OVERVIEW OF TAX PROVISIONS IN HEALTH CARE REFORM(revised March 21, 2010)
by Jay Starkman, CPA
Health care is undoubtedly the most convoluted bill ever to be passed by Congress. It began on July 9 as a 1,017-page H.R. 3200, America?s Affordable Health Choices Act of 2009. Unable to pass it, the House substituted a 2,016-page Affordable Health Care for America Act, H.R. 3962. The Senate substituted its own 2,076-page version, renaming it the Patient Protection and Affordable Care Act, and used the number of a different House bill, H.R. 3590, but unable to pass it, added an additional 334 pages of amendments at the end of its bill.
Rather than incorporate the changes in the text, these additions modified the preceding sections, making it a total of 2,410 pages. The tax provisions in the two bills should not have been too hard to reconcile into a final bill. Other aspects, however, differed so significantly that just combining their non-conflicting provisions would have resulted in a 3,000-page bill that was far over budget. After losing a majority needed to prevent a filibuster, a conference version reconciling the House and Senate versions was no longer possible. So, the House had to pass the Senate version for the president to sign, together with a new 153-page budget reconciliation amendment, H.R. 4872, The Health Care and Education Affordability Reconciliation Act of 2010, which the Senate will consider shortly.
Complexity in this legislation results from efforts to cover those without health insurance and the high transfer taxes between income classes. The most onerous provisions mandate that everyone must purchase health insurance and define what constitutes health coverage, so that inexpensive bare-bones high deductible policies, or policies that lack prescription drug coverage will not qualify.
Abortion was a lightening rod that had to be diffused to secure passage. There were others, ignored perhaps to make understandable arguments for the public over this complex legislation
The legislation is perhaps comparable to the 1974 ERISA, which granted shared responsibility between the IRS and the Department of Labor over pension plans. Responsibility for carrying out this legislation is shares between the IRS and the Department of Health and Education, together with roles for a host of others.
The legislation declares that "47,000,000 million individuals who are uninsured as of the date of enactment of this Act will have health care coverage once this Act is implemented." [Sec. 7103]
Enforcement is largely given over to the Internal Revenue Code by taxation, advance and refundable credits, penalties and disclosure rules. Contributing toward making this bill truly unwieldly is the failure to include all the tax provisions directly in the Internal Revenue Code, such as Senate Sec. 1411 which imposes penalties. This may have resulted from possible exclusion of the Office of Legislative Counsel in some of the drafting process.
The result of all this is perhaps the most difficult and confusing tax legislation ever to descipher. The reconciliation bill is relete with references to "subparagraph x of subsection y of section z of the Internal Revenue Code of 1986, as added by section A of the Patient Protection and Affordable Care Act and amended by section B of such Act, is amended to read as follows...." One must pull the three widely scattered sections from the 2,563 pages of legislative language (and sometimes the existing Code as well) to construct the final legislative language. That's in addition to reliance on the 2016 pages of the defunct House H.R. 3962 to trace and understand some of the legislative changes.
Therefore I ask readers to indulge me should this analysis of the tax provisions in the epic health care legislation contain omissions or errors. It should be used as an overview, not relied upon as a final guide. All references are to the 2,410-page Senate H.R. 3590, unless otherwise noted.
Qualified health plan defined [Secs. 1301-1302]
At the heart of this legislation is the definition and requirement for individuals to carry health insurance.
Insurance plans that satisfy the bill's requirements must be offered by a certified insurer that is qualified in each state in which the policy is offered. The insurer must offer at least a "gold" and a "silver" policy, among other requirements. (The Senate bill defines five policy levels: catastrophic, bronze, silver, gold and platinum plans. Only certain individuals under age 30 will be allowed to buy the cheap "catastrophic" policy.) Self-insured plans will not satisfy this requirement. Each policy must provide for at least the following benefits:
These essential health benefits must be equal to those provided under a typical employer plan. The government will conduct a survey of employer-sponsored coverage to determine the benefits typically covered by employers to enforce this requirement.
For employer-sponsored plans, the deductible generally cannot exceed $2,000 for a plan covering a single individual and $4,000 for others.
Refundable tax credit providing premium assistance [Sec. 1401]
Refundable tax credits are provided to individuals based on the "premium for an applicable lowest cost silver plan" and varies with income up to 400 percent of the poverty level, depending on marital status and number of dependents. There is no provision limiting these benefits when children are resident in Canada or Mexico, for whom dependent exemptions are allowed under tax treaties with those countries.
Provision is made for this refundable tax credit to be paid as an advance directly to the insurance company, with a corresponding reduction in premium charged to the individual. Should income turn out to exceed 400 percent of the poverty level, repayment will be made upon filing the tax return. When income is below 400 percent, the repayment is limited to $400 ($250 if single). There is a $25,000 per year negligence penalty for falsely claiming the credit; $250,000 if willful [Sec. 1411(h)(1)]. How the government is expected to collect is another matter because the law forbids enforcing these penalties through any levy or lien [Sec. 1411(h)(3)] or through criminal charges [Sec. 1501(b), enacting IRC Sec. 5000A(g)(2)]
"If a taxpayer files a joint return and no credit is allowed under this section with respect to 1 of the spouses by reason of subsection (e), the taxpayer shall be treated as described in clause (ii)(I) unless a deduction is allowed under section 151 for the taxable year with respect to a dependent other than either spouse and subsection (e) does not apply to the dependent."
[Sec. 1401, adding IRC Sec. 36B(b)(3)(B)]
Translation: Buy shares in companies that prepare tax returns.
Reduction in confidentiality of tax return information
The Secretary of Health AND ITS CONTRACTORS and state health exchanges will now have access access to your tax return information [House Sec. 541; Senate Sec. 1414, adding IRC Sec. 6103(l)(21)]. However, an employer is not entitled to any taxpayer information to determine whether the government has made a proper determination of who he has failed to cover when the government imposes a Sec. 4980H penalty upon the employer. [Sec. 1411(f)(2)(B).] The House reconciliation further reduces confidentiality by allowing disclosure to Medicare of suppliers who are delinquent in their tax obligations and seizure of payments owed them [H.R. Sec. 1303, adding IRC Sec. 6103(l)(22)]
Small Employer Credits [House Sec. 521; Senate Sec. 1421]
Employers with no more than 25 employees (excluding seasonal workers) whose average annual wage is under $20,000 may be eligible for a credit of up to 50 percent of employee health insurance premiums. The credit may be applied to the employer's income taxes other than alternative minimum income tax. Self-employed, two-percent owners of S corporations, five-percent owners of C corporations, and close relatives are excluded from this provision. (One can imagine the chilling effect this will have on hiring and wages paid by small business.) This is further complicated by extending the credit to tax-exempt entities against payroll taxes paid. It might be interesting to observe the effect of this provision upon Methodist churches whose ministers are included as employees and Assemblies of God churches whose ministers are excluded as independent contractors.
Requirement to maintain minimum essential coverage. [Sec. 1501]
A self-serving statement, "The individual responsibility requirement...is commercial and economic in nature, and substantially affects interstate commerce...." is the Senate's plea to a court review on finding the law constitutional. "In United States v. South-Eastern Underwriters Association (322 US 533 (1944)), the Supreme Court of the United States ruled that insurance is interstate commerce subject to Federal regulation." [Sec. 1501(a)(3)]
All individuals are required to maintain health insurance beginning in 2013 for themselves and each dependent. This turns dependents into liabilities if income is over 400 percent of the poverty level. Previously, a dependent meant some tax savings. Now it will mean a significant cost of $750 - 2,250 per year (reduced to $695 - 2,085 per year in H.R. 4872), not to exceed 8 percent of an individual's income. There is an exemption from mandatory coverage for those with religious objection, illegal aliens, and incarcerated individuals post-sentencing.
Reporting of health insurance coverage [House Sec. 553; Senate Sec. 1502]
Forget about tax simplification - ever - because everyone will have to file a complex report with Internal Revenue Service. For a preview, see Massachusetts' three-page Schedule HC that must be attached to the annual state income tax return. The instructions are another 10 pages. That requirement passed under signature of Governor Mitt Romney, a Republican, and it's the prototype for this mandate. Expect even more complexity in a federal version because of the refundable and advance tax credits.
Automatic enrollment for employees of large employers [Sec. 1511]
If you employ 200 or more and offer health coverage, you must automatically enroll new full-time employees, subject to any waiting period authorized by law. There are penalties for waiting periods that exceed 30 days.
Employer penalty (Sec. 1513)
The original House [Secs. 413 and 512] version required employers to pay up to 8 percent of wages toward health insurance, with reductions and exception for those with under $750,000 of payroll or risk an 8 percent payroll penalty (with exceptions for small employers). An employer could avoid penalty by contributing 8 percent of the average wages. In effect, the bill would have mandated a minimum 8 percent of wages toward health insurance.
The Senate changed that to a "shared responsibility," imposing a $750 - $3,000 penalty for failure to cover an employee as required, calculated in monthly increments of 1/12 the annual penalty amount.
Prohibition against discrimination on assisted suicide [Senate Sec. 1553]
Lesser-known than the abortion battle: Health care plans may not discriminate against health providers that refuse to participate in assisted suicide, euthanasia, or mercy killing.
Dependent Insurance [Sec. 1001; H.R. 4872 Sec. 1004(d)]
The Senate bill requires health insurers to extend coverage to an adult child until the child turns 26 years old, effective 6 months after enactment [Sec. 1004]. The House reconciliation bill allows an itemized or self-employed health insurance medical expense deduction for insurance paid on account of a child who has not attained age 27.
Medicare Part D [Sec. 3308]
While proponents praise closing the "donut hole" in Medicare prescription coverage, it increases the premium assessed against "high income" individuals, beginning in 2011.
Health Insurance Policy Tax [Sec. 6301]
A $2 tax per individual on each health insurance policy is imposed on health insurance companies and provider of self-insured plan ($1 in 2013).
Malpractice reform [Sec. 6801]
The bill includes a "Sense of the Senate regarding medical malpractice" that encourages states to experiment in alternatives to litigation to resolve malpractice claims. That's all. If they were serious, an appropriation would have been provided to fund state experiments. Startup costs for establishing an alternative costs over $1 million for staffing and supplying a modest alternative to litigation.
Excise tax on high cost employer-sponsored health coverage [Sec. 9001; H.R. 4872 Sec. 1401]
A nondeductible 40 percent tax is imposed on the excess of $8,500 in insurance premium payments or employer reimbursements for an individual or $23,000 for all others, beginning in 2013, increased for cost of living thereafter. The House reconciliation will increase these limits to $10,200 and $27,500, delays the effective date to 2018, and adds a cost exception based on the cost of coverage for certain Blue Cross/Blue Shield health policies. For the 17 highest cost states, these benefit limits are increased to 120 percent in 2013, 110 percent for 2014, and 105 percent for 2015. Failure to properly calculate the 40 percent tax is subject to an additional penalty of 100 percent of the excess (making a total of 140 percent) plus interest. This varying rate for different states may violate the Constitution's uniformity clause.
Inclusion of cost of employer-sponsored health coverage on W-2 [Sec. 9002]
The amount of health coverage payments must be reported on a W-2 starting after 2010. The purpose is unstated. It could be merely for collecting statistics. Or, it could be for the purpose of taxing individuals who receive over the $8,500/$23,000 limit in medical benefits from more than one employer for the 40 percent excise tax on excess medical benefits.
Distributions for medicine qualified only if for prescribed drugs [House Sec. 531; Senate Sec. 9003]
Medical expenses will no longer include over-the-counter drugs, only prescription drugs or insulin, beginning in 2011. This overturns a ruling that medical reimbursement plans and health savings accounts could pay for certain over-the-counter drugs like antacids and allergy drugs with pre-tax dollars.
Penalty on non-medical distributions from Health/Medical Savings Accounts [House Sec. 533; Senate Sec. 9004]
The penalty for Health Savings Accounts and Archer Medical Savings Accounts not used for medical expense is increased to 20 percent (up from 10 and 15 percent, respectively).
Limitation on cafeteria plan health flexible spending arrangements [House Sec. 532; Senate Sec. 9005]
Cafeteria plan contributions for health care will be limited to $2,500 annually, effective 2011.
Expansion of information reporting requirements [House Sec. 553; Senate Sec. 9006]
Forms 1099 will now have to be issued to corporations, effective 2011. How will tax administration be served by filing calendar year Form 1099s to fiscal year corporations, or issuing a 1099 to AT&T or Verizon for business telephone use?
Additional requirements for charitable hospitals [Sec. 9007]
Under present law, a nonprofit hospital must participate in Medicare and Medicaid, and it accounts for 56 percent of hospital care. Health Care adds new requirements. In order to remain tax-exempt, a hospital must:
The Senate bill 10-year cost was scored below $1 trillion through a $100 billion assessment on three industries. Should the Senate require an additional $50 billion of revenue, it could simply increase these non-tax-deductible assessments by 50 percent.
Businesses which manufacture or import branded pharmaceuticals are assessed $2.3 billion annually, as a group, apportioned according to sales beginning January 1, 2009 (retroactive for all of last year). The fee is earmarked for Medicare Part B. [Sec. 9008.] The House reconciliation changes the effective date for calculating the tax base to January 1, 2010, and raises the annual tax to a range of $2.5 - $4.2 billion annually. [H.R. 4872, Sec. 1404.]
Manufacturers and importers of medical devices are assessed $2 billion annually, beginning January 1, 2010, $3 billion after 2017 (as modified by Sec. 10904). The penalty for failure to file the required report is $10,000 plus $1,000 per day of nonfiling, or $10,000 plus the assessment (meaning a doubling of the assessment). [Sec. 9009] The original House bill imposed a straight 2.5 percent tax on the retail price, effective 2013 [House Sec. 552]. Both Senate and House versions were projected to raise similar revenue from medical device taxes. The House reconciliation bill restores the straight percentage, but at a 2.9 percent rate. [H.R. 4872, Sec. 1405.]
Health insurance providers are assessed $6.7 billion annually, beginning no later than September 30, 2010 based on 2009 net premiums and third-party administration fees, excluding long term care or disability insurance (as modified by Sec. 10905). The noncompliance penalty is the same as for medical devices. [Sec. 9010.] The House reconciliation bill delays the implementation date to September 30, 2013 and increases the assessments to a range of $8 - $14.3 billion. [H.R. 4872, Sec. 1406.]
This author knows of only one successful nationwide allocable tax assessment in U.S. history. It was attempted three times under the pre-Sixteenth Amendment "direct taxation." Once in 1798 under legislation signed by President John Adams upon dwelling houses, land, and slaves: a national property tax, apportioned among the states on the basis of population with graduated rates from 2/10 of one percent to a full one percent of value. This tax led to "The Hot Water War" and the Fries Rebellion and produced no revenue. The second time, an annual $20 million assessment on property values at April 1, 1862, apportioned among the states and territories. That effort was hobbled because nearly half the states on the tax roll had seceded. A direct tax was used from 1813 - 1816 to finance the War of 1812. The constitutionality of this direct tax upon an industry appears questionable.
Reduction of itemized deduction for medical expenses [Sec. 9013]
The exclusion for itemized medical expenses is increased to 10 percent (from 7-1/2 percent), beginning in 2013 (2018 for seniors over age 65). Medical expenses will be nondeductible to the extent they are less than 10 percent of income.
Limitation on excessive remuneration paid by certain health insurance providers [Sec. 9014]
The $1 million limit on deductible compensation for the five highest-paid employees of a public corporation is reduced to $500,000 for all employees of health insurance providers, beginning in 2010. It's unclear from the triple-negatives in the legislation whether the "performance-based" exception is still applicable to these employees, which would render the new restriction symbolic with little practical effect.
Tax rate increases [Senate Sec. 9015, as amended by Sec. 10906, as amended by House reconciliation Sec. 1402]
The Senate bill raises the Medicare tax by 0.9 percent (to 2.35 percent, from 1.45) on wages and self-employment income exceeding $200,000 ($250,000 married) beginning in 2013. To the extent this wage tax is not paid by the employer, it will be imposed on the employee, including those holding more than one job. Unlike other self-employment taxes, half of which is tax-deductible, this additional 0.9 percent will be nondeductible. The House reconciliation bill clarifies that the higher rate will be applied on income exceeding $125,000 in the case of married filing separately. [H.R. 4872, Sec. 1402(b)]
In addition, the House reconciliation adds a 3.8 percent Medicare tax on net investment income for married individuals and surviving spouses with modified adjusted gross income exceeding $250,000 married ($200,000 single, $125,000 married filing separately) beginning in 2013. This applies to from interest, dividends, annuities, royalties, rent, capital gains and passive activity income. Excluded are wages, qualified plan distributions, and trade or business income (including capital gains therefrom). [H.R. 4872, Sec. 1402(a)]
The original House bill sought to impose a 5.4 percent surcharge on individuals with modified adjusted gross income (not taxable income) exceeding $500,000 ($1 million for joint or surviving spouse), effective 2011. [House Sec. 551]
New restriction on Blue Cross [Senate Sec. 9016]
Blue Cross/Blue Shield organizations will be required to pay at least 85 percent of total premium revenues toward benefits in order to retain their favorable tax treatment, beginning in 2010.
Tax on indoor tanning services [Senate Sec. 10907]
A 10 percent tax will be imposed on indoor tanning services, effective July 1, 2010. [This replaces Sec. 9017 which would have imposed a 5 percent excise tax on elective cosmetic medical procedures.]
Establishment of simple cafeteria plans for small businesses [Sec. 9022]
One of the few bright spots in this dismal legislation is a new simple cafeteria plan for small business with fewer than 100 employees upon adoption (and may be retained until the employee roll grows to 200), effective 2011.
Expansion of adoption credit and adoption assistance programs [Sec. 10909]
The child adoption credit is increased to $13,170 (from $10,000) and made refundable. The income limitations are only slightly increased for cost-of-living adjustments from the $150,000 - $190,000 phase-out. These provisions apply only for 2010 and 2011.
Suppose a U.S. Citizen lives abroad? [House Sec. 501; Senate Sec. 1501(b)]
Someone who lives abroad is not required to pay a penalty if he lacks health insurance. This section refers to Internal Revenue Code section 911(d). 911(d) says someone must be a "bona-fide foreign resident" (a subjective test open to dispute in many cases) or must be physically present for 330 days out of 12 months (a mechanical test, which people often fail). It's a good standard for determining who qualifies for a $90,000 annual exclusion for foreign earned income, but a lousy standard for determining health care.
International revenue-raising provisions
One proposal reduces the amount of interest and other expenses a U.S. corporation can deduct for carrying a foreign investment, effective 2011 [House Sec. 554]. Another restricts treaty benefits when dealing with a related entity, effective for payments made after date of enactment [House Sec. 555].
Codification of economic substance [House Sec. 562, H.R. 4872, Sec. 1409]
This has been Rep. Lloyd Doggett's (D-TX) pet proposal since the abusive corporate tax shelter scandals of the late 1990s. I served on an AICPA task force in the late 1990s that succeeded in showing Congress that this provision wasn't necessary. The courts handle this matter very well and economic substance was better left alone as a judicial doctrine. It's not in the Senate version. It's resurrected word-for-word in the House reconciliation bill. Congressman Doggett won't give up.
It could have been worse.
New tax penalty standard [House Sec. 563]
The House bill Imposes a high "more likely than not" standard (instead of "reasonable basis") to avoid penalties for any entity with gross receipts in excess of $100 million and publicly traded entities, effective for transactions entered into after date of enactment.
Who are "eligible beneficiaries? [House Sec. 571]
Outside of abortion, this was the most controversial provision that didn't make the news, and didn't survive in the Senate version or re-emerge in the House reconciliation bill. It provides parity for "eligible beneficiaries" without clearly stating who are "eligible beneficiaries." This originated with the 110th Cong. (Jim McDermott's (D-WA) H.R. 1820, and Gordon Smith's (R-OR) S. 1556) intended to allow gay domestic partners to receive employer health benefits for their partner without incurring income tax liability because it's not for a spouse.
Conservative groups opposed to gay marriage were fighting against this amendment. McDermott and the Washington-based Human Rights Campaign, which advocates on behalf of lesbian, gay, bisexual, and transgenders, planned to fight for preserving the amendment in the House-Senate conference. It doesn't just affect gays, as unmarried couples living together may also be eligible for these benefits. However, its passage will complicate tax administration at IRS. It will also be a first step toward additional legislation that would permit parity for retirement, gift, estate, and finally filing of joint tax returns.
A parallel provision in the House bill would have allowed a self-employed health insurance deduction made on account of a domestic partner. The Joint Committee on Taxation technical explanation of the House bill provides an eggshell description that obfuscates the controversy by not mentioning gays or domestic partners. Proponents hope that nondiscrimination rules would require employers who extend benefits to spouses, to also provide them to domestic partners. This provision will resurface.
Bankruptcy and financial security
"Half of all personal bankruptcies are caused in part by medical expenses. By significantly increasing health insurance coverage, the requirement, together with the other provisions of this Act, will improve financial security for families." [Sec. 1501(a)(2)(E)] It's not that simplistic. Individuals file for bankruptcy because they cannot afford a 20 percent co-pay for catastrophic illness, and uninsured individuals are charged much much more than the negotiated rates required of insured patients or a Medicare diagnostic-related group payment. Furthermore treating the health mandate as a tax moves penalties for failure to purchase health insurance to the 3-years from the original filing date or 2-years from the late-filing date, making the discharge via bankruptcy for individuals and businesses that cannot pay for health insurance much more difficult.
There's no mention of independent contractor in either bill. However, the 8 percent penalty for failure to provide health benefits to independent contractors reclassified as employees and the $25,000/$250,000 penalties for negligence and willful failure substantially increase the risk in this very gray area of law.
How Does This Compare to HillaryCare?
The 1993 health insurance proposals considered health insurance a labor-related mandate, like minimum wage. It proposed establishment of regional alliances or corporate alliances to collected premiums required by national health insurance. IRS was left out of the enforcement equation.
New taxes were proposed on tobacco (with alcohol and amunition under consideration). Every 2 percent shareholder in a service-related S corporation would have his pro-rata share of income subject to self-employment tax. Medicare coverage (and tax) would have extended to all state and local government employees. IRS would have been authorized to issue legislative regulations defining who is an employee, free of interference from prior rulings and common law.
Charitable organizations rendering health care would annually have been required to assess health care needs of their communities and to develop a plan to meet those needs in order to maintain their tax-exempt status. Medical schools would have been required to restrict access to graduate medical education.
The House reconciliation bill,the Health Care and Education Affordability Reconciliation Act of 2010" (H.R. 4872) now goes to the Senate for consideration where Republicans have promised Majority Leader Harry Reid a circus. The tactic is well-known as a senator once declared, "I will do everything within my power, as will Sen. Bryan, to stop this tax. I will become the most negative, the most irresponsible, the most obnoxious person ever known in the United States Senate." [Sen. Harry Reid, opposing a proposed federal excise tax on gambling establishments to raise revenues to pay for welfare reform. Daily Tax Report, March 25, 1994.]