US Tax: Merged House health care bill retains high-income surcharge
As expected, the chief revenue raiser in the Affordable Health Care for America Act is a modified version of a surcharge on high-income individuals that was approved by the House Ways and Means Committee in July. The bill also retains Ways and Means-approved revenue raisers that would codify the economic substance doctrine, impose a limitation on treaty benefits for deductible related-party payments, and delay the effective date of the worldwide interest allocation election.
But the combined bill also includes a number of new revenue offsets – such as an excise tax on medical device manufacturers, restrictions on certain health-related employee savings plans, and expanded information reporting requirements – that echo some of the provisions in health care legislation approved by the Senate Finance Committee earlier this month.
The Congressional Budget Office sets the total cost of the bill at $894 billion over 10 years. A preliminary estimate from Joint Committee on Taxation (JCT) staff projects that the bill's proposed revenue offsets would raise a combined $557.5 billion over 10 years.
At her press conference to introduce the bill, Pelosi said she is confident that there is enough support for passage in the House. However, Democratic leaders will still need to brace for a tough fight in that chamber, as disagreements over largely nontax issues continue. The debate over the inclusion of a public option, in particular, has divided the Democratic Caucus and underscores the fact that a majority vote is not guaranteed.
Surcharge on high-income taxpayers
The bill would apply a 5.4 percent surcharge on joint-filing taxpayers with a modified adjusted gross income (AGI) above $1 million ($500,000 for all other taxpayers). These thresholds are not adjusted for inflation. For taxpayers living abroad, the threshold amount would be decreased by the excess of the amounts excluded from gross income under section 911 over the amount of any deductions or exclusions disallowed under section 911(d)(6). Additionally, taxpayers could not claim foreign tax credits, alternative minimum tax credits, or other credits against the surcharge. The provision would be effective for taxable years beginning after December 31, 2010. The JCT estimates the provision would raise $460.5 billion over 10 years.
A Deloitte Tax analysis illustrates the effect of the surcharge. A single taxpayer with household income of $800,000 could expect an increase of $16,200 attributable to the surcharge. A married couple with equal income would see no increase.
In some cases at higher income levels, the surcharge would amount to an increase larger than what could be expected by raising the top tax brackets to 36 and 39.6 percent, as proposed by the Obama administration. Compared to the results under earlier surcharge proposals, singles with household income between $500,000 and $800,000 would pay substantially more under the latest iteration because the full 5.4 percent surcharge would apply at a much lower AGI threshold. Conversely, joint filers with AGI between $500,000 and $1 million would owe no surcharge. Under the original Ways and Means proposal, they would have been subject to a 1.5 percent surcharge.
Had the surcharge applied in 2007, it would have been paid by about 0.3 percent of taxpayers. These taxpayers paid about 36 percent of federal income taxes that year.
Economic substance codification & other business revenue raisers
Another significant revenue raiser in the bill would codify the economic substance doctrine. Over the years, House and Senate taxwriters have included similar measures in a number of bills and President Obama included a codification proposal in his fiscal 2010 budget.
Like the other proposals, the provision in the House bill would mandate a conjunctive analysis of economic substance under which taxpayers would have to show that a transaction (1) changed their economic position in a meaningful way apart from the federal tax effects and (2) had a substantial nonfederal tax business purpose.
A 40 percent strict liability penalty would apply to tax understatements attributable to undisclosed noneconomic substance transactions. The penalty would be 20 percent if a transaction is adequately disclosed. In addition, this proposal, unlike its predecessors, provides that noneconomic substance transactions are deemed to lack reasonable basis for purposes of the penalty under section 6676 for erroneous claims for refunds or credits, thereby subjecting taxpayers to an additional 20 percent penalty on these transactions. Recent changes to the economic substance proposals approved by the Senate Finance Committee that would have required the IRS Office of Chief Counsel to assert and compromise the noneconomic substance penalty are not included in this proposal.
Finally, the bill would make substantial modifications to how the accuracy-related penalty provisions would apply to (1) corporations with gross receipts in excess of $100 million and (2) persons who are required to file periodic or other reports under section 13 of the Securities Exchange Act of 1934 (such as persons that acquire more than 5 percent of certain classes of securities). Relief under the section 6664 reasonable cause exception would no longer be available to these taxpayers and a substantial understatement would not be reduced unless the taxpayer establishes that it had a reasonable belief that its tax treatment of an item was more likely than not the proper treatment. Under current law, the understatement would be reduced if the transaction was disclosed, there was substantial authority for tax treatment of the item, and there is a reasonable basis for the treatment.
These provisions would be effective for transactions entered into after the date of enactment. The JCT staff estimates the provisions would raise $5.7 billion over 10 years.
Expansion of information reporting requirements – Businesses would be required to file a Form 1099 to report payments made to a corporation totaling $600 or more in a calendar year, effective for payments made after December 31, 2011. (JCT 10-year revenue estimate: $17.1 billion.)
Delay in application of worldwide interest allocation election – The bill would further delay the effective date of the worldwide interest allocation election (through 2019). Under current law, businesses would be eligible to make the election for taxable years beginning after 2010. (JCT 10-year revenue estimate: $26.1 billion.)
Limitation on treaty benefits for certain deductible payments – The bill retains a provision from the Ways and Means Committee bill that would prevent foreign multinationals from "treaty shopping" to avoid tax on income earned in the United States by having a U.S. subsidiary make a deductible payment to a country with which the United States has a tax treaty with reduced withholding rates before repatriating the earnings in the parent's country.
The provision would limit treaty benefits on payments that are:
- Deductible for U.S. federal income tax purposes;
- Made by a U.S. corporation that is controlled by a foreign parent; and
- Made to a recipient that is also controlled by the same foreign parent.
A reduced withholding rate would not be available for those payments unless the foreign parent would have qualified for a reduced rate on a direct payment. The provision would be effective for payments made after the date of enactment. (JCT 10-year revenue estimate: $7.5 billion.)
Health care-related tax provisions
The bill also includes several health care-related revenue offsets similar to those in the health care reform legislation approved to the Senate Finance Committee on October 13.
Excise tax on medical device manufacturers – A 2.5 percent excise tax would be imposed on the first taxable sale of any medical device. "First taxable sale" would be defined as the first sale, and would not include resale, after production, manufacture, or importation. The tax would not apply to exports or retail sales. The provision would be effective for sales after December 31, 2012. (JCT 10-year revenue estimate: $20 billion.)
The Senate Finance Committee-approved bill would impose an annual fee of $4 billion a year on medical device manufacturers, apportioned to individual taxpayers based on their market share.
Limit on FSA contributions – The bill would impose a limit of $2,500 per taxable year on employee salary reductions for coverage under a cafeteria plan flexible spending arrangement (FSA). The dollar amount would be increased by Consumer Price Index for Urban Consumers for calendar years beginning after December 31, 2012. The provision would be made effective for years beginning after December 31, 2010. It would not apply to health reimbursement arrangements (HRAs). (JCT 10-year revenue estimate: $13.3 billion.)
Higher penalties for ineligible HSA withdrawals – The current-law penalty of 10 percent on withdrawals from health savings accounts (HSAs) not used for qualified medical expenses would be increased to 20 percent for ineligible withdrawals, effective for disbursements made during tax years starting after December 31, 2012. (JCT 10-year revenue estimate: $1.3 billion.)
Definition of qualified medical expenses – The bill would eliminate nontaxable reimbursements of over-the-counter medications from HSAs, HRAs, and health FSAs. It provides that only prescribed medicines or drugs, or insulin would qualify for nontaxable reimbursements from those accounts. This change conforms the definition of medical expenses for employer-provided health coverage to the definition for the itemized deduction. It would apply to expenses incurred after December 31, 2010. (JCT 10-year revenue estimate: $5 billion.)
Deduction for subsidies for retiree drug benefits – The bill would reduce the deduction for retiree prescription drug expenses by the current excluded subsidy given to employers who provide prescription drug plans for their retirees eligible for Medicare Part D. This would be effective for taxable years beginning after December 31, 2010. (JCT 10-year revenue estimate: $3 billion.)
Employer and individual mandates
Employers who do not meet health coverage participation requirements for employees would be required to pay an excise tax of $100 per employee for each day of noncompliance. The tax would not apply if the failure was not discovered exercising reasonable diligence, or the failure was corrected within 30 days. In the case of failures due to reasonable cause, there is an overall limitation equal to the lesser of 10 percent of the aggregate amount paid by the employer during the preceding taxable year for group health plans or $500,000.
Employers electing not to provide health benefits would be subject to an excise tax of 8 percent of their payroll. Under special rules for small employers, the tax would range from 0 to 6 percent, depending on the size of the employer's annual payroll for the preceding calendar year. The threshold would begin at $500,000 and increase to $750,000, at which point the full 8 percent excise tax would then apply. The provisions would be effective for taxable years beginning after December 31, 2012.
Credit for small business employee health coverage expenses – To subsidize the cost of insurance offered to employees, the bill would provide small businesses a tax credit that would be treated as part of the general business credit and based on a percentage of the qualified employee health coverage expenses during the year. The credit would be equal to 50 percent of the amount paid for employee health coverage. Credits would be phased out based on the magnitude of employee compensation and number of employees. The employer would be allowed a deduction under section 162 for health coverage expenses equal to total health care coverage expenses minus the dollar amount of the credit. No credit would be allowed with respect to highly compensated employees. For partnerships and self-employed individuals, a partner or an individual carrying on a trade or business would be treated as an employee. The provision would be effective for taxable years beginning after December 31, 2012.
Individual mandate – Individuals who do not maintain a required level of coverage at any time during the taxable year would be subject to a 2.5 percent tax on their adjusted gross income. The tax would be capped at the cost of the national average premium health insurance plan. Individuals providing only for themselves would pay no more than the national average for the self-only, basic plan in the health insurance exchange, while those required to provide family coverage would be subject to an annual tax not to exceed the basic plan's family coverage. Taxpayers would be required to obtain coverage for themselves and any dependants. The Treasury would be authorized to promulgate regulations to allow for a hardship exemption. Acceptable coverage includes: grandfathered individual and employer-provided plans, certain
government coverage (Medicare, Medicaid, veterans and active duty benefits, and benefits for members of Indian tribes), and coverage obtained through the exchange.
The bill also would require taxpayers to report on their tax returns any coverage obtained for themselves or other individuals. The taxpayer must provide the name, address, and taxpayer identification number for each person for whom insurance is obtained, and must indicate the period of coverage. The provision would be effective for taxable years beginning after December 31, 2012.
Other revenue provisions
The bill contains a number of minor revenue-raising and disclosure provisions that would:
- Allow the Secretary of the Treasury to disclose to the Health Choices Administration (a newly established independent agency in the executive branch operating a health insurance exchange) or the head of an approved state-based health insurance exchange, certain taxpayer return information relevant to determining any affordability credit;
- Provide that coverage purchased through the exchange may not be purchased on a pre‐tax salary reduction basis unless the purchaser's employer is eligible to offer employer coverage through the exchange;
- Provide that subsidies received by an employer or health plan under section 111 of the bill are not includable in gross income;
- Treat the Community Living Assistance Support and Services Act (CLASS) Program (a new voluntary, public longterm care insurance program proposed in the bill) in same manner as private long‐term care insurance;
- Exclude from gross income medical care provided for Indians;
- Extend the exclusion for employer-provided health coverage to a person who is eligible for coverage under the employer's plan and who is not a spouse or dependent;
- Permit disclosures to facilitate identification of individuals likely to be ineligible for the low-income assistance under the Medicare prescription drug program to assist the Social Security Administration's outreach to eligible individuals;
- Provide for a comparative effectiveness research trust fund to be implemented through the Internal Revenue Code, and funded by a fee imposed on private insurance plans according to the number of enrollees; and
- Impose fees on applicable self-insured health plans.
Next Stop: House Floor
Leaders in the House have pledged that text of the Affordable Health Care for America Act released today will be available for review for at least 72 hours prior to floor consideration. The review period also applies to a manager's amendment that may be offered early the week of November 2. The manager's amendment would be offered by House leaders or chairmen of the committees of jurisdiction, and would propose further changes to the bill. Additionally, House Republicans may be given the opportunity to submit a substitute amendment to the legislation.
Given these mandatory review periods, plus any additional time that Democratic leaders may need to gain enough support to ensure passage of the bill, floor consideration is not expected until late the week of November 2.
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