The America’s Affordable Health Choices Act of 2009 (H.R. 3200) (the “Bill”) was introduced jointly by the House of Representatives’ Energy & Commerce, Education & Labor, and Ways & Means Committees on July 14, 2009. The Bill was subsequently “marked up” by Chairman Rangel of the Ways & Means Committee on July 15, 2009. The Bill’s stated purpose is “to provide affordable, quality health care for all Americans and reduce the growth in health care spending.” While our Healthcare Team has highlighted the Bill’s significant proposed changes that would directly affect healthcare providers in the July 23, 2009, issue of the Health Law Update, this Alert is meant to summarize only the potential revisions to the Internal Revenue Code (the “Code”) which were proposed in order to help fund the many healthcare reform measures.
The revenue-raising amendments are generally found in Title IV of Division A (“Amendments to Internal Revenue Code”) of the Bill. The significant tax provisions are summarized below:
Subtitle A—Shared Responsibility
- Individual Responsibility—Individuals who do not maintain “acceptable coverage”1 for themselves and their “qualified children”2 would be subject to an additional tax. This additional tax would be 2.5% on the lesser of (i) the amount by which their “modified adjusted gross income”3 exceeds the threshold income amount for them to be required to file a tax return under Section 6012(a)(1) of the Code, or (ii) the “applicable national average premium” for the tax year. The “applicable national average premium” is defined as the average premium for single/ family coverage (as applicable) under a basic plan which is offered in the Health Insurance Exchange4 for the year. New information returns would be required to be filed by providers of healthcare in order to properly determine who would be subject to this new tax. This tax would be pro-rated for partial year lapses, could not be reduced by tax credits, and would not reduce the otherwise payable alternative minimum tax (“AMT”) by the individual. This tax would also go into effect for tax years beginning after December 31, 2012.
- Employer Responsibility—Employers would now be required to make an election to either (i) meet the “health coverage participation requirements” for each of its employees, or (ii) pay an additional 8% payroll tax on the wages of its employees. To meet the “health coverage participation requirements,” the employer must (i) offer to all employees both single and family coverage that qualifies as either (a) a “qualified health benefits plan,” or (b) a grandfathered “employer-based health plan,” and (ii) make contributions to the plan for each electing employee in an amount equal to (1) 72.5% of the premium of the lowest cost qualified plan for single coverage offered by the employer for employees electing single coverage, or (2) 65% of the applicable premium of the lowest cost qualified plan for family coverage offered by the employer for employees electing family coverage. (The percentages are reduced for part-time employees.) Electing employers that fail to comply with these requirements would be subject to penalties. Certain small employers with annual payrolls for the preceding year of less than $250,000 would be completely exempt from these requirements, and employers with prior year payrolls between $250,000 and $400,000 would be subject to a reduced payroll tax if they did not elect to meet the “health coverage participating requirements.” These rules would also go into effect for tax years beginning after December 31, 2012.
Subtitle B—Credit for Small Business Employee Health Coverage Expenses
Employers with (i) average annual employee compensation of $20,000 or less, and (ii) 10 or less “qualified employees”5 would be eligible for a tax credit equal to 50% of their “qualified employee health coverage expenses”6 for the year. (The credit would be available at a reduced rate for (i) employers with average annual employee compensation between $20,000 and $40,000 (with “qualified employees” of 10 or less), and (ii) employers with between 10 and 25 “qualified employees” (with average annual employee compensation of $20,000 or less).) This tax credit would be available for tax years beginning after December 31, 2012.
Subtitle D—Other Revenue Provisions
- Surcharge on High-Income Individuals—This proposal imposes a surcharge on individuals, trusts, and estates with “modified adjusted gross income”7 in excess of a certain amount. For individuals filing married, filing jointly or as a surviving spouse, the surcharge is the sum of the following: (i) 1% of modified AGI between $350,000 and $500,000, (ii) 1.5% of modified AGI between $500,000 and $1 million, and (iii) 5.4% of modified AGI in excess of $1 million. (For married filing separate taxpayers, the dollar amounts are multiplied by 50%, and for all other taxpayers (e.g. single, head of household, trusts, and estates) the dollar amounts are multiplied by 80%.) This surcharge could not be off-set with tax credits and also would be in addition to any AMT otherwise due. These additional charges would begin for tax years beginning after December 31, 2010. (Furthermore, these charges are anticipated to raise over $543 billion in additional revenue from 2011 through 2019 which clearly makes this proposed change the most lucrative proposed change to the Code.)
- Delay in Application of Worldwide Allocation of Interest—The modification by the American Jobs Creation Act of 2004 of the interest expense allocation rules for purposes of computing the foreign tax credit limitation8 would be delayed until tax years beginning after December 31, 2019.
- Limit on Treaty Benefits for Certain Deductible Payments—This section deals with the applicable withholding tax on deductible payments (e.g. interest) made from a U.S. entity to a foreign payee where the U.S. entity and foreign payee are members of the same “foreign controlled group.” The new rule would deny a treaty-reduced withholding rate with respect to the payment if the foreign parent corporation of the foreign controlled group is a resident of a country that would not provide for a reduced withholding rate if such payment was made directly to the foreign parent. (If the country of the foreign parent provides for any reduction of the withholding rate, however, this section would not apply.) This new rule would apply to payments made after the date this provision is enacted.
Codification of Economic Substance Doctrine—This provision serves to codify the substantial economic substance doctrine that currently exists only in the common law. It clarifies that to be protected from a re-characterization for federal tax purposes, a transaction must meet the following two requirements: (i) the transaction must change the taxpayer’s economic position in a meaningful way (apart from federal, state, and local tax effects), and (ii) the transaction must have a substantial purpose (apart from federal, state, and local tax effects). This section also specifically discusses to what extent the expectation of pre-tax profit and a financial accounting benefit can be relied upon to meet the above requirements. This codification would apply to transactions entered into after the enactment of the Bill.
- Revisions to Underpayment Penalties—These penalties would be revised (i) to account for underpayments as a result of transactions lacking economic substance, and (ii) to make miscellaneous other revisions. First, transactions lacking economic substance would be added to the list of situations to which the Section 6662 20% underpayment penalty would apply. These transactions would also be subject to an increased 40% underpayment penalty if the relevant facts affecting their tax treatment are not adequately disclosed. An additional category of persons (“specified persons”), which would generally cover public companies and large corporations, is also created. Stricter requirements would apply to these new “specified persons” for them to avoid underpayment penalties under Section 6662. These provisions would also apply to transactions entered into after the date of enactment.
WAYS & MEANS MARKUP
While Chairman Rangel’s markup did not significantly alter any of the above provisions, it did add two new provisions under Subtitle D (Other Revenue Provisions) which are summarized below.
- Distributions for Medicine Qualified Only if for Prescribed Drug or Insulin—The definition of “qualified medical expenses” in the context of what qualifies for (i) tax-free reimbursements through health reimbursement arrangements and flexible spending accounts, and also (ii) tax-free distributions through health savings accounts would be revised to include expenses for drugs only if the drug is either (a) a prescription drug, or (b) insulin. (This amendment would effectively eliminate the tax-free benefits associated with these arrangements for the purchase of over-the-counter drugs.) This change would apply to expenses incurred after December 31, 2009.
- Parity in Health Benefits—This proposed amendment would (i) extend certain tax benefits for healthcare benefits provided to a new category of “eligible beneficiaries,” and also (ii) provide additional tax deductions for certain healthcare costs incurred by self-employed individuals. The tax benefits provided under Sections 106, 105(b), 501(c)(9), and various payroll tax sections (e.g. 3121, etc.) would be extended to healthcare coverage provided to “eligible beneficiaries.” An “eligible beneficiary” is defined as any individual who is eligible to receive benefits or coverage under an accident or health plan. (This part of the revision is likely targeted at extending the benefits historically provided only to the taxpayer, his spouse, and his dependents to same-sex partners.) The second part of this amendment permits a self-employed individual to deduct the cost of healthcare provided to two new categories of individuals. These two new categories are generally meant to pick up individuals that meet some, but not all, of the requirements under Section 152 to be considered a “qualifying child” or “qualifying relative.” These amendments would also become effective after December 31, 2009.
This legislation is likely to be revised further before consideration by the entire House. Furthermore, the Senate Finance Committee has yet to introduce its healthcare reform bill which could include tax provisions that differ significantly from the ones discussed above. Nevertheless, we believe it was important to provide you with a summary of the tax changes currently being considered.