BILL ANALYSIS �
AB 1129
Page 1
Date of Hearing: May 13, 2013
ASSEMBLY COMMITTEE ON REVENUE AND TAXATION
Raul Bocanegra, Chair
AB 1129 (Beth Gaines) - As Introduced: February 22, 2013
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
reimbursement arrangements to be transferred to HSAs.
b) 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.
c) 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
AB 1129
Page 2
HDHP during the taxable year in a month other than January.
d) 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.
e) Permitting participants to make a one-time rollover
distribution from an individual retirement account (IRA) to
fund an HSA.
f) 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.
g) Imposing a penalty for a disqualified distribution equal
to 2 % of the distribution amount, rather than 10% as
provided by federal law.
h) Not conforming to the federal 6% excise tax on excess
contributions.
i) Imposing a $50 penalty for failure 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)Establishes HSAs, beginning in tax year 2004, by enacting the
Medicare Prescription Drug, Improvement, and Modernization Act
of 2003 (Public Law 108-173).
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
establish an HSA.
AB 1129
Page 3
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 are 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 of (a) 100% of the annual deductible under
the HDHP, or, (b) $3,250 in the case of self-only coverage and
$6,450 in the case of family coverage for 2013 tax year.
Those limits are indexed for inflation.
10) For taxable year 2013, a HDHP is a health plan that has an
annual deductible that is at least $1,250 for self-only
coverage or $2,500 for family coverage and that has an
out-of-pocket expense limit that is no more than $6,250 in the
case of self-only coverage and $12,500 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
unless the decedent's spouse is the beneficiary of the HSA.
In that case, the HSA balance is deducted in computing the
AB 1129
Page 4
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, after December 20, 2006 and
before January 1, 2012, 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
as well as an additional 10% penalty. Similarly, transfers of
AB 1129
Page 5
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 $100 million in fiscal year (FY)
2013-14, $70 million in FY 2014-15, and $80 million in FY
2015-16.
COMMENTS :
1)The Author's Statement . The author states, "In 2003, federal
reforms allowed for tax-benefited growth and use of funds for
qualified medical expenses for individuals with a High
Deductible Health Plan (HDHP). California is one of only two
states that have not conformed to this tax code. Due to the
lack of conformity, California taxpayers are disadvantaged
financially by additional taxes or by being forced to choose a
plan with monthly premiums that they will not utilize.
"Health Savings Accounts (HSA) are a valuable tool for
individuals and families to mitigate the costs of healthcare.
The purpose of having an HSA is for an individual to have more
control over their financial future, and to plan, responsibly,
for the cost of their own healthcare. Under current
California law, the benefits an individual or family sees from
their HSA are severely limited, which in turn limits the
incentive of the family or individual to take ownership of
their own healthcare costs. Ultimately, this puts a greater
burden on the family or individual to pay for a health plan
with more limited benefits and less flexibility than an HDHP
with an HSA could offer."
2)Arguments in Support . Proponents state that health care is
expensive and that "tax deductions and tax-exempt health
savings accounts will help consumers tremendously." According
to the proponents, "the tax relief provided by AB 1129 will
assist consumers in providing preventative and wellness care
for themselves and their families."
Proponents also point out that AB 1129 would conform California
to the federal HSA rules, "thereby eliminating the need for
tax return adjustments to address state and federal
differences" and will help California taxpayers in filling out
their state income tax returns. Finally, proponents argue
that, by "ensuring California taxpayers are not penalized for
AB 1129
Page 6
investing in HSAs," this bill "will encourage more
Californians to take advantage of this very important savings
plan."
3)Arguments in Opposition . Opponents 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 that high-deductible
plans, to which HSAs are attached, "undercut basic protections
offered by comprehensive health plans, exposing consumers to
medical debt and even bankruptcy."
Opponents acknowledge that the Affordable Care Act (ACA) will
end the worst abuses by eliminating annual and lifetime
maximums and imposing maximum "out of pocket exposure."
However, for many consumers a maximum out of pocket cost of
$6,250 for individual or $12,500 for a family is genuinely
unaffordable."
Lastly, opponents assert that "studies have shown that HSAs
create a perverse incentive for people to forgo needed care,"
resulting in higher costs in the long-run when chronic
conditions are not treated. The opponents cite a 2012 study
by Harvard researchers published in the Journal of General
Internal Medicine, which found that "patients who had
high-deductible insurance were three to four times more likely
to delay or go without needed medical care because of cost,
and would delay care for children as well." The opponents
conclude that plans that create "an incentive to delay needed
care go against the foundation of the ACA, which mandates free
preventive care" and gives California new tools "to help
control costs, increase access to care, and the quality of
that care."
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
AB 1129
Page 7
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
limitations 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
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
establishes 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 increases 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
AB 1129
Page 8
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. 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.
7)California Adjustments . According to the FTB staff,
currently, only two states (among those that impose an income
tax) do not conform to the federal HSA deduction rules:
California and New Jersey. 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
2013, this bill would raise 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 two 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 [SB 401
(Wolk), Chapter 14, Statutes of 2010]. It appears that the
omnibus California-federal conformity bill would be a more
AB 1129
Page 9
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
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 1510 (Garrick), introduced in the 2011-12 legislative
session, was identical to this bill. AB 1510 was held under
submission in this Committee.
AB 854 (Garrick), introduced in the 2010-11 legislative
session, was 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, was 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 in the 2009-10 legislative
session, was similar to this bill. SB 353 was held in the
Senate Revenue and Taxation Committee.
SB 1262 (Aanestad), introduced in the 2009-10 legislative
session, was similar to this bill. SB 1262 was held in the
Assembly Rules Committee.
AB 1129
Page 10
SBX6 13 (Dutton), introduced in the 2009-10 legislative
session, was similar to this bill. SBX6 13 was held in the
Senate Rules Committee.
AB 2292 (Garrick), introduced in the 2007-08 legislative
session, was 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, was 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, was nearly identical to this bill. That bill would
have conformed to federal HSA provisions starting with taxable
year 2008, which was 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, was identical to AB 142. AB 245 was held in this
committee.
SB 25 (Maldonado and Runner), introduced in the 2007-08
legislative session, was 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, was 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.
REGISTERED SUPPORT / OPPOSITION :
Support
California Chiropractic Association
California Taxpayers Association
Opposition
AB 1129
Page 11
American Federation of State, County and Municipal Employees,
AFL-CIO
California Labor Federation
Health Access California
Analysis Prepared by : Oksana Jaffe / REV. & TAX. / (916)
319-2098