17
Other Federal Tax Provisions to Fund Health Care or to Amend the Tai
Treatment of Health-Related Activities
I. Tobacco Products
A. Tobacco Excise Taxes . Tobacco excise taxes are all increased
effective October 1, 1994. The increase is 75 cents per pack for cigarettes, for
a new total tax of 99 cents per pack (312.5% increase). Percentage increases
for other tobacco products are 3,333% on small cigars, 312.5% on large cigars,
312% on cigarette papers, 312.7% on cigarette tubes, 3,472% on snuff, 10,417%
on chewing tobacco, and 1,852% on pipe tobacco. The tobacco excise tax
changes are estimated by the Administration to raises $65 billion over 5 years.
(Sec. 7111.)
B. Floor Stocks Taxes Imposed . Floor stocks taxes will be imposed on
tobacco products on hand on October 1, 1994.
C. Tobacco Product Export Exemption Modified . To retain export tax
exemption, tobacco products would now have to be specially marked for export.
A new penalty equal to the greater of $1,000 or 5 times taxes would be imposed
on export-labelled products which are sold in U.S. (Sec. 7112(a).)
D. Tobacco Importers Required to Obtain Permits and Are Subject to
Penalties and Forfeiture. Tobacco importers would be required to obtain a
permit from the U.S. or risk a $10,000 fine and 5 years imprisonment.
Violation of the import permit, inventory, or reporting provisions would also
subject all real and personal property of the importer to forfeiture. (Sec.
7112(b).)
E. Repeal of Tax Exemption for Sales to Cigarette Company
Emplovees . (Sec. 7112(c).)
F. Repeal of Tax Exemption for Sales to United States .
(Sec. 7112(d).)
G. Imposition of Tax on Small Packages of Cigarette Papers .
(Sec. 7112(e).)
H. Small Tobacco Manufacturers and Importers Could be Denied
Permits to Operate . (Sec. 71 12(g).)
18
I. Cover Over of Tax to Puerto Rico and U.S. Virgin Islands Limited
to Current-Law Tax Amounts . (Sec. 7112(h).)
J. New Tax on Roll-Your-Own Tobacco . Imposes a new $12.50 per
pound tax on roll-your-own tobacco. (Sec. 7113.)
II. Assessment on Corporate Alliance Employers .
A. Additional Tax on Corporate Alliance Employers . In addition to
other employment taxes imposed by the Internal Revenue Code, effective
January 1, 1996, every corporate alliance employer is required to pay a tax
equal to 1% of payroll. This provision is estimated by the Administration to
raise $24 billion over 5 years. (Sec. 7121.)
B. Definition of Corporate Alliance Employer Very Broad . An
employer is a "corporate alliance employer" if just one of its employees is, by
reason of employment, covered in a corporate alliance. [Because all members
of a controlled group, etc. are treated as a single employer, this will preclude
controlled groups from limiting the 1% payroll assessment to just those
subsidiaries participating in a corporate alliance.]
C. Special Rule for Multiemployer Plan Participants . If the only reason
an employer is a "corporate alliance employer" is that some employees are
covered in a corporate alliance through a multiemployer (imion) plan, the 1%
assessment is limited to the payroll for those covered employees.
D. Definition of Payroll Very Broad . For purposes of this assessment,
payroll includes the entire amount of wages paid by the employer during the
year, the net self-employment earnings of a sole proprietorship, and the partner
or shareholder's share of the net self-employment earnings of a partnership or
S corporation. (See below for change in definition of those earnings for
S corporations.)
E. One-Time Election to Opt Out for Large Employers and Others .
Any employer eligible to sponsor a corporate alliance must, by January 1, 1996,
irrevocably waive the right to sponsor a corporate alliance plan or the employer
will evermore be subject to the 1% payroll tax even if it does not sponsor a
corporate alliance. [This imposes a permanent penalty tax on large employers
who choose to evaluate regional alliances before making a permanent
commitment to them]. This forced-choice rule would not apply to employers
subject to the multiemployer plan rule in paragraph C above.
19
III. Recapture of Certain Health Care Subsidies .
A. Certain Subsidy Aniounts Recaptured . In a provision reminiscent of
the income tax on social security benefits, certain subsidies are recaptured as
additional tax payments for taxpayers with incomes exceeding specified
thresholds. (Sec. 7131.)
1. Medicare Part B Premium Recapture . Starting in 1996, the
recapture tax includes, with respect to each month, the excess of 150% of the
monthly actuarial rate for enrollees 65 or older over the total monthly premium.
According to the Treasury's explanation, this provision is intended to raise the
contribution of higher income taxpayers fi-om about 25% to about 75% of
program costs. The recapture amounts are appropriated to the Supplemental
Medical Insurance Trust Fund. (Sec. 7131(b).)
2. Alliance Credit Recapture . The recapture tax also includes,
starting January 1, 1998, reductions through Sec. 6114 in liability relating to
repayment of the alliance credit by certain /families. According to the
Treasury's explanation, this provision is intended to tax higher-income retirees
(between the ages of 55 and 64) on the "early-retiree" discount on the employer
premiums paid by their former employer. [Note: page 1342 of the bill amends
the effective date provided on page 1094.]
B. Income Thresholds for Recapture . The income thresholds for
taxpayers to be subject to recapture are "modified adjusted gross incomes" of
$90,000 (single, head of household), $115,000 (married filing jointly) and $0
(married filing separately, unless spouses lived apart at all times during the
year). If taxpayer income exceeds the relevant threshold by less than $10,000,
recapture is pro-rated based on the ratio of the excess to $10,000. Modified
adjusted gross income is adjusted gross income increased by tax-exempt interest
and certain foreign exclusions. [Because taxable social security benefits are
included in modified adjusted gross income, this can be seen as another
potential surtax on such benefits.]
C. Recapmre Amount Sometimes Treated as a Tax . The recapture
amount is treated as a tax for purpose of filing obligations, tax administration,
and penalties. It is not treated as a tax for purposes of satisfying the tajqjayer's
minimum tax or for allowing any credit.
20
D. New Reporting Requirements . The relevant federal agency [HHS?]
would have to report to the I.R.S. the number of months for which a Medicare
part B premium was paid for a taxpayer. Alliances would have to file reports to
show the liabilities excused pursuant to Sec. 6114. (Sec. 7131(c).)
rV. Treatment of S Corporation Shareholders for Employment Tax
ses.
A. Shareholders of S Corporations in Service-Related Businesses
Subject to Unlimited Medicare Tax on Entire Share of Earnings . Under current
law, only amounts paid as compensation to an S Corporation shareholder are
subject to the 2.9% medicare tax. In cases where insufficient compensation is
paid to shareholders who perform significant services, the I.R,S. will impute
compensation subject to the tax. The bill would treat the efltire service-related
business earnings of an S corporation allocable to a 2% or greater shareholder
who materially participates in the activities of the S corporation as subject to the
tax. Service-related businesses are the fields of health, law, engineering,
architecture, accounting, actuarial science, performing arts, consulting, athletics,
financial services, brokerage services, or any trade or business where the
principal asset of such business is the reputation or skill of one or more of its
employees. [This is comparable to the current law treatment of partners, but is
nonetheless a major tax increase on many S corporation shareholders.] (Sec.
7141(a).)
B. S Corporation Earnings Also Potentially Subject to Social Securitv
Tax . Because the bill recharacterizes the service-related S Corporation earnings
of materially participating 2% or greater shareholders as self-employment
earnings, those earnings will be subject to the 15.3% combined social security
tax if the individual does not otherwise exceed the taxable base ($60,600 if the
rule were applicable in 1994).
C. New Definition of Earnings Reduces Possibilitv of Health Insurance
Premium Subsidy for S Corporations . Because the full earnings of S
Corporation shareholders will be counted in determining the payroll of a
business, the average compensation paid by S Corporations will be higher than
it would otherwise be and the possibility of reduced (below 7.9%) percentage
limitations (discussed above in the computation of mandatory health payments
by employers) will be reduced.
21
V. Modification of Employment Tax Rules for Limited Partners .
A. Limited Partners Who Materially Participate Lose Exemption from
Employment Taxes . Current law excludes from self-employment income
subject to medicare and social security taxes the partnership income share of a
"limited partner, as such." The bill would exclude only the shares of limited
partners who do not materially participate in the activities of the partnership.
[While the target of this provision is unclear, it appears to be directed at
partners who take shares as both general and limited partners and who take the
position that there are no employment taxes on the "limited partner" portion.]
(Sec. 7141(b).)
VI. Extension of Medicare Coverage and Medicare Taxes to State and
Local Government Employees .
A. Medicare Tax Applicable to Services Performed After September
30. 1995 . The 2.9% combined medicare tax (1.45% employer, 1.45%
employee) would apply to the wages of state and local government employees
for services after September 30, 1995. Under current law, state and local
government employees who began work prior to April 1, 1986 are generally
exempt from the medicare tax. [The last time the Joint Committee on Taxation
scored this in February 1993, it raised $7.3 billion in the period 1994 - 1998.]
(Sec. 7142.)
B. Transition Rule for Benefits . The employees newly subject to the
medicare tax would be eligible for medicare coverage, subject to certain
transition rules.
VII. Limitation on Exclusion for Employer-Provided Health Benefits .
A. Current Law . The Internal Revenue Code provides, in 17 words,
that "Gross income of an employee does not include employer-provided
coverage under an accident or health plan." The bill would add the phrase
"except as otherwise provided" to the beginning of that sentence and then
provide several new pages.
22
B. Bill Limits Exclusion . Starting on January 1, 2003, the exclusion
would be limited to "comprehensive health coverage" and "permitted coverage."
Anything beyond these limited amounts would be taxed to the employee and
included in wages for purposes of PICA, FUTA, and withholding. The bill does
not change the employer's ability to deduct extra benefits. (Sec. 7201.)
1. Comprehensive Health Coverage . Comprehensive health
coverage is the core plan specified in the President's bill provided through an
alliance.
2. Permitted Coverage . Permitted coverage means sick pay
coverage, coverage for permanent injuries under I.R.C. Sec. 105(c), coverage
provided to a present or former employee after age 65 unleSS provided by
reason of current employment with the employer providing the coverage,
coverage under a qualified long-term care insurance policy, coverage provided
under Federal law to veterans or those in the armed services, and any other
coverage determined by the Secretary of the Treasury not to be inconsistent with
the purposes of the rule taxing certain benefits. [This is a very broad grant of
regulatory authority to exempt employer-provided benefits fi-om taxation,
without any specification of standards for exercising this discretionary
authority.]
3. Cafeteria Plan and Flexible Spending Arrangement Benefits
Taxed Sooner . Cafeteria plan health benefits would no longer be permitted,
and health benefits provided under a flexible spending arrangement would be
taxed, starting on January 1, 1997 (instead of the general 2003 effective date for
increased benefits taxation). (Sees. 7201, 7202.)
4. First-Dollar Benefits Subject to Taxation . According to the
Treasur>' explanation, starting on January 1, 2003, employer payments for
supplemental health coverage, including comprehensive plan copayments and
deductibles, will be taxable to the employee.
5. Possibility of Cash Benefits Not Per Se Taxable . Under the
health plan, because employers cannot discriminate in the payment of benefits,
they will have to offer cash benefits to employees going into lower-cost plans
(see discussion above). Employees receiving such cash benefits will be taxed,
but other employees will not (despite constructive receipt concepts in the tax
law which would otherwise apply).
VIII. Health Insurance Deduction for Self-Emploved .
A. Permanent Extension of 25% Deduction . The 25% deduction for
purchase of health insurance by self-employed taxpayers would be extended
permanently beyond its December 31, 1993 scheduled e;q)iration.
(Sec. 7203(a).)
B. Changes to a Deduction of Up to 100% of Cost of Regional
Alliance Coverage . Starting on the earlier of January 1, 1997 or the date the
taxpayer could first purchase alliance coverage, self-employed taxpayers can
deduct 100% of the cost of comprehensive benefits purchased fi-om an alliance.
(Sec. 7203(b).)
1. Deduction Reduced Where Taxpayer Has Employees for Whom
Taxpayer Does Not Pay 100% of Cost . Where a self-employed taxpayer
(S Corporation shareholder or partner) has employees, the deduction is reduced
to the lowest percentage paid by the employer for any of its employees
[probably taking into account any reduction available as part of the small
business employer subsidy for premiums].
2. Deduction Limited to Earned Income .
3. Deduction Not Available for Taxpayers Who Are Full-Time
Employees of Some Other Employer .
IX. Limitation on Prepayment of Medical Insurance Premiums .
A. No Deduction for Prepaid Medical Insurance Premiums. Starting on
January 1, 1997, no medical expense deduction will be allowed for health
insurance premiums paid more than 1 2 months in advance. This prepayment
disallowance rule will not apply to payments for qualified long-term care
policies or to payments (specifically deductible under current law) made before
age 65 for policies to cover post-age 65 medical expenses.
X. Employment Status
A. Repeal of Section 530 of 1978 Tax Act . Current law (not contained
in the Internal Revenue Code) has since 1978 prohibited the I.R.S. from issuing
rules regarding, and provided a safe-harbor for, the treatment of certain workers
as independent contractors. The l.R.S. has been seeking to repeal this provision
24
with some regularity since 1978. Under the bill, the old safe harbor would be
repealed and replaced for periods after 1995, but the I.R.S. would be free to
issue new rules as soon as the bill is enacted. (Sec. 7303(c).)
B. New Statutory Definition of Employee . The Treasury would be
permitted to issue rules defining who is an employee for purposes of
employment taxes (Social Security, Medicare, FUTA, wage withholding, etc.)
and, to the extent provided in regulations, income taxes. Because the
employment tax defmition of "employee" is cross-referenced in the Health Plan
defmition of "employee" (Sec. 1901(a)(1)(B)), the individuals defined as
employees for tax purposes will also attract mandatory health plan premium
payments from their "employers." This new provision allows the I.R.S. to
override all other provisions of law except the new, limited safe harbor
discussed below. [This provision is certain to be of extreme concern to small
business as it gives the I.R.S. carte blanche to treat workers as employees and,
thereby, subject them to the full panoply of employment taxes and health bill
mandates.] (Sec. 7301(a).)
C. Limited Safe Harbor . The old safe harbor would be replaced by a
new, extremely limited safe harbor. To avoid being penalized for misclassifying
a worker during a particular tax period, an employer would have to satisfy
consistency requirements, return filing requirements, safe harbor requirements,
and non-notification requirements.
1 . Consistency Requirement . The employer must not have treated
the worker (or any other worker holding a substantially similar position) as an
employee for the current or any prior period. [This same rule is in the current
safe harbor.]
2. Return Filing Requirement . The employer must have timely
filed all returns for the period (including information returns) with respect to the
worker (and workers in substantially similar positions), and those returns must
have been consistent with the position that the worker is not an employee.
There are de minimis, reasonable cause, and substantial compliance exceptions
to the requirement. [This is tighter than the current safe harbor because the
returns in the current safe harbor are limited to the worker in question.]
3. Safe Harbor Requirements . An employer must satisfy one of
the following safe harbor requirements: (i) reasonable reliance on a written
I.R.S. determination; (ii) reasonable reliance on a concluded I.R.S. audit in
which the rules were the same and in which employment status was actually
25
examined and found to be acceptable [the current safe harbor allows reliance on
a prior audit but does not require the I.R.S. to have raised the employment
status question during the audit]; (iii) reasonable reliance on a longstanding
recognized practice of a significant segment of the employer's industry [this safe
harbor is in current law and disfavored by the I.R.S.; the bill makes it
inapplicable after the issuance of regulations]; (iv) support by substantial
authority, not including private letter rulings issued to other taxpayers
[subsequent authority such as regulations may invalidate this safe harbor for
future periods].
4. Non-notification Requirement . The employer must not have
been notified in writing by the I.R.S. to treat the worker (or any worker holding
a substantially similar position) as an employee. [This means all safe harbors
disappear once the I.R.S. decides that a worker is an employee. No appeal of
this decision is permitted.]
D. New Penalties . The penalty for any failure with respect to an
information return for services (other than as an employee) would be increased
to the greater of $50 or 5% of the amount required to be reported correctly but
not so reported. This penalty would remain subject to an overall $250,000 per
taxpayer per year cap. (Sec. 7302.)
E. Constitutional Issue . The new employment status rules give the
Treasury discretion to override current statutory law. This could raise questions
as to whether the provision is an impermissible delegation of legislative
authority.
F. Revenues . Published reports (e.g.. Wall St. Journal, 10/29/93)
indicate that the Administration scores the employment status provisions as
raising only $100 million per year, ail from the penalty increase. [This estimate
may understate actual federal revenues to be obtained as there is likely to be
little or no revenue attributed to the vast grant of regulatory authority due to the
uncertainty over how and when that authority would be exercised.]
XI. Tax Treatment of Funding of Retiree Health Benefits
A. Limitation of Deduction for Reserve for Retiree-Health and Life
Insurance Benefits . Current law allows employers a reserve deduction for pre-
fimding retiree health and life insurance benefits (typically through VEBAs).
26
The deduction is to be taken over the actuarially-calculated working lives of the
employees. The bill raises revenue by providing that the deduction cannot be
taken over a period shorter than 10 years. (Sec. 7401(a).)
B. Additional Rules for Treatment of Reserves . Reserves for prefiinded
retiree health and life insurance benefits would have to be maintained as a
separate account. Any payment from the reserve account for other than post-
retirement medical benefits or life insurance benefits would be subject to a
100% penalty tax. No reserve deduction would be allowed for funding a benefit
to the extent the benefit can reasonably be anticipated to be includible in gross
income when provided. The separate account rule would apply to contributions
made after the date of enactment. The other rules for reserves, including the
10 year rule in paragraph A, would apply to contributions made on or after
January 1, 1995.
C. Health Benefit Accounts Maintained by Pension Plans .
Contributions to retiree health accounts in pension plans would be disallowed
starting on January 1, 1995, except in the case of collectively-bargained plans
which (if ratified on or before October 29, 1993) would be given up to three
additional years. Employers who have a retiree health cost reduction due to the
enactment of the President's plan will be protected from failing the requirements
ofI.R.C. Sec. 420.
XII. Coordination With COBRA Continuing Care Provisions
A. COBRA Repealed for All by 1998 . The right of employees to
continue to participate in employer group health plans after leaving employment
will cease on January 1, 1998, or, if earlier, when all of the States have a
regional alliance in effect. Prior to that time, COBRA coverage will cease to
apply to particular individuals when they become eligible for alliance coverage.
(Sec. 7501.)
XIII. Tax-Exempt Health Care and Related Organizations .
A. Charitable Exemption for Hospitals and Other Entities Providing
Health Care Services . Hospitals and other entities providing health care services
will lose their charitable tax exemptions under I.R.C. Sec. 501(c)(3) on January
1, 1995 unless the organization, at least annually and with the participation of
community representatives, assesses the health care needs of the
27
community and develops a plan to meet those needs. Health maintenance
organizations would be subject to an additional requirement [requirement is
unclear because of an apparently incorrect cross-reference]. (Sec. 7601.)
B. Clarification of When an HMO is Providing Commercial-Type
Insurance . Under current law, an organization is not eligible for tax exemption
if any substantial part of its activities consists of providing commercial-type
insurance. The bill provides that HMO insurance related to care provided other
than pursuant to a pre-existing arrangement with the HMO is not commercial-
type insurance. On the other hand, the bill specifies that the following kinds of
insurance are commercial-type: care provided by the HMO to its members at its
own facilities by professionals who do not provide substantial health care
services other than on behalf of the HMO; primary care by a health care
professional to a member of the HMO if the amoimt paid tb the professional
does not vary with the amount of the care provided to the member; services
other than primary care provided pursuant to a pre-existing arrangement with
the HMO; and emergency care provided to a member of the HMO at a location
outside the member's area of residence. The Treasury's explanation appears to
be in conflict with the statutory language of the bill and states that the bill
"clarifies that, except for 'point of service' benefits, most types of insurance
provided by health maintenance organizations are not commercial-type
insurance." [However, our reading of the bill is that the primary type of
insurance provided by HMOs is commercial. The bill says that most HMO's
are taxable]. This change would take effect on date of enactment. (Sec.
7601(b).)
C. Clarification That Holding Companies Are Not Private Foundations .
The bill clarifies that tax-exempt organizations which act as holding companies
to other medical tax-exempt organizations are not private foundations. This
change would take effect on date of enactment. (Sec. 7601(c).)
D. Regional Alliances Treated as Tax-Exempt . Effective on the date of
enactment, regional health alliances established under the bill will be exempt
from tax. (Sec. 7603.)
XIV. Tax Treatment of Taxable Organizations Providing Health Insurance
and Other Prepaid Health Care Services .
A. Taxable Organizations Treated as Property and Casualty Insurance
Companies . Starting on January 1, 1997, taxable companies issuing accident
and health insurance conu-acts (or reinsurance contracts for such risks), operating
76-304O-94-2
as an HMO [under the rules discussed above, most HMOs would be taxable], or