed by the law.
Some exemptions apply
Uninsured individuals with incomes so low they aren't required to file a federal tax return or who can't find coverage that costs less than 8 percent of their income do not face a fine . Others exempt include members of Indian tribes, people whose religion objects to health insurance, undocumented immigrants, Americans living abroad, members of a health care sharing ministry and people in prison.
Flat fee versus percentage of income
The penalty for going without health insurance involves a flat fee or a percentage of taxable income, depending on which is greater. In 2014 the tax begins at $95 per adult and $47.50 per child (up to $285 for a family) or 1 percent of annual income, whichever is greater.
In 2015, the penalty goes to $325 per adult and $162.50 per child (up to $975 for a family) or 2 percent of annual income, whichever is greater. By 2016, the tax is $695 per adult and $347.50 per child (up to $2,085 for a family) or 2.5 percent of annual income, whichever is greater. The tax will be adjusted for inflation beginning 2017.
Experts recommend seeking professional advice because the law comes with many tax complexities, including the penalty formula. The tax is based on the difference between your annual income and the "filing threshold" which refers to the amount you can earn tax free in a year (about $10,000 for an individual and $20,000 for a family, in 2013).