BILL ANALYSIS                                                                                                                                                                                                    Ó



                                                                  AB 1510
                                                                  Page  1

          Date of Hearing:  April 9, 2012

                     ASSEMBLY COMMITTEE ON REVENUE AND TAXATION
                                Henry T. Perea, Chair
                 AB 1510 (Garrick) - As Introduced:  January 12, 2012

          Majority vote.  Tax levy.  Fiscal committee.
           
          SUBJECT  :  Income tax:  health savings accounts.

           SUMMARY  :  Conforms California tax law to federal tax law with 
          respect to health savings accounts (HSAs) for taxable years 
          beginning on or after January 1, 2013.  Specifically,  this bill  : 
           

          1)Allows eligible individuals to claim an above-the-line 
            deduction related to their contributions to HSAs in computing 
            their adjusted gross income (AGI).  

          2)Treats an HSA as a tax-exempt trust for tax purposes.  

          3)Excludes from the gross income of the employee any 
            contributions to an HSA made by an employer on the employee's 
            behalf.

          4)Includes HSAs as an approved option in a nontaxable cafeteria 
            plan for employee benefits created by an employer.

          5)Adopts federal changes enacted in 2006 that enhance the HSAs 
            by: 

             a)   Permitting the funds remaining upon termination of 
               health flexible spending arrangements or health 
               reimbursements arrangements to be transferred to HSAs.

             b)   Revising the annual deductible limitation on 
               contributions to HSAs to disregard the amount of the annual 
               deductible under the high deductible health plan (HDHP). 

             c)   Modifying the cost-of-living adjustments for Consumer 
               Price Index for a calendar year to use the 12-month period 
               ending on March 31 of the calendar year rather than the 
               12-month period ending on August 31, of the preceding 
               calendar year.









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             d)   Eliminating the requirement to prorate the amount of HSA 
               contribution based on the number of months of enrollment in 
               an HDHP for an individual who becomes covered under the 
               HDHP during the taxable year in a month other than January.

             e)   Enacting an exception to the requirement for comparable 
               contributions by employers to permit employers to make 
               larger contributions for non-highly compensated employees 
               than for highly compensated employees. 

             f)   Permitting participants to make a one-time distribution 
               from an individual retirement account (IRA) to fund an HSA.

             g)   Allowing a taxpayer to rollover the balance of an 
               existing Archer medical savings account (Archer MSA) to an 
               HSA for taxable years beginning on or after January 1, 
               2013, without penalty.

             h)   Imposing a penalty for a disqualified distribution equal 
               to 2 % of the distribution amount, rather than 10% as 
               provided by federal law.

             i)   Not conforming to the federal 6% excise tax on excess 
               contributions.

             j)   Imposing a $50 penalty for failing to make required 
               reports by the HSA trustee or other person providing an 
               individual with an HDHP.

          6)Takes effect immediately as a tax levy.

           EXISTING FEDERAL LAW  :

          1)The Medicare Prescription Drug, Improvement, and Modernization 
            Act of 2003 (Public Law 108-173) established HSAs, beginning 
            in tax year 2004.

          2)Defines an HSA as a tax-exempt trust or custodial account 
            created exclusively to pay for the qualified medical expenses 
            of the account holder and his/her spouse and dependents. 

          3)Allows any balance in an HSA to grow on a tax-free basis.

          4)Allows individuals with an HDHP, and no other health plan 
            other than a plan that provides certain permitted coverage, to 








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            establish an HSA. 

          5)Allows a deduction for contributions to HSAs when computing 
            AGI, if made by an eligible individual.  Distributions from an 
            HSA for qualified medical expenses of the eligible individual, 
            spouse or dependents are not includible in gross income.  

          6)Defines "qualified medical expenses" as medical expenses 
            including expenses for diagnosis, cure, mitigation, treatment, 
            or prevention of disease, including prescription drugs, 
            transportation primarily for and to such care, and qualified 
            long-term care expenses.  Distributions made for non-qualified 
            medical expenses are includible in gross income and also 
            subject to an additional 20% penalty, unless the distributions 
            are made after death, disability, or after the individual 
            attains the age of 65.  

          7)Specifies that medical expenses paid via distributions that 
            are excludable from income may not be claimed as medical 
            expenses for purposes of reporting itemized deductions.

          8)Excludes contributions to an HSA from income and employment 
            taxes if made by the employer.  Eligible individuals include 
            those covered by high-deductible health plans and, in general, 
            are not eligible for other health coverage.  

          9)Specifies the maximum aggregate annual contribution that may 
            be made to an HSA by or on behalf of the eligible individual, 
            which is the lesser a) 100% of the annual deductible under the 
            HDHP, or, b) $3,100 in the case of self-only coverage and 
            $6,250 in the case of family coverage for 2012 tax year.  
            Those limits are indexed for inflation.  
          10) For taxable year 2012, a HDHP is a health plan that has an 
            annual deductible that is at least $1,200 for self-only 
            coverage or $2,400 for family coverage and that has an 
            out-of-pocket expense limit that is no more than $6,050 in the 
            case of self-only coverage and $12,100 in the case of family 
            coverage.

          11)Allows employers to make larger HSA contributions for 
            non-highly compensated employees than for highly compensated 
            employees.  

          12)Includes the balance remaining in an HSA after the death of 
            the eligible individual in the gross estate of the decedent 








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            unless the decedent's spouse is the beneficiary of the HSA.  
            In that case, the HSA balance is deducted in computing the 
            taxable estate and the HSA passes to the surviving spouse, 
            subject to the general restrictions on, and taxation of, 
            distributions.

          13)Imposes numerous reporting requirements related to HSAs.  
            Employer contributions to the HSAs must be reported on the 
            employees Form W-2.  In addition, the trustee of the HSA must 
            report information on distributions, contributions, and other 
            required information to the Secretary of the Treasury.  Health 
            insurance providers must report information as required by the 
            Secretary of the Treasury.

          14)Authorizes a direct transfer of funds from the health 
            Flexible Spending Arrangements (FSAs) or Health Reimbursement 
            Arrangements (HRAs) to an HSA, but limits the amount that may 
            be transferred to an amount equal to the lesser of a) the 
            balance in the health FSA or HRA as of September 21, 2006, or, 
            b) the balance in the health FSA or HRA as of the date of the 
            transfer.  

          15)Authorizes a one-time contribution to an HSA of amounts 
            distributed from an IRA as a direct trustee-to-trustee 
            transfer.  Excludes the transfer amount from the gross income 
            of the accountholder and from the 10% penalty on early IRA 
            distributions. 

          16)Allows tax-exempt medical accounts called Archer MSAs.  The 
            Acher MSAs create a tax-exempt trust or custodial account for 
            the benefit of the account holder.  Rules similar to those for 
            IRAs apply to Archer MSAs.  Participants of Archer MSAs are 
            able to transfer or roll over their balances from an Archer 
            MSA to a new HSA.  This transfer specifically is not treated 
            as a disqualifying distribution.

          EXISTING STATE LAW:   Allows tax-benefited growth and use of 
          funds for qualified medical expenses, conforming to the federal 
          rules for Archer MSAs.  However, California has not adopted the 
          HSAs created as part of the 2003 federal legislation.  Due to 
          the lack of conformity, California taxpayers will be 
          disadvantaged financially if they roll over (transfer) their 
          Archer MSAs to HSAs.  Although specifically approved for federal 
          tax purposes, the transfer is a disqualified distribution for 
          California tax purposes, includable in income and subject to tax 








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          as well as an additional 10% penalty.  Similarly, transfers of 
          funds from IRAs will be treated as income subject to tax, and 
          potentially subject to the 2 % penalty for early distribution.

           FISCAL EFFECT  :  The Franchise Tax Board (FTB) staff estimate a 
          revenue loss from this bill of $33 million in fiscal year (FY) 
          2012-13, $65 million in FY 2013-14, and $70 million in FY 
          2014-15.

           


          COMMENTS  : 

          1)The author states, "Health Savings Accounts ÝHSAs] were 
            created with the passage of the 2003 Medicare bill signed by 
            President Bush.  HSA's allow for individuals to plan ahead for 
            qualified medical expenses on a tax free basis. HSA's have 
            also been used to defray the costs associated with High 
            Deductible Health Plans. HDHP's & HSA's give individuals 
            further flexibility when determining what type of health care 
            coverage is best for them.  HSA's and HDHPs offer consumers 
            security, affordability, flexibility and they are 100% 
            portable.  By encouraging contributions to HSAs we make 
            insurance that much more affordable. 

            "A recent Kaiser Family Foundation survey found that 79 
            percent of participants believe that allowing individuals to 
            shop around for the best prices they can get for health care 
            and health insurance would be very (37%) or somewhat (43%) 
            effective at controlling health care costs.

            "AB 1510 encourages the use of HSA's by allowing for a tax 
            deduction for contributions made to an HSA by, or on behalf 
            of, an eligible individual.  AB 1510 would extend the option 
            of contributing to any eligible HSA to employers who may be 
            interested in exploring cost-effective ways to help employees 
            defray medical expenses. 

            "Encouraging the uninsured to purchase health insurance by 
            allowing this tax deductible option, will reduce the number of 
            uninsured, and accordingly, reduce costs associated with 
            providing healthcare to the uninsured.  Reducing healthcare 
            costs will make healthcare insurance more affordable for all.  
            Furthermore, allowing employers to contribute to 








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            tax-deductible HSAs on behalf of their employees provides a 
            low-cost mechanism to offer their employees an additional 
            benefit. Many employers would provide some form of health 
            benefit to their employees if it were cost efficient. 

            "Additionally, Ýi]individuals who are self-employed tend to 
            have one of two health insurance options - a HSA or nothing - 
            by conforming with federal HSA provisions, small businesses 
            will benefit in two ways:  First, Ý] those who already 
            contribute to a HSA, will be able to keep more of their money, 
            which can then be put back into their business.  Second, those 
            who do not currently have health insurance will likely be 
            encouraged to contribute to a HSA due to the tax benefit.  
            This is good for small business, the individual and the State.

            "Further, lower income may appreciate a refundable tax credit 
            for health care expenses, while the middle class may be 
            convinced to obtain coverage if they can apply tax deductions 
            for health care expenses, including premiums.  These tax 
            incentives would be conditioned on individuals' maintaining at 
            least a HSA - compatible high deductible plan throughout the 
            year.  Allowing health insurers to develop a minimum benefits 
            plan will require additional legislation to afford the market 
            the flexibility to actually meet the needs of consumers.

            "This is a simple conformity measure, bringing California in 
            line with federal HSA provisions. Given our current healthcare 
            crisis and impending Federal changes, we should be creating 
            options for people to save for future healthcare costs 
            unknowns, and AB 1510 creates one such option."

           2)Arguments in Support  .  Proponents state that HSAs, when 
            combined with HDHPs, present an option for business to provide 
            some health insurance for employees rather than none at all.  
            According to the proponents, use of HSAs help individuals take 
            control of how their health care dollars are spent and enable 
            them to save for future medical expenses and retiree-health 
            expenses on a tax-free basis.  Proponents argue that, in fact, 
            HSAs improve upon existing tax-deductible saving options 
            because both the employer and employee may contribute to an 
            employee's HSA without increasing the employee's taxable 
            income.  Also, unspent funds roll over from year to year and 
            move with an employee.  

          Proponents also point out that HSAs provide one the fastest 








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            growing coverage options for those currently lacking health 
            insurance coverage.  Proponents argue that, in light of the 
            skyrocketing cost of healthcare, California taxpayers are 
            continually searching for help in easing the high price of 
            health services.  Finally, the proponents believe that this 
            measure, by providing conformity to federal tax laws, will 
            save California taxpayers much confusion and heartache in 
            filling out their state income tax forms. 

           3)Arguments in Opposition  .  Opponents state that this bill 
            amounts to a tax giveaway for holders of HSAs because they 
            already have the financial resources to afford health 
            insurance.  Opponents argue that HSAs in many cases "become a 
            tax shelter for the wealthy who can afford to stash large 
            amounts in an HSA and do not require frequent care."  
            According to the opponents, this bill would do nothing to make 
            health care more affordable for the uninsured and low-income 
            earners.  They argue that HSAs are bad health policy because 
            they encourage underinsurance by shifting cost risk to 
            consumers without adequate price transparency in the medical 
            sector, and high-deductible plans undercut basic health care 
            benefits, including reasonable cost sharing.

          Opponents also argue that HSAs actually limit consumer choice 
            and ultimately cost low- and middle-income workers more money 
            because HSAs must be coupled with HDHPs.  Opponents contend 
            that HDHPs are bad for workers as they discourage sick workers 
            and their families from seeking care for routine illnesses, 
            potentially leading to subsequent health care costs that are 
            much higher than they would have been with early treatments.  
            Opponents believe that this cycle of high barriers to care and 
            worsening illnesses hurts working families.  

          Additionally, opponents assert that HSAs hurt the health system 
            as a whole because the health system needs to spread its risk. 
             Taking healthy individuals out of the insurance pool 
            increases the cost to those in need of more extensive health 
            insurance.  Opponents also believe that this measure would 
            result in a revenue loss that could impact the provision of 
            critical firefighting and public safety services, at times 
            when California is facing a projected $9.2 billion budget 
            shortfall. 

            Lastly, opponents argue that the Patient Protection and 
            Affordable Care Act (ACA) gives California even more reason 








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            not to conform to the federal tax law on HSAs.  Opponents 
            argue that HSAs are justified as a cost-containment strategy 
            for health care costs.  However, opponents point that the ACA 
            contains a number of cost-containment strategies, one of which 
            is ensuring that individuals have access to affordable or 
            subsidized health plans.  Thus, because the health plans 
            required by the ACA have to meet standards for actuarial 
            value, cost-sharing limits, comprehensive coverage (that 
            includes essential health benefits), and free preventative 
            care, opponents contend there is no need for California to 
            conform to HSA federal tax law.  According to opponents, the 
            "ACA is a much more comprehensive strategy for 
            cost-containment that does not give tax privileges to those 
            that can afford ÝHSAs] while relegating those who cannot to 
            low-quality health plans".

           4)HSAs  :  Under federal law, individuals with a high deductible 
            health plan, and no other health plan other than a plan that 
            provides certain permitted coverage, may establish an HSA.  In 
            general, HSAs are tax-exempt trusts or custodial accounts 
            established exclusively to pay for the qualified medical 
            expenses of the account holder, his/her spouse and dependents. 
             Within certain limits, contributions to an HSA are 
            deductible.  An HSA is a savings account that provides for 
            tax-deductible deposits and allows tax-free withdrawals, as 
            long as the funds are used for qualified medical expenses.  In 
            contrast, a traditional IRA allows tax-deductible 
            contributions but subjects distributions to tax.  Further, in 
            the case of a Roth IRA, contributions to the account are 
            taxable, but qualified distributions are tax-free.  In 
            addition, both a traditional IRA and a Roth IRA have income 
            limitation restricting eligibility.  HSAs have no income 
            restrictions and are available to anyone.

           5)Tax Incentive for High-Income Taxpayers  .  In its 2008 report, 
            the United States (U.S.) Government Accountability Office 
            (GAO) found that the median income of tax filers reporting an 
            HSA contribution in 2005 was $139,000 and 59% of those tax 
            filers contributing to HSAs had an AGI of $60,000 or more.  It 
            appears that HSAs disproportionately benefit high-income 
            individuals.  According to the report, many HSA participants 
            appear to be using their accounts purely or primarily as a tax 
            shelter rather than paying for out-of-pocket health care 
            costs.  The GAO found that, "a stunning 41 percent of tax 
            filers reporting HSA contributions in 2005 did not withdraw 








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            any funds from their accounts at any time during the year."  
            In recent Congressional testimony, the GAO stated that "this 
            was consistent with the view held by industry experts that 
            many HSA users are people who primarily use their HSAs as a 
            tax-advantaged savings vehicle."

           6)The Recent Federal Health Care Reform and Its Effect on HSAs  .  
            The ACA passed in March of 2010 requires most citizens and 
            legal residents of the U.S. to have health insurance by 
            January 1, 2014.  The legislation outlines the minimum 
            coverage and essential health benefits that need to be 
            provided for a plan to qualify for the mandated coverage; 
            ultimately, these requirements could limit the types of plans 
            offered to individuals. 
             
             The ACA does not greatly affect HSAs.  Instead, the ACA 
            affected HSAs in two minor ways.  First, ACA Section 9003 
            established a new uniform standard for medical expenses. 
            Effective January 1, 2011, only prescribed medicines and drugs 
            are considered "qualifying medical expenses" and are subject 
            to preferred tax treatment.  Secondly, the ACA increased the 
            tax penalty on HSA distributions for unqualified medical 
            expenses from 10% to 20%.  Given the minor changes in HSAs 
            treatment under the ACA, previous policy objections to HSAs 
            have not yet been overcome.

            The ACA may reduce the need for HSAs given the expansion of 
            Medicaid coverage. Individuals who would have signed up for an 
            HSA may not do so if they are able to purchase more affordable 
            health care or are covered under Medicaid.  Conversely, the 
            ACA may also encourage the use of HSAs.  Assuming the ACA is 
            upheld, most people will be required to have health insurance 
            by 2014.  Businesses with 50 or more full-time employees will 
            have to offer health insurance plans.  Thus, individuals and 
            companies might opt for high deductible plans which can be 
            coupled with HSAs.  Some experts state that, HDHP coupled with 
            HSAs will be the most affordable plans that meet the 
            requirements for minimal essential coverage.

            On March 28, 2012, U.S. Supreme concluded a three day review 
            of the ACA.  During oral arguments, the high Court considered: 
             a) whether it was appropriate to hear the case before the 
            penalties for not obtaining health insurance take effect; b) 
            the constitutionality of the ACA's individual mandate; c) 
            whether the rest of the ACA will remain in effect if the 








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            individual mandate if found to be unconstitutional; and d) the 
            constitutionality of Medicaid's expansion.  A decision is 
            expected later this year.  However, because of the ACA's 
            minimal effect on HSAs, the Court's decision is not likely 
            significantly alter this policy analysis.

           7)California Adjustments  .  Currently, only three states (among 
            those that impose an income tax) do not conform to the federal 
            HSA deduction rules:  California, New Jersey, and Alabama.  
            Pennsylvania allows a deduction for employer's contribution 
            only.  Because California has not conformed to any of the 
            federal HSA provisions, a taxpayer taking a deduction on 
            his/her federal personal income tax return is required to 
            increase his/her AGI on the California personal income tax 
            return by the amount of that deduction.  In addition, any 
            interest earned on the HSA account must be added to the 
            taxpayer's AGI for California tax purposes, and any 
            contributions made by the taxpayer's employer to the HSA, must 
            be included in the taxpayer's AGI.

           8)Implementation Concerns  .  This bill does not address the 
            impact of HSAs created before the effective date of this bill. 
             Without addressing the tax treatment of HSAs created before 
                                   2012, there might be implementation concerns because part of 
            the HSA will be pre-tax dollars and part will be post-tax 
            dollars.  Additional legislation or regulations would be 
            required to provide guidance to the FTB with respect to 
            treatment of qualified and disqualified distributions from 
            such HSAs.  Because California is one of only three states 
            that have not adopted federal HSA deduction rules, there may 
            be implementation concerns from employees that move into 
            California from a conforming state.

          9)Conformity Bill.   This bill fully conforms California law to 
            federal HSA provisions beginning with tax year 2013.  
            California does not automatically conform to federal law but 
            instead considers each provision individually.  The last 
            California-federal conformity bill was enacted in 2010 ÝSB 401 
            (Wolk), Chapter 14, Statutes of 2010].  It appears that the 
            omnibus California-federal conformity bill would be a more 
            appropriate vehicle for conforming to the federal HSA 
            provisions. 

           10)Partial Conformity  .  An alternative step to full conformity 
            would be to remove the penalty associated with rollovers of 








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            Archer MSA and IRA funds, which are both allowed tax-free for 
            federal purposes.  As mentioned above, the Archer MSA rollover 
            is a disqualified distribution and is subjected to both income 
            tax and a penalty for disqualified distributions.  Similarly, 
            the transfer of funds from an IRA is subject to income tax and 
            might be an early withdrawal subject to a penalty (if the 
            transferor/IRA owner is less than age 59  when the transfer 
            is made).  California could choose to exempt those 
            distributions or transfers from penalty.

           11)Related Legislation  .  Committee staff notes that the issue of 
            conformity to federal HSA legislation has been proposed in 
            every legislative session since the federal law was enacted.  

            AB 854 (Garrick), introduced in the 2010-11 legislative 
            session, is nearly identical to this bill, but would have 
            applied to taxable years beginning on or after January 1, 
            2012.  AB 854 was held in this committee.

            AB 1178 (Portantino), introduced in the 2009-10 legislative 
            session, contained a provision similar to the provisions of 
            this bill.  AB 1178 was held in the Senate Appropriations 
            Committee. 

            AB 326 (Garrick), introduced in the 2009-10 legislative 
            session, is similar to this bill, but would have applied to 
            taxable years beginning on or after January 1, 2010.  AB 326 
            was held in this committee.

            SB 353 (Dutton), introduced a bill in the 2009-10 legislative 
            session, is similar to this bill.  SB 353 was held in the 
            Senate Revenue and Taxation Committee.

            SB 1262 (Aanestad), introduced a bill in the 2009-10 
            legislative session, is similar to this bill.  SB 1262 was 
            held in the Assembly Rules Committee.

            SBX6 13 (Dutton), introduced a bill in the 2009-10 legislative 
            session, is similar to this bill.  SBX6 13 was held in the 
            Senate Rules Committee.

            SBX8 47 (Dutton), introduced a bill in the 2009-10 legislative 
            session, is similar to this bill.  SBX8 47 was held in the 
            Senate Rules Committee.









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            AB 2292 (Garrick), introduced in the 2007-08 legislative 
            session, is similar to this bill, but would have applied to 
            taxable years beginning on or after January 1, 2008. AB 2292 
            was held in this committee. 

            AB 84 (Nakanishi/Smyth), introduced in the 2007-08 legislative 
            session, is similar to this bill.  AB 84, as amended on March 
            12, 2007, would have conformed to federal HSA provisions 
            starting with taxable year 2008.  AB 84 was held in this 
            committee. 

            AB 142 (Plescia), introduced in the 2007-08 legislative 
            session, is nearly identical to this bill.  That bill would 
            have conformed to federal HSA provisions starting with taxable 
            year 2008, which is the same as this bill; however, AB 142 
            specified a different nonconformity period than this bill.  AB 
            142 was held in the Senate Revenue and Taxation Committee. 

            AB 245 (DeVore), introduced in the 2007-08 legislative 
            session, is identical to AB 142.  AB 245 was held in this 
            committee.

            SB 25 (Maldonado and Runner), introduced in the 2007-08 
            legislative session, is identical to this bill.  SB 25 was 
            held in the Senate Revenue and Taxation Committee. 

            SBx1 10 (Maldonado), introduced in the 2007-08 legislative 
            session, is nearly identical to this bill, except that 
            conformity to the federal HSA provisions would apply starting 
            with taxable year 2006.  SBx1 10 failed to pass the Senate 
            Health Committee.  

          12)  FTB's Suggested Technical Amendments  .  The FTB staff 
            suggests the following technical amendments to address its 
            concerns regarding the unnecessary references. 

          AMENDMENT 1 

            On page 3, strikeout line 3.

            AMENDMENT 2 

            On page 3, line 24, strikeout "as added by", strikeout lines 
            25 through 26, inclusive, and insert:  as









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            AMENDMENT 3

            On page 3, line 30, strikeout "as added," strikeout line 31, 
            and on line 32, strikeout "and Modernization Act of 2003 
            (Public Law 108-173)."

            AMENDMENT 4

            On page 3, line 36, strikeout "as added", strikeout line 37, 
            and on line 38, strikeout "and Modernization Act of 2003 
            (Public Law 108-173)."

            AMENDMENT 5

            On page 4, line 13, strikeout, "as added by," strikeout line 
            14, on line 15, strikeout "and Modernization Act of 2003 
            (Public Law 108-173)," and on line 16, strikeout "health 
            savings accounts," and insert: reports.

           REGISTERED SUPPORT / OPPOSITION  :   

           Support 
           
          United Contractors
          California Taxpayers Association
          National Federation of Independent Business
          California Grocers Association
          Southwest California Legislative Council
          California Manufacturers & Technology Association
          California Association of Health Underwriters
          California Association of Health Plans
          California Chamber of Commerce

           Opposition 
           
          California Labor Federation
          Health Access California
          California Tax Reform Association
          California School Employees Association
           
          Analysis Prepared by  :  Rosailda Perez / Oksana Jaffe / REV.  & 
          TAX. / (916) 319-2098 











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