BILL ANALYSIS
SENATE REVENUE & TAXATION COMMITTEE
Senator Jenny Oropeza, Chair
SB 25 - Maldonado and Runner
Amended: As introduced
Hearing: April 25, 2007 Tax Levy Fiscal: YES
SUBJECT: Conforms California law to federal law with
respect to Health Savings Accounts (HSAs).
EXISTING LAW
Federal Law
The Medicare Prescription Drug, Improvement, and
Modernization Act of 2003 (Public Law 108-173) established
Health Savings Accounts (HSAs) beginning in tax year 2004.
HSAs are tax-exempt trusts to which individuals may
contribute to pay for current and future out-of-pocket
medical expenses.
As with Individual Retirement Accounts (IRAs), HSAs are
tax-exempt accounts created solely for the purposes of
paying for qualified medical expenses incurred by the
account holder, his or her spouse and his or her
dependants. To be eligible to contribute to an HSA,
individuals must be covered by a high-deductible health
plan (HDHP). Under federal law an HDHP must have a
deductible of at least $1,100 for individuals and $2,200
for families. Furthermore, the annual out-of-pocket
expenses under the HDHP may not exceed $5,500 for
individuals and $11,000 for families. These limits are
indexed for inflation. With certain exceptions, including
accident, disability, dental care, vision care, or
long-term care insurance, an individual may have no other
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health plan other than a HDHP.
HSAs are individually owned and controlled. Therefore, an
individual may choose the level at which to fund the
account, which medical expenses to pay for, and which
investments to make. HSAs are also fully portable; an
individual keeps his or her HSA even if he or she changes
jobs, moves to a different state, or becomes unemployed.
Additionally, HSAs may roll over from one year to another
without limit, meaning that HSA owners do not have to
expend the entire amount in any given year.
Contributions to an HSA by or on behalf of an eligible
individual are deductible when determining adjusted gross
income and, if made by an employer on behalf of an eligible
individual, are excludable from gross income and employment
taxes. For example, a contribution made by a family member
to an eligible individual is deductible by the eligible
individual instead of the contributor.
Enrollees to an HSA must not be enrolled in Medicare and
cannot be claimed as a dependant on another federal tax
return. There are no income limits for participation in an
HSA.
The maximum annual HSA contribution, regardless of the HDHP
deductible, is $2,850 for an individual and $5,650 for
families. Individuals aged 55 and older can make an
annual catch-up contribution of $800 to an HSA. Again,
these limits are indexed for inflation.
Distributions from HSAs for qualified medical expenses are
not calculated in the HSA owner's gross income.
Distributions from HSAs for non-qualified medical expenses
are calculated in gross income and subject to a 10 percent
penalty tax. This penalty does not apply if the
distribution is made after death, disability, or the
individual attains the age of Medicare eligibility (i.e.,
age 65).
The Tax Relief and Health Care Act (TRHCA) of 2006 (Public
Law 109-432), made several changes to HSAs beginning in
2007. Those changes include:
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1. Certain amounts in Flexible Spending Arrangements
(FSA) and Health Reimbursement Accounts (HRA) are
allowed, through a direct transfer, to be distributed
to an HSA. The amount that can be distributed from an
FSA or HRA and contributed to an HSA may not exceed an
amount equal to the lesser of (1) the balance in the
health FSA or HRA as of September 21, 2006, or (2) the
balance in the health FSA or HRA as of the date of
distribution.
2. Contribution limits are no longer subject to the
amount of the HDHP deductible.
3. As limits are indexed for inflation, the Consumer
Price Index for the calendar year is determined as the
close of the 12 month period ending on March 31 rather
than August 31.
4. In general, individuals who become covered under a
HDHP in a month other than January are allowed to make
the full deductible HSA contribution for the year
rather than prorating the deduction based on the
number of months the individual was enrolled in the
HDHP.
5. Allows employers to make larger HSA contributions
for non-highly compensated employees versus highly
compensated employees.
6. Allows a one-time contribution to an HSA of an
amount distributed from an IRA.
California Law
California law conforms to the federal rules for Archer
Medical Savings Accounts (MSAs) and allows a deduction
equal to the amount deducted on the federal return.
California imposes a 10 percent additional tax rather than
the 15 percent additional tax on distributions from an MSA
not used for qualified medical expenses. While the MSAs
still exist in federal law, they are hardly used as the
HSAs are considered a more simple tax planning tool.
California does not, however, conform to any of the federal
HSA provisions. In this state, a taxpayer's Adjusted Gross
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Income (AGI) must be adjusted to account for the
differences between federal and California law.
Adjustments relating to HSAs are required under current
law, as follows:
A taxpayer taking an HSA deduction on the federal
return is required to increase AGI on the taxpayer's
California return by the amount of the federal
deduction.
Any interest earned on the account is added to AGI
on the taxpayer's California return.
Any contribution to an HSA, including salary
reduction contributions made through a cafeteria plan,
made on the employee's behalf by their employer is
added to AGI on the employee's California return.
Neither a tax-free rollover from an MSA or a distribution
from an IRA to an HSA is allowed under California law.
Therefore, any distribution from an MSA or IRA to an HSA
must be added to a taxpayer's AGI on the California return.
Because an MSA distribution is not considered a qualified
medical expense it would be subject to an additional 10
percent penalty tax. Additionally, as the IRA distribution
is considered a premature distribution, it would be subject
to an additional two and a half percent penalty tax.
THIS BILL
Starting with taxable year 2006, this bill would fully
conform to the federal HSA provisions as follows:
1. Allows the same above-the-line deduction for
contributions to an HSA by or on behalf of an
individual and adopts the rules applicable to trusts
in order for the trust to be exempt from tax. In
addition, the disqualified distribution penalty
applicable to HSAs is modified for California purposes
to be two and a half percent instead of the federal
rate of 10 percent to be consistent with the other
California penalty provisions applicable to IRAs.
Consistent with general conformity policy in other
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areas, the federal six percent excise tax on excess
contributions and the federal estate tax provisions
are not being conformed to by this bill.
2. Allows the same exclusion from an employee's gross
income for the amount of any contributions to an HSA
(including salary reduction contributions made through
a cafeteria plan) made on the employee's behalf by
their employer.
3. Allows rollovers from MSAs to be made to HSAs, as
well as rollovers between HSAs, without penalty.
4. Adopts the same $50 penalty for failure to make
required reports.
Allows amended returns to be filed for taxable year 2006 to
claim the deduction and refund penalties assessed on
amounts rolled over from an MSA for that taxable year.
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FISCAL EFFECT:
According to FTB, the revenue losses associated with this
bill would be as follows:
----------------------------------------------------
| $ In Millions |
| |
----------------------------------------------------
|------------+------------+------------+------------|
| 2006-07 | 2007-08 | 2008-09 | 2009-10 |
| | | | |
|------------+------------+------------+------------|
| -$5 | -$16 | -$23 | -$28 |
| | | | |
---------------------------------------------------
COMMENTS:
A. Purpose of the bill
According to the author, the purpose of the bill is "for
California's tax laws to conform to federal tax laws
regarding Health Savings Accounts (HSAs). California
taxpayers are currently being doubly penalized for having
an HSA: they are taxed for their HSA and California law
also penalizes them for getting a tax break from the
federal government. Under the 2003 federal law that created
HSAs, people can open up savings accounts and invest
thousands of dollars annually to pay for qualified health
care expenses, such as co-payments for medical services and
drug prescriptions, for themselves and their families.
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This money is exempt from federal taxes and can be carried
over from year to year to build up savings. Unfortunately,
California is one of six states that still have not
conformed their tax laws to federal law. As a result,
savings accrued in a California resident's HSAs are still
subject to state tax penalties. SB 25 would solve this
problem and allow Californians to save their tax-free
dollars in Health Savings Accounts."
B. Health Care Coverage
UCLA recently studied the uninsured population in this
state; according to the study, there are approximately 6.5
million uninsured in this state. The Department of the
Treasury released a fact sheet, using figures from the
America Health Insurance Providers, which showed that
438,000 Americans were covered by an HSA type plan in 2004.
In 2005, 3.2 million were covered by one of these plans of
which 31 percent were previously uninsured individuals and
33 percent were small businesses which did not offer health
coverage. The Department of the Treasury projects that by
2010 there will be 14 million HSA policies that cover 25 to
30 million people.
C. Health Care Costs
Proponents of HSAs maintain that they can reduce overall
spending on health care by allowing consumers more control
over their health care costs. President Bush's Council of
Economic Advisors says "health insurance in the United
States has now also become a vehicle for financing
relatively low-cost, routine expenditures" and "has three
important consequence: (1) It encourages consumers to
overuse certain types of health care. (2) It gives little
incentive for consumers to search for the lowest-price
providers. (3) It distorts incentives for technological
change."
The author states that "HSAs provide more control over
healthcare costs. Participants decide how to spend the
money in their account based on their own healthcare needs
and they keep what they do not spend." This concept of
providing consumers with more control over healthcare costs
is central to the argument of how HSAs may reduce
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healthcare costs over time. The President's Council of
Economic Advisors states, "As more consumers shift into
high-deductible plans, there is greater potential for
slowing price growth and long-run increase in cost-reducing
technology, which could benefit even consumers in
traditional insurance plans." Furthermore, proponents
state that a high deductible forces consumers to be more
aware of the cost of routine medical procedures and that
this increased price awareness and sensitivity will in turn
control health care costs.
Opponents of this measure state that this bill does not
reduce costs at all; instead, it merely shifts the cost
from a traditional employer provided healthcare system to
the employee. Furthermore, these types of plans provide
less healthcare in the form of prevention and annual check
ups and more insurance for catastrophes.
D. Rich Tax Incentive
HSAs are the only savings account with both tax-deductible
deposits and tax-free withdrawals, provided those
withdrawals are for qualified medical expenses.
Additionally, HSAs have no income limits. Comparatively, a
traditional IRA generally allows contributions to be tax
deductible, but treats withdrawals as income subject to
tax. Contributions to a Roth IRA are taxable but qualified
withdrawals are tax-free and Roth IRAs have income limits
restricting eligibility.
E. Usage: High Income Individuals
In August 2006, the United States Government Accountability
Office issued a report titled, "Consumer-Directed Health
Plans: Early Enrollee Experiences with Health Savings
Accounts and Eligible Health Plans." The report stated
that the median income of tax filers reporting an HSA
contribution in 2004 was $133,000. Additionally, 51
percent of those tax filers contributing to an HSA had an
income of $75,000 or more. According to the report,
"HSA-eligible plan enrollees had higher incomes than
comparison groups."
The report also stated that, "In addition to using HSAs to
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pay for medical and other expenses, account holders appear
to use their HSAs as a savings vehicle. About 55 percent
of those reporting HSA contributions to the IRS in 2004 did
not withdrawal any funds from their account 2004. We could
not determine whether HSA-eligible plan enrollees
accumulated balances because they did not need to use their
account (that is, they paid for care from out-of-pocket
sources or did not need health care during the year) or
because they reduced their health care spending as a result
of financial incentives associated with the HSA-eligible
plan and HSA. However, many focus group participants
reported using their HSAs as a tax-advantaged savings
vehicle, accumulating their HSA funds for future use."
Opponents to this measure cite this report as further
evidence of the fact that HSAs are generally used by
wealthier individuals and not accessible to lower income
people.
F. HSAs could move the employers away from low deductible
plans
Opponents of these accounts are concerned that it could
result in employers no longer offering low deductible
health plans, opting for high deductible plans instead, and
shifting the costs to employees. The opponents further
state that "high deductible health plans and savings
accounts hurt poor people who simply cannot afford to buy
high deductibles and are barely making ends meet."
Opponents further state that HSAs are an example of adverse
selection where one healthy group of people is more likely
to use the high deductible programs than a less healthy
group of people that cannot afford the deductibles.
G. Conformity
This bill conforms California law to federal HSA provisions
beginning with tax year 2006, however HSAs were established
beginning with tax year 2004. California is only one of
five states that do not conform to these accounts.
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California does not automatically conform to federal law
but instead considers each provision individually in order
to analyze each individual policy.
Support and Opposition
Support: Bayshore Ambulance
Small Business California
California Federation of Republican Women
National Association of Insurance and
Financial Advisors of California
California Association of Health Plans
America's Health Insurance Plans
Association of California Life and Health
Insurance Companies
California Chamber of Commerce
California Association of Health
Underwriters
John Deere
California Restaurant Association
National Federation of Independent Business
Opposition:California Teachers' Association
California School Employees Association
Health Access California
California Alliance for Retied Americans
California Tax Reform Association
California Nurses Association
Jericho
California Professional Firefighters
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Consultant: Brendan P. Hughes
05/07/07 15:46
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