BILL ANALYSIS Ó AB 242 Page 1 Date of Hearing: March 21, 2011 ASSEMBLY COMMITTEE ON REVENUE AND TAXATION Henry T. Perea, Chair AB 242 (Committee on Revenue and Taxation) - As Amended: March 14, 2011 VOTE ONLY Majority vote. Tax levy. Fiscal committee. SUBJECT : Income tax conformity: federal health care. SUMMARY : Conforms several provisions of the Personal Income Tax (PIT) Law to specified provisions of the federal Patient Protection and Affordable Care Act of 2010 (PPACA) and the Health Care and Education Reconciliation Act of 2010 (HCERA). Specifically, this bill : 1)Provides that, for taxable years beginning on or after January 1, 2013, a simple cafeteria plan created by a certain small employer for its employees would be treated as having satisfied the nondiscrimination rules of a classic cafeteria plan; 2)Allows small employers to offer exchange-participating health plans through cafeteria plans effective in 2014. 3)Increases, for taxable years beginning on or after January 1, 2010, the amount of qualified adoption expenses excludable from an employee's gross income by $1,000. 4)Excludes from income certain qualified health care benefits provided after March 30, 2010, to a member of an Indian tribe, the member's spouse, or the member's dependents. 5)Excludes from a qualified employee's income the value of a specified free-choice voucher if it is used to purchase a health plan, and allows the employer to deduct the value of the voucher as compensation for personal services actually rendered. AB 242 Page 2 6)Excludes from gross income and the alternative minimum taxable income, for taxable years beginning on or after January 1, 2009, a federal grant for a qualifying therapeutic discovery project undertaken by the taxpayer in a tax year beginning in 2009 or 2010. 7)Excludes from income, for taxable years beginning on or after January 1, 2010, certain payments received by an individual taxpayer under the National Health Service Corps loan repayment or forgiveness programs. EXISTING FEDERAL LAW : 1)Imposes certain "non-discrimination" requirements on cafeteria plans and certain qualified benefits to prevent discrimination in favor of highly-compensated individuals as to eligibility for benefits and to actual contributions and the amount of benefits provided. Provides, for taxable years beginning on or after January 1, 2011, a safe harbor from the nondiscrimination requirements of a cafeteria plan for certain small employers. 2)Excludes from taxation certain qualified benefits under a cafeteria plan and provides that reimbursement or direct payment for the premiums for coverage under any qualified health plan offered through an exchange is a qualified benefit under a cafeteria plan if the employer is a qualified employer. 3)Provides an exclusion from employee's gross income for qualified adoption expenses paid or reimbursed by an employer under an adoption assistance program. For taxable years beginning on or after January 1, 2010, the maximum exclusion was increased to $13,170 per eligible child. 4)Provides an exclusion from income for certain health care benefits, including the value of specified Indian tribe health care benefits provided after March 30, 2010. 5)Excludes from an employee's income the value of contributions made by his/her employer to the employee's health care and allows the employer to deduct the contributions. It also excludes from employee's income free choice vouchers and allows the employer a deduction for the vouchers. AB 242 Page 3 6)Excludes from income any grant received in lieu of a tax credit for a qualified therapeutic discovery project. 7)Excludes from gross income an amount from the forgiveness of certain student loans, to the extent that the forgiveness is contingent on the student's working for a certain period of time in certain professions for any of a broad class of employers. Modifies this exclusion for amounts received under the National Health Service Corps loan repayment program or certain state loan repayment programs. EXISTING STATE LAW : 1)Conforms, for taxable years beginning on or after January 1, 2010, to the federal tax exclusion for qualified adoption expenses paid or reimbursed by an employer under an adoption assistance program. 2)Conforms to the general federal welfare doctrine and the exclusion of certain health care benefits from gross income. Exempts from taxation income received by an Indian tribal member who lives in that tribe's Indian country and such income is sourced in the tribal member's Indian country. 3)Excludes from income an employer's contributions for its employee's health care and allows employers to deduct the contributions. FISCAL EFFECT : The Franchise Tax Board (FTB) staff estimates that this bill will result in an annual loss of approximately $4 million in fiscal year (FY) 2010-11, $3 million in FY 2011-12, $461,000 in FY 2012-13, and $55.5 million in FY 2013-14. COMMENTS : Committee staff notes all of the following: 1)Establishment of Simple Cafeteria Plans for Small Businesses . Under existing law, an employer may establish a "cafeteria plan" - a separate written plan under which all participants are employees and are permitted to choose among at least one taxable benefit (e.g., current cash compensation) and at least one "qualified benefit". "Qualified benefits" are employer-provided benefits that are not taxable, such as, for example, group term life insurance coverage not in excess of $50,000 and benefits under a dependent care assistance program. Cafeteria plans and certain qualified benefits are AB 242 Page 4 subject to non-discrimination requirements. The basic purpose of those requirements is to prevent the provision of disproportionate benefits to highly-compensated employees. A failure to satisfy the nondiscrimination rules, generally, results in a loss of the tax exclusion by the highly-compensated individuals. For taxable years beginning on or after January 1, 2013, the PPACA (Public Law 111-148) allows certain small employers to provide a simple cafeteria plan for their employees, under which the nondiscrimination rules of a classic cafeteria plan would be treated as satisfied. A small business is an employer that, during either of the two preceding years, employed an average of 100 or fewer employees on business days. This bill would conform California's income tax law to the federal change under the PPACA to provide small employers a safe harbor from the nondiscrimination requirements of a cafeteria plan. The safe harbor would apply to taxable years beginning on or after January 1, 2011. 2)Offering of Exchange-Participating Qualified Health Plans Through Cafeteria Plans . For taxable years beginning after December 31, 2013, reimbursement or direct payments for the premiums for coverage under any qualified health plan offered through an exchange is a qualified benefit under a cafeteria plan if the employer is a qualified employer (Section 1515 of the PPACA). A qualified employer, generally, is a small employer that elects to make all its full-time employees eligible for one or more qualified plans offered in the small group market through an Exchange. This bill would conform California's tax laws to the federal definition of "qualified benefits" to include reimbursement and direct payments for the premiums for qualified health plan offered through an Exchange under a qualified employer's cafeteria plan. 3)Adoptions Assistance Exclusion . Under federal tax law, an employee may exclude from his/her gross income qualified adoption expenses paid or reimbursed by an employer under an adoption assistance program. The PPACA increased the amount of qualified adoption expenses excludable from gross income to $13,170, for taxable years beginning on or after January 1, 2010. The maximum amount is phased out ratably for taxpayers with modified adjusted gross income between $182,520 and $222,520. AB 242 Page 5 4)Health Care Benefits of Indian Tribe Members . Under the PPACA, qualified health care benefits provided to a member of an Indian tribe, the member's spouse, or the member's dependents are excludable from the member's gross income, for benefits and coverage provided after March 30, 2010. The exclusion applies to the value of a) health services or benefits provided or purchased by the Indian Health Service (HIS) through a grant to or a contract or compact with an Indian tribe or tribal organization, or through programs of third parties funded by the HIS; b) medical care provided by an Indian tribe or tribal organization to a member of an Indian tribe, including the member's spouse or dependents; c) accident or health plan coverage provided by an Indian tribe or tribal organization for medical care to a member of an Indian tribe, including the member's spouse or dependents; and d) any other medical care provided by an Indian tribe or tribal organization that supplements, replaces, or substitutes for the programs and services provided by the federal government to Indian tribes or Indians. This bill would allow the same tax treatment for those benefits under the PIT Law. 5)Free Choice Vouchers . Under the PPACA, for taxable years beginning on or after January 1, 2014, an employer who offers minimum essential coverage to its employees through an employer-sponsored plan must provide employees, who choose not to participate in the employer's health plan, with vouchers that can be used to purchase health plans on the exchange. Only employees who must contribute more than 8% of income for the minimum employer-sponsored plan, and whose total household income does not exceed 400% of the poverty line are eligible for free choice vouchers. The value of the voucher is equal to the employer's contribution to its health plan. The federal tax law excludes from an employee's income the value of contributions made by employers to the employee's health care and allows employers to deduct the contributions. It also provides that free choice vouchers are excluded from employee's income and are allowed as a deduction to the employer. This bill, for purposes of the state income tax laws, would exclude the value of a free choice voucher from an employee's income to the extent it is used to purchase a health plan, and would allow the employer to deduct the value of the voucher as AB 242 Page 6 compensation for personal services actually rendered. 6)Therapeutic Discovery Project Grants . Under the PPACA, a 50% tax credit is allowed as part of the federal investment credit for eligible taxpayers' qualified investment with respect to any qualifying therapeutic discovery project made in a tax year beginning in 2009 or 2010. The federal tax credit is available only to companies with 250 or fewer employees. Companies can apply to have their research projects certified as eligible for the credit or grant - in lieu of the credit - which can be excluded from the taxpayer's gross income. A "qualifying therapeutic discovery project" is a project that is designed to develop a product, process, or therapy to diagnose, treat or prevent diseases and afflictions, as specified. This provision allocates $1 billion for the program during 2009 and 2010. This bill would provide an exclusion from income for such grants under California's tax laws, for taxable years beginning on or after January 1, 2009. 7)Student Loan Repayment Program. Gross income generally includes the discharge of indebtedness of the taxpayer. Under an exception to this general rule, gross income does not include any amount from the forgiveness of certain student loans, provided that the forgiveness is contingent on the student's working for a certain period of time in certain professions for any of a broad class of employers. The new federal law (Internal Revenue Code Section 108) modifies the gross income exclusion for amounts received under the National Health Service Corps loan repayment program and certain state loan repayment programs to include any amount received by an individual under any state loan repayment or loan forgiveness program that is intended to provide for the increased availability of health care services in underserved or health professional shortage areas (as determined by the state). Thus, under the PPACA, for taxable years beginning on or after January 1, 2010, individuals are allowed to exclude from income certain payments received under the National Health Service Corps loan repayment or forgiveness programs. This bill would also exclude from gross income those types of payments for purposes of the PIT Law. REGISTERED SUPPORT / OPPOSITION : AB 242 Page 7 Support California Society of Enrolled Agents Opposition None on file Analysis Prepared by : Oksana Jaffe / REV. & TAX. / (916) 319-2098