- Analysis of the Health Care Act and the Reconciliation Act of 2010
- April 13, 2010 | Authors: Edward J. Adkins; Christopher A. Davis; Jeffrey A. Markowitz; Lisa K. Shallue; Thomas J. St. Ville
- Law Firm: Miles & Stockbridge P.C. - Baltimore Office
On March 30, 2010, President Obama signed the Health Care and Education Reconciliation Act of 2010 (“Reconciliation Act”). The Reconciliation Act modifies the Patient Protection and Affordable Care Act (“Health Care Act”), which was signed by the President one week earlier. Although the Health Care Act contains the majority of the new healthcare laws, the Reconciliation Act modifies many of the Health Care Act’s provisions and includes a number of additional provisions. Together, the Health Care Act and the Reconciliation Act (collectively, the “Health Care Legislation”) contain the new healthcare laws and establish a mandate for most U.S. residents to obtain health insurance. The Health Care Legislation also imposes an excise tax on insurance plans with relatively high premiums, imposes a surtax on unearned income, increases certain tax rates for high income earners, and subjects employers to new penalties for failure to provide adequate health insurance. Other tax changes include codification of the “economic substance doctrine” and imposition of penalties relating to the doctrine, and various revenue raisers and other tax changes targeting specific health-related industries.
The following summary contains an overview of the key provisions of the Health Care Legislation in the areas of Employee Benefits and Tax.
Employee Benefits-Related Provisions of the Health Care Legislation
The Health Care Legislation contains provisions that will have a substantial effect on employer group health plans. Although many of these provisions are not effective until 2014 or later, some provisions are effective as soon as the next plan year. Set forth below is a general explanation of some of the major provisions that will affect employer group health plans during the next year, and a brief explanation of a few of the major provisions with later effective dates.
Key Provisions for Next Year
- Grandfather Provisions. Existing individual and group health plans are exempt from the application of certain provisions in the new Health Care Legislation. The grandfather rules appear to apply forever to individuals who were enrolled in an individual or group health plan as of March 23, 2010. The protection granted to these existing plans does not end merely because family members of such individuals or new employees subsequently enroll in the plan. It is expected that future guidance will clarify the scope of these rules. Unless otherwise noted, the provisions discussed below apply to all plans, including grandfathered plans.
For health plans provided pursuant to a collective bargaining agreement, the grandfather rules will cease to apply beginning on the date on which the last of the agreements relating to the coverage terminates.
- Pre-Existing Conditions. For plan years beginning after 2013, group health plans are prohibited from imposing any pre-existing condition exclusions with respect to coverage for participants. For children who are less than 19 years of age, this prohibition is effective for plan years beginning six months after enactment of the Health Care Legislation. Employer group health plans, including grandfathered plans, must comply with this provision.
- Lifetime Maximums. Effective for plan years beginning six months after enactment, health plans may not impose lifetime limits on the value of benefits for any participant or beneficiary.
- Annual Maximums. Effective for plan years beginning six months after enactment, group health plans may only apply “restricted” annual limitations with respect to essential health benefits. It is expected that the term “restricted” will be defined in future guidance. For plan years beginning after 2013, a group health plan may not impose any annual limits on the value of benefits for any participant or beneficiary.
- Dependents under the Age of 26. Effective for plan years beginning six months after enactment, the Health Care Legislation requires health plans that otherwise offer dependent coverage to continue to offer this coverage until the dependent reaches the age of 26. For plan years beginning prior to 2014, a group health plan does not have to offer this coverage if the adult child is eligible to enroll in a separate employer-sponsored health plan.
- Nondiscrimination Rules. The Health Care Legislation extends the “self-insured” nondiscrimination rules of Internal Revenue Code Section 105(h) to insured health plans, effective six months after enactment. Under these rules, plans generally may not provide health benefits on a basis that is more favorable to highly compensated employees than to rank and file employees. Grandfathered plans are not subject to these nondiscrimination rules.
- Rescission of Coverage. Effective for plan years beginning six months after enactment, health plans may no longer rescind health coverage once a participant is covered under the plan, unless the participant has committed fraud or makes an intentional misrepresentation of material fact.
- Preventive Services Requirement. Under the new law, health plans are required to provide coverage for certain types of preventive care, without cost to the participants. These services include immunizations, screenings for infants and children, and preventive care for women. The preventive care provisions apply to plan years beginning six months after enactment. This provision does not apply to grandfathered plans.
- Appeals and Reviews. Effective for plan years beginning six months after enactment, health plans are required to implement an appeals process for coverage determinations similar to that currently required by the claims procedure regulation. The appeals process must also provide for an external review that complies with certain consumer protections set forth in the legislation. This provision does not apply to grandfathered plans.
- Form W-2 Reporting. For tax years beginning after 2010, employers must report on Form W-2 the aggregate cost of employer-sponsored coverage. The aggregate cost is determined using rules similar to the existing reporting rules for COBRA coverage.
- Over-the-Counter Drug Prohibition. The Health Care Legislation provides that over-the-counter drugs will no longer receive beneficial tax treatment under flexible spending accounts (“FSA”), health reimbursement arrangements (“HRA”), health savings accounts (“HSA”) and Archer medical savings accounts (“Archer MSA”) for amounts paid or expenses incurred on such items in tax years beginning after 2010. Only prescribed drugs and insulin will receive tax-advantaged treatment under these plans after the effective date of this provision.”
- Simple Cafeteria Plans. For tax years beginning after 2010, small employers (employers that employ an average of 100 or fewer individuals) may establish a simple cafeteria plan. A simple cafeteria plan that satisfies certain conditions will be treated as meeting the applicable nondiscrimination requirements. This plan eases the participation requirements under Internal Revenue Code Section 125 for the purpose of encouraging employers to provide tax-free benefits to their employees.
- Retiree Reinsurance. A new reinsurance program will be established to provide reimbursement to certain employers for a portion of the cost of providing health insurance coverage to early retirees, eligible spouses, and dependents of these early retirees. The new reinsurance program will be created not later than June 21, 2010 and will end on January 1, 2014. The term “early retirees” means individuals who are age 55 and older, who are not yet eligible for coverage under Medicare and who are not active employees of an employer maintaining, or currently contributing to, an employment-based plan. Under this provision, the program will reimburse 80% of annual claims between $15,000 and $90,000.
- Increased Tax on Certain HSA or Archer MSA Distributions. For distributions made after 2010 from an HSA or Archer MSA, the penalty tax is increased to 20% if an individual is under the age of 65 and uses the distribution for purposes other than qualified medical expenses.
- CLASS Act. The Community Living Assistance Services and Supports Act (CLASS Act) establishes a national, voluntary disability insurance program under which eligible beneficiaries will receive long-term care benefits. Employers may automatically enroll certain employees and begin contributions to the program beginning on January 1, 2011.
Key Provisions with Later Effective Dates
- Health FSA Contributions Limit. Effective for tax years beginning after 2012, contributions to health FSAs under cafeteria plans will be limited to $2,500 per year.
- Elimination of Deduction for Retiree Drug Subsidy. For tax years beginning after 2012, the deduction for the subsidy for employers who maintain prescription drug plans for continuing their retiree prescription drug program will be eliminated.
- Individual Mandate. Subject to certain exemptions, effective for tax years beginning after 2013, non-exempt U.S. citizens and legal residents will have to maintain minimum essential coverage or pay a penalty.
- American Health Benefit Exchange. The Health Care Legislation requires each state to establish an American Health Benefit Exchange (“Exchange”) not later than January 1, 2014. An Exchange will be operated by a governmental agency or nonprofit entity, and will provide a marketplace through which individuals and small business can purchase affordable health insurance plans. Beginning in 2017, states are permitted, but not required, to open the Exchanges to larger employers.
- Free Choice Vouchers. Beginning after 2013, employers that offer minimum essential coverage through an employer-sponsored plan, and who pay a portion of the premium related to the coverage, will be required to provide certain employees who do not participate in the employer’s health plan with a voucher that can be used to purchase a health plan through the Exchange. The value of the voucher is equal to the value of the employer contribution to the employer offered health plan.
- Employer Penalty. For months beginning after 2013, employers that employ an average of at least 50 full-time employees and do not offer sufficient health insurance coverage for employees will be required to pay a penalty if any full-time employee purchases health insurance through the Exchange with respect to which a tax credit or cost-sharing reduction is allowed or paid to the employee.
- Other New Employer Reporting Requirements. For periods beginning after 2013, large employers will be required to report certain information with respect to coverage provided to its employees to both the covered individual and the Internal Revenue Service.
- Excise Tax on Certain Employer-Sponsored Health Coverage. Effective for tax years beginning after 2017, insurance companies and self-insured plans will be required to pay a 40% nondeductible excise tax for certain high cost employer-sponsored health plans.
There are numerous other rules that will take effect in later years that will affect employer group health plans. For example, there are rules regarding automatic enrollment, waiting periods, essential benefits package requirements, and wellness plan reward increases. Miles & Stockbridge intends to continue to monitor developments with respect to the impact of the Health Care Legislation and will address any major developments in subsequent news briefs.
General Tax Related Provisions of the Health Care Legislation
As noted above, the Health Care Legislation contains many important new tax and revenue raising provisions. These include increased Medicare taxes on high income taxpayers, an extension of the Medicare tax to cover investment income, a codification of the judicial “economic substance doctrine,” and various other industry specific taxes and reporting requirements.
- Higher Medicare Payroll Tax on Wages. Effective in 2013, certain high income taxpayers (single people earning more than $200,000 and married couples earning more than $250,000) will face an increase in Medicare taxes. Currently, the Medicare payroll tax is the primary source of financing for Medicare’s hospital insurance trust fund, which pays hospital bills for beneficiaries who are 65 and older or disabled. Under current law, wages are subject to a 2.9% Medicare payroll tax, of which workers and employers pay 1.45% each. Self-employed individuals are responsible for the entire tax, but are allowed to deduct half of this amount for income tax purposes. Unlike the payroll tax for Social Security, which applies to earnings up to an annual ceiling, the Medicare tax is levied on all of a worker’s wages without limit. Under the Health Care Legislation, high income taxpayers will be taxed at an additional 0.9% (2.35% in total) on wages in excess of the $200,000/$250,000 thresholds. Self-employed persons will pay 3.8% on earnings over the threshold.
- Medicare Payroll Tax Extended to Investments. Under current law, the Medicare payroll tax only applies to wages. Beginning in 2013, a Medicare tax will, for the first time, be applied to investment income. A new 3.8% tax will be imposed on net investment income of single taxpayers with income above $200,000 and married couples over $250,000. Net investment income is comprised of interest, dividends, royalties, rents, gross income from a trade or business involving passive activities, and net gain from disposition of property (other than property held in a trade or business). Importantly, the new tax won’t apply to income in tax-deferred retirement accounts such as 401(k) plans. Also, the new tax will apply only to income in excess of the $200,000/$250,000 thresholds.
- Corporate Information Reporting. Under prior law, businesses that pay any amount greater than $600 during the year to corporations for property or services were not subject to information reporting requirements on IRS Form 1099 or similar forms. Under the Health Care Legislation, businesses that pay such amounts to corporate providers of property and services will have to file an information report with each provider and with the IRS.
- Codification of Economic Substance Doctrine. The “economic substance doctrine” is a judicial doctrine that has been used by the courts to deny tax benefits when the transaction generating these tax benefits lacks economic substance. The courts have not applied the economic substance doctrine uniformly. For transactions entered into after the enactment date of the Health Care Legislation, the manner in which the economic substance doctrine should be applied by the courts is clarified and a penalty is imposed on understatements attributable to a transaction lacking economic substance.
- Tax Credits to Certain Small Employers. The new law provides small employers with a tax credit for contributions to purchase health insurance for their employees. The credit can offset an employer’s regular tax or its alternative minimum tax liability. To qualify, a business must offer health insurance to its employees as part of their compensation and contribute at least half the total premium cost. The business must have no more than 25 full-time equivalent employees and the employees must have annual full-time equivalent wages that average no more than $50,000. However, the full amount of the credit is available only to an employer with 10 or fewer full time employees and whose employees have average annual full-time equivalent wages from the employer of less than $25,000.
- Industry-Specific Revenue Raisers. The following revenue raising changes will be imposed on health-related industries:
- Pharmaceutical manufacturers and importers will have to collectively pay an annual flat fee beginning in 2011. This annual fee will be allocated across the industry according to market share. The schedule for the flat fee will be: 2011, $2.5 billion; 2012 to 2016, $3 billion; 2017, $4 billion; 2018, $4.1 billion; 2019 and later, $2.8 billion. The fee will not apply to companies with sales of branded pharmaceuticals of $5 million or less.
- Manufacturers or importers of medical devices will have to pay a tax equal to 2.3% of the sale price (for sales after December 31, 2012) on the sale of any taxable medical device by the manufacturer, producer, or importer of the device. A taxable medical device is any device, defined in section 201(h) of the Federal Food, Drug, and Cosmetic Act, intended for humans. The excise tax will not apply to eyeglasses, contact lenses, hearing aids, and any other medical device determined by IRS to be of a type that is generally purchased by the general public at retail for individual use.
Health insurance providers will face an annual flat fee on the health insurance sector effective for calendar years beginning after December 31, 2013. The fee will be allocated based on market share of net premiums. The aggregate annual flat fee for the industry will be: $8 billion for 2014; $11.3 billion for 2015 and 2016; $13.9 billion for 2017; and $14.3 billion for 2018. The fee will not apply to companies whose net premiums written are $25 million or less.