BILL ANALYSIS Ó
SENATE GOVERNANCE & FINANCE COMMITTEE
Senator Lois Wolk, Chair
BILL NO: SB 1035 HEARING: 4/24/2014
AUTHOR: Huff FISCAL: Yes
VERSION: 4/10/2014 TAX LEVY: Yes
CONSULTANT: Bouaziz
PERSONAL INCOME TAXES: HEALTH SAVINGS ACCOUNTS
Conforms state law to federal law regarding Health Savings
Accounts (HSAs).
Background and Existing Law
Congress enacted the Medicare Prescription Drug,
Improvement, and Modernization Act of 2003 (Public Law
108-173), establishing HSAs, beginning in tax year 2004.
An HSA is defined 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. An HSA may be established when an
individual has a high deductible health plan (HDHP).
For taxable year 2014, 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 of no more than $6,350 in the
case of self-only coverage, and $12,700 in the case of
family coverage.
Federal law allows a deduction for contributions to HSAs.
Distributions from a HSA for qualified "medical expenses"
of the eligible individual, spouse or dependents are not
includible in gross income. Any balance in an HSA grows on
a tax-free basis.
A "qualified medical expense" includes 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
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the individual attains the age of 65. Medical expenses
paid via distributions that are excludable from income and
may not be claimed as medical expenses for purposes of
reporting itemized deductions.
Employer contributions to a HSA are excluded from income
and employment taxes. Eligible individuals include those
covered by high-deductible health plans and, in general,
not eligible for other health coverage.
The maximum aggregate annual HSA contribution for 2014 is
the lesser of: (a) 100% of the annual deductible under the
HDHP, or (b) $3,300 in the case of self-only coverage and
$6,550 in the case of family coverage. Those limits are
indexed for inflation. The maximum contribution is
increased by $1,000 per year for catch-up contributions for
persons over age 55. Contributions in excess of the
maximum contribution amount are generally subject to a 6%
excise tax.
A one-time contribution to an HSA of amounts distributed
from an individual retirement account (IRA) as a direct
trustee-to-trustee transfer are permitted. The transfer
amount is excluded from the gross income of the
accountholder and from the 10% penalty on early IRA
distributions.
California has not conformed to the federal tax treatment
of 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 IRAs 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 funds from IRAs will be
treated as income subject to tax, and potentially subject
to the 2% penalty for early distribution.
Proposed Law
SB 1035 conforms to federal law by allowing taxpayers to
deduct contributions to HSAs from income and allows
employers to exclude from an employee's gross income
employer HSA contributions, effective for taxable years
SB 1035 -- 04/10/14 -- Page 3
beginning on or after January 1, 2015. SB 1035 reduces the
disqualified distribution penalty applicable to HSAs from
the federal percentage of 20% to 2.5% for state purposes,
consistent with state law regarding Individual Retirement
Accounts (IRAs). The measure allows tax-free rollovers
from IRAs and MSAs to HSAs. SB 1035 also does not conform
to the federal 6% excise tax on excess contributions.
SB 1035 takes effect immediately as a tax levy and applies
to taxable years beginning on or after January 1, 2015.
State Revenue Impact
The Franchise Tax Board (FTB) estimates that this bill
would reduce General Fund revenues by $30 million in fiscal
year (FY) 2014-15, $55 million in FY 2015-16, and $55
million in FY 2016-17.
This estimate does not account for changes in employment,
personal income, or gross state product that could result
from this bill.
Comments
1. Purpose of the bill . According to the author,
"Tax-deductible HSAs help people plan ahead by saving for
future medical expenses on a tax-free basis. This gives
individuals more control of their own healthcare and
improves upon existing tax deductible savings options
because contributions to an employee's HSA can be made
without increasing the employee's taxable income.
Consistent with federal law, SB 1035 encourages the use of
HSAs by allowing for a state tax deduction for
contributions made to an HSA by, or on behalf of, an
eligible individual. In an era of skyrocketing, mandated
healthcare costs and an uncertain job market, SB 1035
offers an affordable option and more control to employees
in their healthcare choices. "
2. 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
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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 limitations
restricting eligibility. HSAs have no income restrictions
and are available to anyone.
3. 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 adjusted
gross income (AGI) of $60,000 or more. It appears that
HSAs disproportionately benefits 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."
4. The Recent Federal Health Care Reform and Its Effect on
HSAs . The Affordable Care Act (ACA), passed in March 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 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
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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%.
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.
Starting with 2014, businesses with 50 or more full-time
employees have to offer health insurance plans. Thus,
individuals and companies might opt for high-deductible
plans that 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.
5. California Adjustments . Only three states (among those
that impose an income tax) do not conform to the federal
HSA deduction rules: California, Alabama, 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.
6. 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 2015, 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 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.
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7. Conformity Bill. This bill fully conforms California
law to federal HSA provisions beginning with tax year 2015.
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) of 2010). It appears that the omnibus
California-federal conformity bill would be a more
appropriate vehicle for conforming to the federal HSA
provisions.
8. 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 nonqualified distribution and
is subjected to both income tax and a penalty for
nonqualified distributions. The transfer of funds from an
IRA is subject to income tax and might be similarly 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.
9. Related Legislation . HSA federal conformity
legislation has been proposed in every legislative session
since the federal law was enacted.
i. AB 2576 (Harkey), of the 2013-14 Legislative
Session, would have conformed California PIT law to
the federal HSA deduction rules. AB 2576 is currently
in the Assembly Committee on Revenue and Taxation.
ii. AB 1129 (Gaines), of the 2013-14 Legislative
Session, would have conformed California PIT law to
the federal HSA deduction rules. AB 1129 was held
under submission by the Assembly Committee on Revenue
and Taxation.
iii. AB 1510 (Garrick), of the 2011-12 Legislative
Session, would have conformed California PIT law to
the federal HSA deduction rules. AB 1510 was held by
the Assembly Committee on Revenue and Taxation.
iv. AB 854 (Garrick), of 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 by the Assembly
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Committee on Revenue and Taxation.
v. AB 1178 (Portantino), of the 2009-10 Legislative
Session, contained a provision similar to the
provisions of this bill. AB 1178 was held in the
Senate Appropriations Committee.
vi. AB 326 (Garrick), of 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 by the Assembly Committee on
Revenue and Taxation.
vii. SB 353 (Dutton), of the 2009-10 Legislative
Session, was similar to this bill. SB 353 was held in
the Senate Revenue and Taxation Committee.
viii.SB 1262 (Aanestad), of the 2009-10 Legislative
Session, was similar to this bill. SB 1262 was held
in the Assembly Rules Committee.
ix. SBx6 13 (Dutton), of the 2009-10 Legislative
Session, was similar to this bill. SBx6 13 was held
in the Senate Rules Committee.
10. FTB and Committee Staff Suggest the Following
Technical Amendments .
On page 2, line 25, after "relating to", strikeout "the
exception" and insert: exceptions.
On page 2, strikeout lines 31 to 37 inclusive.
On page 3, line 1, strikeout "SEC. 5", and insert: SEC. 4
On page 3, line 9, strikeout "SEC. 6", and insert: SEC. 5
On page 3, line 17, strikeout "SEC. 7", and insert: SEC.
6
On page 3, lines 28-29, strikeout "for"20 percent,"
contained therein.", and insert: for "10 percent",
contained therein.
On page 3, line 30, strikeout "SEC. 8", and insert: SEC.
7
SB 1035 -- 04/10/14 -- Page 8
On page 4, line 2, strikeout "medical savings accounts",
and insert: reports
On page 4, line 26, strikeout "SEC. 9", and insert: SEC.
8
Support and Opposition (04/24/14)
Support : The California Chamber of Commerce; The
California Chapter of the American College of Emergency
Physicians (California ACEP); California Taxpayers
Association; Peace Officers Research Association of
California (PORAC).
Opposition : The American Federation of State, County and
Municipal Employees (AFSCME); California Labor Federation.