The House Reform Bill--Winners and Losers; Revenue-Raisers; Next Steps

Winners and Losers
Late Saturday, November 7, 2009, the House passed The Affordable Health Care for America Act of 2009 (H.R. 3962) by a narrow margin of 220-215 votes. Issues of continuing concern to the healthcare industry addressed in the bill include (1) incentives to strengthen the primary care workforce by requiring Medicaid programs to pay primary care physicians at least 80 percent of the comparable Medicare fee in 2010; (2) a richer federal match to the states to compensate for the large expansion in Medicaid coverage; and (3) clarification of off-site rotations for graduate medical education reimbursement with the intent to further encourage off-site rotations in residency programs. Other winners include facilities, hospitals and physician groups that operate in an integrated system. Significant incentives designed to encourage accountable care organizations, comparative effectiveness studies, medical homes and the use of health information technology in improving patient outcomes also are addressed by the bill.

While H.R. 3962 proposes to curtail a number of current practices by the health insurance industry, this sector appears to have much to gain under the House bill. For example, under the individual mandate, millions of uninsured Americans who are ineligible for Medicaid would purchase coverage from private commercial insurers through the health insurance exchange. Additionally, since many of the bill’s provisions contemplate outsourcing the third party administrative functions, health insurance companies could find a new venue to provide services under H.R. 3962.

The House bill would direct children currently covered by the Children’s Health Insurance Program (CHIP)—one of the most popular bi-partisan programs recently enacted—to transition into products sold through the exchange, leading to the ultimate demise of the CHIP program by 2014. Many child advocates are opposed to the House bill’s provisions for this reason, favoring the Senate Finance Committee’s version (S. 1796) instead.

Revenue-Raisers
Though similar to the provisions included in H.R. 3200 (please see Baker Hostetler’s July 23, 2009, Executive Alert), the tax-related provisions of H.R. 3962 underwent some significant modifications from that first bill. The following summarizes the changes made by H.R. 3962 to the tax provisions originally included in H.R. 3200 and those completely new tax provisions contained in H.R. 3962.

Amendments to Internal Revenue Code -- Like those under H.R. 3200, the tax-related provisions of H.R. 3962, generally found under “Title V—Amendments to Internal Revenue Code of 1986,” include tax changes aimed at reforming the healthcare system as well as important revenue-raising provisions unrelated to health reform.

Provisions Relating to Health Reform -- These provisions generally seek to reform healthcare by encouraging/discouraging certain behaviors through the use of taxes. A summary of the material changes made by H.R. 3962 are as follows:

Part 1. Shared Responsibility (Employer Responsibility)

The exception for certain “small employers” from the additional eight percent payroll tax assessed on employers that do not provide health benefits for employees was broadened. Under H.R. 3200, small employers with annual payrolls for the preceding year of less than $250,000 would be completely exempt from the “health coverage participation requirements,” while employers with prior year payrolls between $250,000 and $400,000 would be subject to a reduced payroll tax. Additionally, the threshold amounts were increased to $500,000 and $750,000, respectively, thereby broadening the exception.

Part 2. Credit for Small Business Employee Health Coverage Expenses

H.R. 3962 would limit this tax credit to only two taxable years in total for each small business.

Part 3. Limitations on Healthcare-Related Expenditures (NEW)

The new Part 3 adds a number of the provisions of the Senate Finance Committee’s America’s Healthy Future Act of 2009 (S. 1796) which originally were not included in H.R. 3200. These new provisions are summarized as follows:

• Change in Definition of “Qualified Medical Expenses.” The definition of “qualified medical expenses” in the context of what qualifies for tax-free reimbursements through health reimbursement arrangements and flexible spending accounts and tax-free distributions through health savings accounts would be revised to include expenses for drugs only if the drug is either a prescription drug or insulin, effective December 31, 2010. While similar to the provision in the Senate Finance Committee’s bill, H.R. 3962’s provision eliminates all over-the-counter drugs from the definition, while the Senate bill still would include doctor-prescribed over-the-counter drugs in the definition. As a result, this amendment effectively would eliminate the tax-free benefits associated with these arrangements for the purchase of over-the-counter drugs.
• Increased Penalty (Nonqualified Health Savings Account (HSA) Distributions). The penalty for distributions from HSAs that are not made for “qualified medical expenses” is increased from 10 percent to 20 percent of the disbursed amount. This penalty would apply to distributions made in tax years after December 31, 2010.
• Limitation on Flexible Spending Account (FSA) Salary Reductions. Elective salary reductions under a cafeteria plan for purposes of coverage under a Health FSA would be limited to $2,500 per year. This limitation would take effect for taxable years beginning after December 31, 2012.
• Elimination of Deduction for Federal Prescription Drug Subsidies. Sponsors of qualified retiree prescription drug plans that receive tax-free subsidy payments from the Secretary of the U.S. Department of Health and Human Services (HHS) would be prohibited from deducting the costs reimbursed by such subsidy for federal income tax purposes. This tax deduction would be eliminated for tax years beginning after December 31, 2010.

Other Revenue Provisions -- As noted above, the provisions below do not necessarily help to specifically reform healthcare, but are intended to provide additional revenue needed to carry out the provisions that do. A summary of the material changes made by H.R. 3962 to these revenue-raisers are as follows:

• Surcharge on High-Income Individuals. H.R. 3200 imposed a surcharge on individuals, trusts and estates with “modified adjusted gross income” in excess of a certain amount. “Modified adjusted gross income” is defined as “AGI” less the Section 163(d) deduction for investment interest. (Note that the definition of “modified adjusted gross income” in the context of the surcharge differs from the definition with respect to the additional tax on individuals that do not provide themselves with adequate health coverage.) Under H.R. 3200, for individuals married filing jointly or as a surviving spouse, the surcharge was the sum of the following: (1) 1 percent of modified AGI between $350,000 and $500,000, (2) 1.5 percent of modified AGI between $500,000 and $1 million, and (3) 5.4 percent of modified AGI in excess of $1 million. (For married filing separate taxpayers, the dollar amounts were multiplied by 50 percent, and for all other taxpayers (e.g., single, head of household, trusts and estates) the dollar amounts were multiplied by 80 percent.)

H.R. 3962 modifies this surcharge by (1) eliminating the 1 percent and 1.5 percent surcharges completely and (2) revising the 5.4 percent surcharge so that it is assessed on the modified AGI greater than $500,000 for all eligible taxpayers (other than those married filing jointly or as a surviving spouse who has the same $1 million threshold as discussed above). While this surcharge still is projected to be the largest revenue-raiser for the House bill, the elimination of the lower-tier surcharges reduces the anticipated revenue to be raised over the next ten years from this provision from $543 billion to approximately $460.5 billion.

• Repeal of 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 limitation would be repealed completely. Under the American Jobs Creation Act, the common parent of an affiliated group is permitted to make a one-time “worldwide affiliated group election” whereby the taxable income from sources outside the U.S. of its domestic members would be determined generally by allocating and apportioning their interest expense on a world-wide basis. As originally contemplated, common parents could make this election for the first taxable year beginning after December 31, 2010. This is a change from H.R. 3200 and from the original text of H.R. 3962, both of which simply delayed the modification’s effective date until tax years beginning after December 31, 2019.

The following provisions are completely new revenue-raisers that originally were not included in H.R. 3200:

• Increased Information Reporting for Payments to Corporations (NEW). Persons who make payments to corporations of $600 per year or more in exchange for either property or services would be required to file an information return with both the Internal Revenue Service and the corporation itself with the goal of increasing disclosure of potentially taxable payments. This increased reporting would be effective for payments made in taxable years beginning after December 31, 2011.
• Excise Tax on Sales of Medical Devices (NEW). A 2.5 percent excise tax would be assessed on the sales price of the “first taxable sale” of “medical devices.” Generally, the tax would not apply to exported devices or retail sales, and special rules would apply for certain leases treated as sales, certain contract arrangements and credits and refunds. This tax would apply to sales made after December 31, 2012.
• Revised Cellulosic Biofuel Producer Credit (NEW). Though not included in the original text of H.R. 3962, this provision was offered as an amendment to the bill prior to Saturday’s House vote by Rep. John Dingell (D-Mich.). Currently, taxpayers are entitled to a nonrefundable tax credit equal to $1.01 for each gallon of “qualified cellulosic biofuel” produced. As passed by the House, H.R. 3962 revises this tax credit regime by limiting the types of fuel eligible for the credit (including “black liquor”) and reducing the tax credit per gallon based on the British thermal unit (BTU) content of the fuel. This provision, which would be effective for all fuel sold or used after the date of enactment of the House bill, is projected to raise about $23.9 million over the next ten years.

Next Steps
Hailed by proponents of H.R. 3962 as an important step forward for healthcare reform, the focus now turns to the Senate where the merged product of two reform bills—S. 1796 and S. 1679, adopted by the Senate Finance and Health, Education, Labor and Pension Committees, respectively—is being negotiated and assembled by Senate Majority Leader Harry Reid (D-Nev.). Currently stalled as the Democratic leadership awaits a score from the Congressional Budget Office, little detail is known about the merged Senate bill other than an announcement by the Majority Leader late last month that it will contain a public option.

The arsenal of procedural tools available to all sides of the reform debate is expected to dictate the pace of reform legislation in the Senate, where 60 votes can be required to take action on a bill. While the President has urged swift movement in the Senate, and Democratic leaders have promised a vote by the Thanksgiving holiday, Senate watchers, however, predict the debate will spill over into next year with the possibility for final passage of a reconciled bill by both chambers in mid-January.