BILL ANALYSIS Ó
AB 36
Page 1
Date of Hearing: February 14, 2011
ASSEMBLY COMMITTEE ON REVENUE AND TAXATION
Henry T. Perea, Chair
AB 36 (Perea) - As Amended: January 27, 2011
REVISED
Majority vote. Tax levy. Fiscal committee.
SUBJECT : Personal income tax: adult child health care
benefits: exclusion or deduction.
SUMMARY : Conforms to the federal tax law that excludes from the
gross income of a parent the value of health care benefits and
reimbursements for medical care provided by the parent's
employer to an adult child 26 years or younger. Specifically,
this bill :
1)Excludes from the employee's gross income the value of
employer-provided health coverage, under an accident or health
plan, for the employee's adult child who, as of the end of the
taxable year, has not attained the age of 27.
2)Excludes from the employee's gross income any reimbursements
made under an employer-provided accident or health plan for
medical expenses for the employee's child who, as of the end
of the taxable year, has not attained the age of 27.
3)Allows self-employed individuals to deduct the cost of health
insurance provided for an adult child through the end of the
taxable year in which the child turns 26.
4)Allows a member of a nonprofit voluntary employees'
beneficiary association that provides health benefits to an
adult child, through the end of the taxable year in which the
child turns 26, to exclude the benefit from the member's gross
income.
5)Applies to expenses incurred and benefits provided on or after
March 30, 2010.
6)Takes effect immediately as a tax levy.
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EXISTING FEDERAL LAW:
Under federal law, the value of employer-provided health
coverage under an accident or health plan is excluded from an
employee's gross income, if provided to the employee, his/her
spouse, dependent or child who, as of the end of the taxable
year, has not attained age 27 (adult child). The exclusion also
applies to reimbursements for medical care expenses for an
employee's adult child. Existing federal law also authorizes a
similar exclusion for health benefits provided to the adult
children of retired employees under qualified retiree health
pension plans ŬInternal Revenue Code (IRC) Section 401(h)] and
members of voluntary employees' beneficiary associations ŬIRC
Section 501(c)].
EXISTING STATE LAW:
California, in conformity with the recently-enacted federal
health care acts, requires group health plans and health
insurance issuers to provide health care coverage for adult
children up to the age of 26, beginning on or after September
23, 2010, except under specified circumstances (SB 1088 (Price),
Chapter 660, Statutes of 2010). However, California does not
conform to the federal change that excludes from tax the value
of health care benefits provided by an employer to the
employee's adult children under the age of 26.
For health care benefit tax purposes, California law conforms to
the definition of a qualifying child under IRC Section 152. To
qualify for an excludable or deductible benefit, a qualified
child must satisfy five tests for the taxable year:
1)The child has the same principal place of abode as the
taxpayer for more than one-half of the taxable year;
2)The child is the taxpayer's son, daughter, stepson,
stepdaughter, brother, sister, stepbrother, stepsister, or a
descendant of any such individual;
3)The child has not yet attained the age of 19 by the close of
the taxable year (or, if a full-time student, has not attained
the age of 24 by the close of the taxable year);
4)The child has not provided over one-half of their own support
for the calendar year in which the taxable year of the
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taxpayer begins; and
5)The qualifying child has not filed a joint return (other than
for a claim of refund) with their spouse for the taxable year
beginning in the calendar year in which the taxable year of
the taxpayer begins. A tie-breaking rule applies if more than
one taxpayer claims a child as a qualifying child, and there
is no age limit with respect to individuals who are totally
and permanently disabled at any time during the calendar year.
FISCAL EFFECT : The Franchise Tax Board (FTB) staff estimates
that this bill will result in a revenue loss of $4.8 million in
fiscal year (FY) 2010-11, $38 million in FY 2011-2012, $35
million in FY 2012-13, $40 million in FY 2013-14, and $44
million in 2014-15.
COMMENTS :
1)Author's Statement. The author states, "With an estimated 1.2
million young adults between the ages of 19-25 uninsured, many
young adults find themselves without medical coverage. By
conforming California's tax laws to federal standards, the
state creates an affordable health insurance option for the
large pool of uninsured young adults in California. Although
SB 1088 allows parents to add their adult child to their
health care plan, the cost of non-conformity may become a tax
burden some families may not be able to afford. By conforming
California's tax laws to federal standards, the state ensures
many more young adults are insured and their parents are not
burdened by additional taxes as a result."
2)Arguments in Support. Proponents state that the added
administrative and financial burden on employers in attempting
to calculate the taxable amount attributable to the adult
child would be eliminated with the passage of AB 36.
Proponents also point out the additional tax burden that
parents will face, along with the potential cost of adding an
adult child to their health plans, may become a disincentive
for parents to add an adult child to their health care plan.
3)Committee staff notes the following:
a) Background. President Obama's sweeping health care
reform legislation, the Patient Protection and Affordable
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Care Act (PPACA) (H.R. 3590), was enacted March 23, 2010
and amended by the Health Care and Education Reconciliation
Act (HCERA) of 2010 (H.R. 4872) enacted March 30, 2010.
The White House believes this legislation will make health
care more affordable, make health insurers more
accountable, expand health coverage to all Americans, and
make the health system sustainable. Implementation of this
legislation started in 2010 and continues through 2014 and
beyond.
In connection with this expanded coverage, Congress also
amended the IRC to give certain favorable tax treatment for
coverage for adult children. Specifically, IRC Section
105(b) was amended to extend the general exclusion from
gross income for reimbursements for medical care under an
employer-provided accident or health plan to any employee's
child who has not attained age 27 as of the end of the
taxable year. Similar amendments were also made to IRC
Section 401(h) for retiree health accounts in pension
plans, IRC Section 501(c)(9) for voluntary employees'
beneficiary associations (VEBAs), and to IRC Section 162(l)
for deductions by self-employed individuals for medical
care insurance.
Furthermore, on April 27, 2010, the Internal Revenue Service
(IRS) issued Notice 2010-38, in which it stated that the
regulations under IRC Section 106 would be amended
retroactively to March 30, 2010, to provide that health
care coverage for an employee's child under age 27 is
excluded from the employee's gross income. Most health
benefits are provided to employees as health plan coverage
through IRC Section 106, which expressly excludes from an
employee's gross income coverage under an employer-provided
accident or health plan. However, the recent amendment to
the federal tax law only provides for an exclusion for
employer reimbursements for medical care expenses ŬIRC
Section 105(b)], and not employer-provided health coverage.
Prior to the enactment of the PPACA and HCERA, the
exclusion for employer-provided health coverage under IRC
Section 106 had paralleled the exclusion for reimbursements
for medical care under IRC Section 105(b). In issuing
Notice 2010-38, the IRS re-affirmed that the exclusions
under IRC Sections 105 and 106 had always been parallel and
concluded that there was no indication that Congress
intended to provide a broader exclusion for reimbursements
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than for health plan coverage. Thus, on and after March
30, 2010, both coverage under an employer-provided accident
or health plan and amounts paid or reimbursed under such a
plan for medical care expenses of an employee's child who
has not attained age 27 as of the end of the employee's
taxable year are excluded from the employee's gross income
under federal law.
California, however, has not yet conformed to this federal
tax exclusion. When changes are made to the federal income
tax law, California does not automatically adopt such
provisions. Instead, state legislation is needed to
conform to most of those changes. Conformity legislation
is introduced either as individual tax bills to conform to
specific federal changes or as one omnibus bill to conform
to the federal law as of a certain date with specified
exceptions. The purpose of AB 36 is to provide such
conformity to the recent federal tax law changes to exclude
from taxation the value of health coverage and
reimbursement for medical care expenses for adult children
in order to make the mandated implementation of health care
reform an easier transition.
b) IRS Notice 2010-38. California adopts a broad range of
IRS published guidance, though excludes letter rulings (FTB
Letter 2010-5). Under Revenue and Taxation Code (R&TC)
Section 17131, California conforms to IRC Section 106, as
of the "specified date" of January 1, 2009. Thus, if AB 36
is enacted into law, IRS Notice 2010-38 would apply for
California tax purposes as a regulation under the
California Personal Income Tax Law ŬR&TC section
17024.5(d)].
c) Employer Tax Compliance Burden. Because California has
not conformed to the federal adult child health care
benefit tax provision, an employer has the burden of
determining how much to withhold from an individual's wages
who takes advantage of the benefit. Many employers first
realized the difference in federal and state income
treatment when preparing W-2s for 2010. As more parents
add their adult children to their health insurance, more
employers will face this administrative burden. In
addition, the employer not only has the task of dealing
with different withholding requirements between the federal
and state levels, it also lacks guidance in determining the
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proper withholding amount.
d) Additional Tax Liability on Parents. Parents could pay
more taxes as a result of non-conformity, depending on the
method used to calculate tax liability. As stated above,
this tax has not been previously collected, so determining
the financial burden on the participating parents is
difficult to estimate. The tax liability could amount to
upwards of hundreds of dollars per year. This added
financial strain could dissuade parents from providing
health care to their uninsured adult children.
Although there is no statutory guideline mandating the
method for determination of the amount taxable, there is a
method proposed by the FTB and a method suggested by the
California's Employment Development Department (EDD). The
FTB released a Tax News Alert on January 24, 2011,
providing guidance for employers. The Tax News Alert
stated that, "The fair market value of employer-provided
medical coverage for some adult children in excess of the
amount paid by the employee for such coverage may result in
taxable income to the employee." According to the FTB,
the amount paid by an employee for such additional coverage
is not excludable from state taxable wages for purpose of
the Personal Income Tax Law.
Under the EDD method, outlined in the January 24, 2011
Announcement, the calculation used is the difference
between the cost of the premium before the addition of the
adult child and the cost after the addition. The issue
with the utilization of this method is that some parents
will see no additional tax liability and other parents will
be taxed hundreds of dollars yearly, depending on the
number of dependents on the health plan. This is because
the addition of a dependent does not always result in an
increase in insurance premium. For example, some health
care premiums charge the same amount whether there are two
or three dependents on the health care plan. So a parent
with two dependents who adds an adult child will see no tax
liability, whereas a parent who has one dependent will see
a premium increase of $1,300 yearly if there is an addition
of an adult child. The resulting disparity is inequitable
and will cause employers to calculate tax liability on an
employee-by-employee basis, a task that, needless to say,
will result in additional time and expense for employers.
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The two methods have led to confusion for employers
attempting to determine the appropriate amount to withhold.
If AB 36 does not become law, it may result in employers
having to calculate different withholding amounts - one for
the purpose of the Personal Income Tax Law, under FTB
guidance, and another one for State Disability Insurance
purposes, as suggested by the EDD.
e) Estimated Revenue Loss. Although this bill is estimated
to result in a loss, the estimate may not be entirely
accurate. Currently, there is no method set for
determining the amount of the benefit to tax. Also, since
this benefit has never been taxed in the past, passage of
AB 36 would not result in a revenue loss to the General
Fund. In fact, if AB 36 is not enacted, any amount
collected would result in a windfall to the state.
Estimating the amount of the windfall is difficult, given
there is no set method that employers must follow.
Therefore, the current FTB estimate could over or
understate what would be collected if the benefit is taxed.
f) Young Adult Benefit. According to the Federal
Department of Health and Human Services, young adults have
the highest rate of uninsured of any age group. About 30%
of young adults are uninsured, representing more than one
in five of the uninsured. This rate is higher than any
other age group, and is three times higher than the
uninsured rate among children. Young adults have the lowest
rate of access to employer-based insurance. Also, contrary
to the myth that young people do not need health insurance,
one in six young adults has a chronic illness like cancer,
diabetes or asthma. Nearly half of uninsured young adults
report problems paying medical bills.
4)Related Legislation.
SB 1088 (Price), Chapter 660, Statutes of 2010. This bill
extended the age which parents could add their adult child to
their health care plan to 26 years of age. This bill did not
affect tax treatment of this benefit.
AB 1178, introduced in the 2009-10 Legislative Session, had a
similar provision. AB 1178 was held in the Senate
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Appropriations Committee.
REGISTERED SUPPORT / OPPOSITION :
Support
AFSCME
Aaron Read & Associates, LLC
Butte County Board of Supervisors
California Association of Health Plans
California Association of Psychiatric Technicians
California Chamber of Commerce
California Hospital Association
California Labor Federation
California School Employees Association
Cal-Tax
Livermore Valley Joint Unified School District
Merced County Board of Supervisors
Spidell Publishing Inc.
Opposition
None on file
Analysis Prepared by : Myriam Bouaziz/Oksana Jaffe / REV. & TAX.
/ (916) 319-2098