Health care reform bill clears House; includes high-income surtax, business revenue raisers - US Tax
As approved, the Affordable Health Care for America Act also contains revenue raisers that, among other things, would codify the economic substance doctrine, impose a limitation on treaty benefits for deductible related-party payments, impose an excise tax on medical device manufacturers, place restrictions on certain health-related employee savings plans, and expand information reporting requirements. A manager's amendment that was folded into the bill during floor consideration would raise additional revenue by making "black liquor" ineligible for the cellulosic biofuel credit and repealing the worldwide interest allocation election.
The Congressional Budget Office (CBO) sets the total cost of the bill at $1.05 trillion over 10 years. An estimate from Joint Committee on Taxation (JCT) staff projects that the bill's proposed revenue offsets would raise a combined $560.5 billion over 10 years. Notably, the JCT does not include in its projections revenue garnered from penalties that would be imposed on individuals who do not maintain a required level of health insurance coverage (under the bill's individual mandate) and on employers that do not provide health care coverage for their employees (under the employer mandate).
The approved measure – a compilation of separate bills approved by the Ways and Means, Education and Labor, and Energy and Commerce committees during the summer – is the result of months of intense discussion and negotiations over the largest of President Barack Obama's initiatives to date. Debate over the revenue package was no exception. After some Democrats expressed concern that the high-income surtax that the Ways and Means Committee approved in July would affect too many small business owners, leaders raised the AGI thresholds at which the tax would apply. A proposal in the manager's amendment to make "black liquor" ineligible for the cellulosic biofuel credit was narrowed due to member concern that the provision as drafted could have adversely affected the ethanol industry. These deals, as well as nontax issues resolved over the course of the past weeks, ensured that leaders would in fact secure the 218 votes necessary for passage.
Only one Republican supported the measure and 39 Democrats voted against it. GOP leaders were given the opportunity to offer a full substitute amendment to the bill, but their proposal was defeated 176-258.
Surtax on high-income taxpayers
The bill would apply a 5.4 percent surtax on joint-filing taxpayers with modified AGI above $1 million ($500,000 for all other taxpayers). These thresholds are not adjusted for inflation, prompting some political observers to suggest that without future indexing, the surtax would, over time, affect a wider range of taxpayers than originally intended.
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 surtax. 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 surtax. A single taxpayer with household income of $800,000 could expect an increase of $16,200 attributable to the surtax. A married couple with equal income would see no increase. In some cases at higher income levels, the surtax 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 surtax proposals, singles with household income between $500,000 and $800,000 would pay substantially more under the House-approved provision because the full 5.4 percent surtax would apply at a much lower AGI threshold.
Conversely, joint filers with AGI between $500,000 and $1 million would owe no surtax. Under the original Ways and Means proposal, they would have been subject to a 1.5 percent surtax.
Had the surtax 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 proposed fiscal 2010 budget.
Like these other proposals, the House-approved provision 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. (A Senate Finance Committee-approved provision that would require the IRS Office of Chief Counsel to assert and compromise the noneconomic substance penalty is 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.
Black liquor – The bill would modify the cellulosic biofuel producer credit under section 40(b) to preclude "black liquor" – the wood pulp byproduct that paper companies use to power their mills --from eligibility.
This provision is intended to resolve a debate over the tax treatment of black liquor that has continued since 2007. Much to the consternation of some in Congress, when section 6426(d)(2)(G) was clarified in 2007 to apply to "liquid fuel derived from biomass," paper mills became eligible to claim the refundable alternative fuel mixture credit under section 6426(e) by adding a small amount of diesel fuel to their black liquor. The alternative fuel mixture credit is scheduled to expire on December 31, 2009. If Congress decides to extend the credit, it is generally expected to add a provision that will make black liquor ineligible.
But a new issue in the debate emerged recently when the IRS held in an internal legal memorandum (ILM 200941011) that black liquor also is eligible for the nonrefundable cellulosic biofuel producer credit under section 40(b)(6), which is not scheduled to expire until December 31, 2012. To address this, the bill would modify section 40(b)(6) to provide that a fuel is ineligible for the cellulosic biofuel producer credit if:
- Its combined water-and-sediment content is greater than 4 percent (determined by weight) or
- Its ash content exceeds 1 percent (determined by weight).
The effect of this statutory change would be that black liquor will not qualify for a nonrefundable credit under section 40(b)(6).
The provision would be effective for fuels sold or used after the date of enactment. (JCT 10-year revenue estimated: $23.9 billion.)
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.)
Repeal worldwide interest allocation election – A provision incorporated from the manager's amendment would repeal the worldwide interest allocation election outright, rather than delaying its effective date until December 31, 2019, as originally proposed.
When the manager's amendment was released on November 4, the JCT estimated that repealing the election would raise $26.1 billion over 10 years. But that estimate had to be reduced to take into account the enactment on November 6 of the Worker, Homeownership, and Business Assistance Act of 2009, which includes a provision delaying the effective date of the election until tax years beginning after December 31, 2017. According to the JCT staff, the revised 10-year revenue gain from repealing the election is now estimated to be only $6 billion.
Limitation on treaty benefits for certain deductible payments – The bill 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 by 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 the Consumer Price Index for Urban Consumers for taxable years beginning after 2013. The provision would be made effective for years beginning after December 31, 2012. 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, effective for disbursements made during tax years starting after December 31, 2010. (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, 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, 2012. (JCT 10-year revenue estimate: $2.2 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 (an employer with an annual payroll below $500,000 would have no excise tax obligation) and increase to $750,000, at which point the full 8 percent excise tax would apply. The provisions would be effective for taxable years beginning after December 31, 2012. (CBO 10-year revenue estimate: $135 billion)
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. (CBO 10-year cost estimate: $25 billion.)
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. Required information includes the name, address, and taxpayer identification number for each person for whom insurance is obtained, as well as the period of coverage. The provision would be effective for taxable years beginning after December 31, 2012. (CBO 10-year revenue estimate: $33 billion.)
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 specified federal and state health insurance agencies 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 (CLASS) Act 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.
Senate outlook
In the Senate, committees with jurisdiction over health care reform – the Health, Education, Labor and Pensions and the Finance committees – have finished their respective markups and negotiators have merged the two components together, although the combined bill has not yet been made public. The Congressional Budget Office has been dispatched to draft a cost estimate of the combined bill, which is expected to be completed the week of November 9.
Unlike the House-approved bill, the revenue package approved by Senate taxwriters last month relies primarily on health care-related offsets, most notably an excise tax on insurance companies that offer high-cost "Cadillac" group health plans, a cap on executive compensation for health insurance providers, and annual fees on health insurance providers and medical device manufacturers.
Senate Finance Chairman Max Baucus, D-Mont., said on November 3 that the Senate should aim to pass its health care measure before the end of the year. However, that same day Majority Leader Harry Reid, D-Nev., refused to guarantee that the Senate would complete its work by that point, saying that his chamber would not be "bound by any timelines." A White House spokesperson said November 5 that the administration has imposed a "deadline" of December 31 for completion of a joint health care bill in the House and Senate.
TAX NEWS - NOVEMBER 2009
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