U.S. Health Care Reform Taxation
The Democratic drive in 2009 to reform U.S. health care began with the 2008 presidential campaign. Upon his election, President Obama vowed to make available a new national health plan for all Americans, including the self-employed and small businesses, which would provide affordable health coverage similar to the plan available to members of Congress. From a financial perspective, the objective of the Obama administration and House and Senate Democratic leadership is for any government health care funding to be budget-neutral, which means government funds will be found via new revenues or cost-cutting measures in order to pay for services.
- This Alert briefly summarizes selected taxation and related elements of HR 3962 adopted by the House of Representatives on November 7, 2009, and of the Senate bill as amended through December 19 and adopted by the Senate on December 24, 2009.
- To put the taxation provisions in a larger context, we also summarize briefly the overall structure of each bill.
- Reconciliation of the House and Senate versions is moving to a Conference Committee, followed by reconsideration of the reconciled bill by both houses of Congress and, if passed by both by simple majority votes, Presidential action on the law.
Frank, Rimerman + Co. LLP will be releasing future summaries of selected taxation and other provisions of pending health care legislation as it continues to evolve in both the House and the Senate, and as additional details become known.
Key Tax Provisions of the House Bill
To help pay for expanded federal health care coverage, the House bill – in addition to providing for major cuts in Medicare payments – imposes a number of levies, including the following:
- Effective from 2011, an additional tax of 5.4% on individuals, trusts and estates with so-called “modified adjusted gross income” of more than $1 million per year. For married persons filing separately, the threshold is $500,000. The additional tax applies to amounts in excess of the threshold. “Modified adjusted gross income” is adjusted gross income less allowable investment interest expense. This additional tax also applies to capital gains, which are included in adjusted gross income. Thus, after 2010 when the federal tax rate on capital gains is scheduled to increase to 20%, the total capital gains tax rate will be 25.4% where capital gains are included in the amounts above the threshold.
- For employers which fail to contribute for each full-time employee at least 72.5% of singles’ and 65% of families’ premium costs of health care insurance, a tax of 2%-6% of payrolls for employers with payrolls of $500,000-$750,000 per year and a tax of 8% for larger employers.
- For individuals who don’t have health care insurance paid through their employers or by themselves, a penalty of up to 2.5% of their income.
The House bill, however, provides a tax credit, beginning after 2012, for the first two years during which a business with 10 or fewer employees with average wages of $20,000 or less offers qualified health coverage to its employees. The credit is phased-out for employers with greater than 25 employees and wages of more than $40,000.
The House bill also contains non-health care tax provisions intended to help pay for health care reform, such as the following:
- Repealing a liberalized rule for allocating interest expense between U.S. and foreign source income for purposes of computing a taxpayer’s foreign tax credit limitation.
- Limiting tax treaty benefits with respect to U.S. withholding payments for certain related-party payments.
- Codifying the economic substance doctrine defining certain factors that must be met in order for a transaction to be respected for tax purposes.
- Requiring corporations with more than $100 million in gross receipts to meet the “more likely than not” standard on tax positions they take, in order to avoid penalties for tax underpayments.
- Requiring information reporting on Form 1099 for payments made to corporations.
Overall Structure of the House Bill
In addition to the new surtax on income and other taxes and penalties listed above, the House bill provides significant health care reforms that the Obama administration sought, with the goal of providing affordable and quality care for approximately 30 million Americans who do not have health care coverage.
First, under the bill’s so-called “public option” plans, doctors, hospitals and other medical professionals will be reimbursed at individually or regionally negotiated rates. Drug prices for Medicare recipients will be negotiated by the Health and Human Services Secretary.
Second, private insurers will be required to accept all applicants, may not charge higher premiums because an individual becomes ill, are prohibited from using pre-existing medical conditions to limit or disallow coverage, and must allow children to remain on parents’ insurance through age 26.
The Congressional Budget Office (CBO) estimates the House bill will result in 18 million people remaining uninsured in 2019, including about six million illegal immigrants. However, the CBO also estimates 96% of the U.S. eligible population will have health insurance coverage under the House bill. Other economists and analysts anticipate that costs of employer-sponsored insurance will be lowered when private insurers are forced to compete with the government plans.
The House bill provides four levels of Medicare-like government plans to be offered to all U.S. citizens and legal residents, without regard to pre-existing medical conditions: basic, enhanced, premium and premium-plus. The basic government plan must provide benefits comparable to those offered by most employer-based plans in the same region. The four government plan levels are differentiated by services covered and costs to participants. Key to the legislation is that Americans may opt to keep their present health care insurance or to join one of the government plans.
All Americans will be required to obtain some form of health care insurance coverage. As the new government plans are initially implemented, Americans without health care insurance coverage and those purchasing their own coverage will be given highest priority to enroll. Subsidies to help pay for the costs of government plans will be given on a sliding scale to individuals and families with annual incomes between 133% to 400% of poverty level. Those earning less than 133% will be eligible for Medicaid coverage.
Under the government plans, doctors and other medical professionals will be reimbursed at the same rates used for Medicare reimbursements. Hospitals will be reimbursed at Medicare rates plus 5%. It’s widely expected that doctors and hospitals that currently provide Medicare services will also opt to provide government health care plan services.
Key Tax Provisions of the Senate Bill
To help pay for expanded federal health care coverage, the Senate bill – in addition to providing, like the House bill, for major cuts in Medicare payments – adds or increases levies in several ways, including the following:
- New taxes totaling $6.7 billion per year on insurers (except Medicare supplement insurers not providing major medical plans), medical device makers (initially $2 billion of the total tax and rising to $3 billion per year in 2018), pharmaceutical manufacturers and others. However, nonprofit insurers meeting certain qualifications are exempt.
- An excise tax on insurers equal to 40% of the portion of health benefit policies valued at more than $23,000 per year for family coverage or $8,500 for single coverage. While the tax is on insurers, it can be expected to be passed on to insureds via higher premiums for such policies. However, such policies offered to, e.g., dock workers and other special groups, or offered in the 17 states with highest health care costs, are not subject to this tax.
- A Medicare payroll tax increase of 0.9% (from the current 1.45% to 2.35%) for individuals earning more than $200,000 per year or couples earning more than $250,000 per year. This increase applies to the employee’s portion of the tax and to self-employed individuals.
- A 10% tax on customers of indoor tanning salons.
- For employers with more than 50 employees which fail to provide specified health care insurance, a penalty of up to $750 per year for each uncovered employee who obtains federal subsidies for such insurance under other provisions of the bill.
- For individuals who don’t have health care insurance paid through their employers or by themselves, a penalty of up to $750 per year for individuals and up to $2,250 for families.
- An increase in the current floor of 7.5% of adjusted gross income, above which medical expenses can be taken as an itemized deduction, to 10% of adjusted gross income.
The amended Senate bill, however, also provides expanded tax credits to buy health coverage for employers with 25 or fewer workers with average wages of $50,000 per year or less.
Like the House bill, the Senate bill adds a requirement of information reporting for payments to corporations as a general revenue raiser to help pay for health care reform.
Overall Structure of the Senate Bill
First, the Senate bill requires most Americans to have health care insurance, adds 15 million people to the Medicaid rolls, and subsidizes private coverage for low- and middle-income individuals. The CBO estimates the cost to the government at $871 billion over 10 years, somewhat less than its estimated cost of the House bill. The CBO also estimates that the Senate bill will provide coverage to 31 million currently uninsured individuals and still leave 23 million uninsured in 2019 (with one-third of those remaining uninsured being illegal immigrants).
Second, the bill establishes stringent federal standards for an industry that, since its inception, has been regulated mainly by the states. Under the bill, insurers cannot deny coverage because of an individual’s medical condition; cannot charge higher premiums because of an individual’s gender or health status; and cannot rescind coverage when an individual becomes sick or disabled. The government will, in effect, limit the profits of insurers by requiring them to spend at least 80 to 85 cents of every premium dollar on medical care. The bill also requires insurers to issue a summary of benefits that is in a printed format and readable by consumers.
Costs of the bill will, according to the CBO, be more than offset by new taxes and fees and by savings in Medicare. Similarly to the House bill, the Senate measure proposes to squeeze nearly a half-trillion dollars from Medicare over the next 10 years, mainly by reducing the growth of payments to hospitals, nursing homes, private Medicare Advantage plans and other health care providers.
To help pay for expanded federal health care benefits, both the House and Senate bills look in part to large reductions in Medicare spending. However, the approaches in the House and Senate bills to generate further revenue for such benefits are broadly different – the House bill looks in good part to increases in the highest marginal rates of income tax, while the Senate bill looks in good part to taxes on insurers and medical products manufacturers which in turn are likely to be passed on to consumers.
One question that both bills raise is whether there is legal authority to impose a penalty (whether or not called a tax) for the failure of an individual to purchase insurance – i.e., whether Congress’s power to regulate individuals’ economic activity includes the power to require that they engage in such activity. (For example, while many U.S. states require individuals to purchase motor vehicle insurance in order to be permitted to operate a vehicle, their authority to do so may be seen as part of powers generally left to the states, but the federal government generally is thought to have only specific powers expressly granted to it in the Constitution; moreover, such a state requirement is a condition to obtaining a license, rather than an absolute requirement to purchase insurance).
Another question raised by the Senate bill is whether exemptions of certain states from higher health care funding obligations – widely perceived as being included to obtain a total of 60 Senators’ votes in favor of the bill – are permissible within Congressional authority to provide for the general (as opposed to specific states’) welfare, and whether these may be dropped or amended in the reconciliation process because Senate passage of a reconciled bill will require only a simple majority of 51 Senators.
Earlier Republican and other legislative proposals focused on, e.g., providing vouchers of $2,000-$5,000 directly to individuals and families without employer-based health care insurance, eliminating state law restrictions on provision of health care insurance across state lines for greater competition among private insurers, and other less sweeping regulatory and tax changes. However, passage of the current bills seems likely to preempt these other approaches.
Please contact Frank, Rimerman + Co. LLP partner Nancy Moriarty with questions or comments.
Any tax advice in this communication is not intended or written by Frank, Rimerman + Co. LLP to be used, and cannot be used, by a client or any other person or entity for the purpose of (i) avoiding penalties that may be imposed on any taxpayer or (ii) promoting, marketing, or recommending to another party any matters addressed herein. With this alert, Frank, Rimerman + Co. LLP is not rendering any specific advice to the reader.