July 13, 2020
The U.S. Supreme Court has recently announced it will hear a case that challenges the constitutionality of the individual mandate under the Affordable Care Act (ACA). The Supreme Court will hear the case during the Fall of 2020 and is expected to render a decision during the first part of 2021. One potential outcome to consider: If the ACA is found to be unconstitutional in its entirety, income taxes established under the ACA may effectively be repealed.
Taxes created under the ACA include the net investment income tax (NIIT) and the .9% Additional Medicare Tax. Under the NIIT, investment income of individuals, trusts, and estates over specific thresholds (for example, over $200,000 for single/$250,000 married filing jointly) are taxed at an incremental rate of 3.8%. The .9% Additional Medicare Tax applies to individual wages, compensation, and self-employment income over specific thresholds based on filing status. Therefore, if the ACA is found to be unconstitutional in its entirety, the NIIT and .9% Additional Medicare Tax could be impacted. Taxpayers who paid a substantial amount of NIIT and/or the .9% Additional Medicare Tax in 2016 and 2017 may consider filing a protective claim for these years to protect a potential refund.
In 2012, the Supreme Court found the individual mandate to be constitutional as a function of Congress’ taxing power. In 2017, Congress reduced the penalty for those who did not meet the individual mandate to zero as part of tax reform legislation, and this change was effective 2019. This is the subject of the current case challenging the constitutionality of the individual mandate. In December 2019, The U.S. Court of Appeals for the Fifth Circuit concluded the individual mandate is unconstitutional, but the Court did not conclude whether the individual mandate is severable from the rest of ACA. If the Supreme Court agrees that the individual mandate is unconstitutional, the Supreme Court will need to consider whether this provision is severable from the rest of ACA, if it renders additional provisions unconstitutional (potentially all of ACA), or it could remand the case to a lower court for fuller development of the severability issue.
Given the options for the Supreme Court to consider, there are a range of potential outcomes, and the likelihood the Supreme Court will conclude that the ACA is unconstitutional in its entirety is hard to predict. Furthermore, given that the current challenge to the ACA is based on 2017 tax reform legislation that was effective in 2019, assuming the ACA is determined to be unconstitutional, it’s hard to predict which years the NIIT and .9% Additional Medicare Tax would be deemed invalidated. For example, would this be retroactive to 2019 only? Or to earlier years?
The statute of limitations for 2016 returns is July 15, 2020. Taxpayers who paid significant NIIT and .9% Additional Medicare tax during 2016 may want to file a protective claim in order to protect a potential refund. As the statute of limitations on 2017 returns that were timely filed and not extended would potentially expire before the expected Supreme Court decision in the first half of 2021, taxpayers who paid a significant NIIT and 0.9% Additional Medicare Tax during 2017 may want to consider filing a protective claim as well.
A protective claim must be in writing and signed, include taxpayer identifying information, identify and describe the contingencies affecting the claim, clearly alert the IRS to the essential nature of the claim and identify the specific year(s) for which the refund is sought. Note that filing a protective claim would keep other potential issues on the return open, but only for the purpose of determining the final liability with respect to the refund claim.
In summary, the potential outcome that both the U.S. Supreme Court will conclude the ACA is unconstitutional in its entirety in this upcoming Fall case and that the NIIT and .9% Additional Medicare Taxes would be invalidated as far back as 2016 under such a conclusion is hard to predict. Taxpayers who paid a substantial amount of NIIT and .9% Additional Medicare Tax during 2016 and 2017 may want to incur the time and cost of filing a protective claim for these years to protect a potential refund even if these outcomes are considered remote. Please contact us for questions or assistance regarding this matter.
Abeles and Hoffman, P.C.