BILL ANALYSIS
AB 2041
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Date of Hearing: April 12, 2010
ASSEMBLY COMMITTEE ON REVENUE AND TAXATION
Anthony J. Portantino, Chair
AB 2041 (Villines) - As Amended: March 10, 2010
Majority vote. Tax levy. Fiscal committee.
SUBJECT : Personal income tax: Health Savings Account (HSA):
deductions
SUMMARY : Conforms to federal tax law with respect to health
savings accounts (HSAs) for taxable years beginning on or after
January 1, 2010. 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 his/her 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) Allows 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, 2010,
without penalty.
h) Does not conform to the federal 6% excise tax on excess
contributions.
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
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.
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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 10% tax, unless the distributions are
made after death, disability, or after the individual attains
the age of Medicare eligibility.
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) $3,050 in the case of self-only coverage and
$6,150 in the case of family coverage for 2010 tax year.
Those limits are indexed for inflation. Contributions in
excess of the maximum contribution amount are generally
subject to 6% excise tax.
10)Allows employers to make larger HSA contributions for
non-highly compensated employees than for highly compensated
employees.
11)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
taxable estate and the HSA passes to the surviving spouse,
subject to the general restrictions on, and taxation of,
distributions.
12)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
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insurance providers must report information as required by the
Secretary of the Treasury.
13)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.
14)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.
15)Allows tax-benefited 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 the Archer MSAs. Archer MSAs do not provide
the assistance needed by many working families and do not
receive widespread support or participation. As part of the
legislation enacting HSAs, participants of Archer MSAs are
able to transfer or rollover their balances from the Archer
MSAs 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 rollover (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 funds from IRAs
will be treated as income subject to tax, and potentially
subject to the 2 % penalty for early distribution.
FISCAL EFFECT : Franchise Tax Board (FTB) staff estimate a
revenue loss from this bill of $65 million in fiscal year (FY)
2010-11, $55 million in FY 2011-12, and $65 million in FY
2012-13.
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COMMENTS :
1)Author's Statement . The author states, "With California
unemployment at an astonishing 12%, thousands of Californians
have found themselves without their employer funded health
plan, leaving the pool of uninsured arguably higher than ever
before. By conforming California's tax laws to federal
standards, the state creates an affordable health insurance
option for this growing pool of uninsured, therefore, reducing
their cost to the state, and further encourages individuals to
save for future health related expenses."
2)Arguments in Support . Proponents state that, HSAs, when
combined with HDHPs, allow individuals to use pre-tax dollars
to pay their share of cost and are a tool to make increased
costs of health insurance more affordable. Proponents also
point out that HSAs provide one the fastest growing coverage
options for those currently lacking health insurance coverage.
With millions of Californians currently living without health
insurance, the tax exemption provided by AB 2041 would offer
more affordable health insurance options for the uninsured.
By simply conforming to current federal law, this bill would
help lower the number of uninsured while reducing uninsured
health related costs to the state. Proponents argue that,
while HSAs are not for everyone, Californians are
disadvantaged in several important ways. First, they will
continue to pay after-tax dollars for their share of costs of
health coverage, making coverage less affordable. Secondly,
because California is one of only a few states that do not
permit HSAs, California employees of multistate or
multinational employers will not enjoy the tax advantages of
HSAs, thereby paying more for the same medical coverage.
Finally, many Californians have mistakenly switched their MSA
accounts into an HSA account and now are hit with penalties
for early withdrawals. The proponents believe that this
measure will also save California taxpayers much confusion and
heartache in filling out their income tax forms.
3)Arguments in Opposition . Opponents state that this bill would
do nothing to make health care more affordable for the
uninsured and low-income earners and will not reduce the
number of uninsured people. Given that the primary difference
between and HSA and a regular savings account is that income
in the HSA is not taxed, the only attraction of an HSA is its
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tax deductibility - and more than half of the uninsured have
not income tax liability. Furthermore, HSA-compatible plans
still have high premiums, so that HSAs really only benefit
high-wage earners and do nothing to make health care more
affordable for the uninsured and low-income earners. Finally,
opponents argue that this measure would result in a revenue
loss that could impact the provision of critical firefighting
and public safety services.
4)Committee staff notes all of the following:
a) California adjustments . 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 in 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.
b) Tax incentive for high-income taxpayers . 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. 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. In its 2008 report, the
United States Government Accountability Office found that
the average adjusted gross household income for taxpayers
reporting an HSA contribution in 2005 was $139,000, as
opposed to $57,000 for all other filers, and 59% of those
tax filers contributing to HSAs had an income of $60,000 or
more. It appears that HSAs disproportionately benefit
high-income individuals.
c) New Federal Health Care Reform Act . The final health
insurance reform legislation, HR 3590, as amended by the
Reconciliation Bill (HR 4872), contains provisions
affecting the HSA and flexible spending accounts. By 2011,
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the maximum amount of a contribution to an HSA will be
limited to $2,500. The new law also caps FSA
contributions, standardizes the definition of qualified
medical expense, and places additional restrictions on how
health savings account funds may be used. Thus, if the
moneys from the health savings account are used improperly,
the HSA holder will face a 20% tax penalty. The additional
tax for Archer MSA withdrawals not used for qualified
medical expenses would increase from 15% to 20%.
d) 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 2010, 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 FTB with respect
to treatment of qualified and disqualified distributions
from such HSAs. Because California is one of only four
states that have not adopted HSAs, there may be
implementation concerns from employees that move into
California from a conforming state.
e) Partial Conformity . An alternative step to full
conformity available would be to remove the penalty
associated with rollovers of Archer MSA and IRA funds into
an HSA, which are both allowed tax-free for federal
purposes. As mentioned above, the Archer MSA rollover is a
disqualified distribution and 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 make those
distributions or transfers not subject to penalty.
f) Conformity Bill. This bill fully conforms California
law to federal HSA provisions beginning with tax year 2010.
California does not automatically conform to federal law
but instead considers each provision individually. The
last California-federal conformity bill was enacted in 2005
[AB 115 (Klehs), Chapter 691, Statutes of 2005]. It
appears that the omnibus California-federal conformity bill
would be a more appropriate vehicle for conforming to the
federal HSA provisions.
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5)Suggested Amendments . FTB staff notes that this bill contains
unnecessary references to a federal act, Section 1201 of the
Medicare Prescription Drug, Improvement, and Modernization Act
of 2003 (P.L. 108-173), to which California conforms as of the
specified date of January 1, 2005. FTB staff suggests a
number of technical amendments to remove the unnecessary
references, a copy of which is attached to the FTB's analysis
of this bill.
6)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.
SB x6 13 (Dutton), introduced in the current Sixth Extraordinary
Session, is similar to this bill. SB x6 13 is pending in the
Senate Rules Committee.
AB 326 (Garrick), introduced in the 2009-10 Legislative Session,
is similar to this bill. AB 326 was held in this Committee.
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 but it 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 similar to AB 142. AB 245 was held in this Committee.
SB 25 (Maldonado and Runner), introduced in the 2007-08
legislative session, is similar to this bill. SB 25 was held
in the Senate Revenue and Taxation Committee.
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REGISTERED SUPPORT / OPPOSITION :
Support
The National Association of Insurance and Financial Advisors of
California
The Association of California Life and Health Insurance
Companies
California Taxpayers' Association
The California Association of Health Underwriters
Opposition
California Labor Federation
California Professional Firefighters
Analysis Prepared by : Oksana Jaffe / REV. & TAX. / (916)
319-2098