What are the impacts of the ACA?

The next question I received could take me years of blogs to explain, which makes sense since it is about a piece of legislation that is longer than the novel War and Peace. The question is “what are the impacts of the Affordable Care Act?” There are hundreds of impacts, but I am going to focus on two; one that affects individuals and is very misunderstood and one that affects companies and is not really discussed.

The individual mandate to buy insurance is well known, but the tax (that is what the Supreme Court said it was and who am I to argue) for not buying insurance is very misunderstood. The press and talk shows focus on the minimum payment for not buying insurance. In 2014 that will be $95. In 2015 it increases to over $325. The problem is that is where most people stop talking, but that is not what the law says. The law says that the minimum tax for not buying insurance in 2014 is the greater of $95 or 1% of an individual’s AGI. As most CPAs are good at math I assume you can easily figure out that once an individual’s AGI exceeds $9,500, they will no longer be paying $95, but instead 1% of their AGI. Most people who file and pay taxes make significantly more than $9,500. Looking at an income of $35,000 which is around the average reported, the tax would be $350. Those who want to argue that $95 is not enough of a tax to get people to pay several hundred dollars a month in premiums can probably make the same point with a $350 payment, but that is not the point. The point is that there are a lot of people out there that have not bought insurance and are thinking they will just have to pay (or receive a reduced refund of) $95 who will be negatively surprised when the bill is a lot higher next April 15. And the percentage doubles in 2015 to 2% which drives that tax to $700. People will be feeling that tax hit just as the presidential primaries are getting into full swing in 2016. That will make for some interesting political discussions.

The impact to companies is being felt by employees all over the country right now, but they may not have realized it. All self-insured companies have to pay a $63 per “covered life” (if the company covers their employee, spouse and 2 children, they have to pay 4*$63 or $252). The fee is called the “transitional reinsurance fee” and is over $5 per month per covered life. So if you are single and your monthly contributions went up this year, $5 of that increase is going straight to the government as a stealth tax on you. If you cover your family of 4 then it is over $20 a month. If you are thinking, well only big companies are self-insured and they can afford it, you are wrong; not on the “afford it” part which can be debated, but because all insurance companies must pay the fee too. If you think the insurance companies will just eat the cost you don’t understand how they work. Insurance companies raised their premium rates to cover the fee, so that increase in your contributions driven by higher insurance premiums is, at least in part, going straight to the government. The problem is this fee really hasn’t been talked about so everyone just assumes it is the big companies and insurers sticking it to the little guy when it is really your friend and ally, the Federal government.

That is all I have space to talk about for now, but if there is a specific part of the Affordable Care Act you would like me to discuss, just send your question into Ask Bill and I will try to address it.

Ask Bill about Stock Options

The first question I received was:

My daughter just accepted a position at a high-tech company. The offer for employment included 2,000 stock options as well as an annual salary. Just how do stock options work, and how could the options affect her time with the company?

First let’s talk about how they work from the recipient’s point of view.

A stock option is a right to buy a share of stock at a specified price at some future date or range of dates. While you can also buy and sell options on the open market, the terms of employee stock options are usually different from those you can buy on the open market. Generally there are three critical factors in a stock option offer.

  1. How long before the option can be exercised? That is, how long before the holder can actually use the option? This period is called the vesting period and can vary greatly by company from less than 1 year to as many as 5 years. Generally, if the employee leaves before the vesting period is completed, the employee forfeits all of the options (they get nothing).
  2. What is the exercise price of the option? That is, what is the price they must pay to buy the share of stock the option entitles the holder to purchase? Often employee stock options have an exercise price equal to the stock price on the date the option was granted, but options can also have exercise prices above the grant date stock price or below the grant date stock price.
  3. How long before the option expires? That is, when does the employee no longer have the right to buy a share of stock at the option price? This varies by company as well, but often you see exercise periods of 5 to 10 years. Almost always the exercise period is several years longer than the vesting period discussed on number 1 above.

The basic point of an option is for the employee to share in the benefits if the stock price (and therefore value) of the company increases. The idea is that by sharing in that increase in value, the employee will be incented to help the company increase its value and therefore benefit the stockholders of the company. If the exercise price of the option is $30 and after a period of time, the stock price is $40, then your daughter can exercise the option, buy the share for $30 and turn around and sell the share of stock for $40 and make $10. On the other hand if the stock price is $20, then the option is essentially worthless because no one would pay $30 for a share of stock they could simply go out on the market and buy for $20. And that is the issue with stock options as compensation. They are great and do an excellent job of retaining employees because no one wants to leave if the stock price goes up, but they are lousy and have no retention benefit at all to the company if the stock price goes down.

When it comes to actually exercising options, many employees don’t have thousands of dollars sitting around to buy the shares (per the example above 2,000 shares at $30 per share would cost $60,000) before they turn around and sell them, so companies often set up “cash-less” exercise programs. These programs essentially allow the employee to exercise the options and get paid the difference between the exercise price and the current stock price. In the example above, with an exercise price of $30 and a stock price of $40, if she exercised all 2,000 options in such a program she would receive $20,000 (the difference between the current value of the stock $40 * 2,000 shares and the payment she would have to make to buy the stock $30 * 2,000 shares). Of course she would have to pay income tax on the $20,000 and almost all cash-less exercise programs include automatic withholding of taxes so she would only get the after tax amount, not the full $20,000.

There are many financial and tax planning opportunities around options. Should you exercise the option as soon as it vests or wait for it to continue to go up in value until the very last day it can be exercised? Of course it can also go down in value (remember the stock market crash of 2008). Should you actually buy the stock rather than take advantage of the cash-less exercise program and then hold onto the stock for a period of time in an effort to turn some of the taxable income into capital gains income rather than ordinary income (which is generally taxed at a higher rate than capital gains in today’s tax rules)? Of course, if you don’t have $60,000 sitting around, this may be a moot point.

2,000 options is probably not enough to get really serious and seek expert financial advice on what to do, but if she continues to move up in the company and is granted additional options that become worth a considerable sum of money, she should seek out advice from an expert such as a CPA or a CPA-PFS (a Personal Financial Specialist credential offered only to CPAs) to help her work through the financial and tax planning aspects of the options.

Next week I will talk about how options work from the company’s point of view.

Your Turn

Over the last five years I have chosen the topics for discussion in my blog. The topics have ranged far and wide:

  • AICPA Council, Board, Task Force and Conference updates
  • The CGMA and what it means to you as a professional
  • Supervising and evaluating staff
  • Accounting standards and the FASB & IASB
  • Financial Literacy
  • Risk Management and Internal Controls
  • Ethics
  • Becoming a CPA
  • And more!

But now it is your turn. In conjunction with the TSCPA I am going to discuss the topics and answer the questions you choose over the next several blogs. You can submit questions through the TSCPA Business & Industry Center on LinkedIn here or you can submit your questions to Rori Shaw on the TSCPA staff at rshaw@tscpa.net. So send in those questions or I’ll keep deciding what to write about.