BILL ANALYSIS �
SENATE GOVERNANCE & FINANCE COMMITTEE
Senator Lois Wolk, Chair
BILL NO: SB 1552 HEARING: 5/9/12
AUTHOR: Gaines FISCAL: Yes
VERSION: 4/17/12 TAX LEVY: Yes
CONSULTANT: Grinnell
TAX CONFORMITY FOR LONG-TERM CARE INSURANCE
Conforms state law to federal law relating to specified
insurance contracts.
Background and Existing Law
California law does not automatically conform to changes to
federal tax law, except under specified circumstances.
Instead, the Legislature must affirmatively conform to
federal changes. Conformity legislation is introduced
either as individual tax bills to conform to specific
federal changes, like the Regulated Investment Company
Modernization Act (AB 1423, Perea, 2011), or as one omnibus
bill that provides that state law conforms to federal law
as of a specified date, currently January 1, 2009 (SB 401,
Wolk, 2010). However, the Legislature modifies or excludes
some federal changes due to fiscal or policy reasons during
the legislative process - the state neither conforms to
federal tax treatment of Health Savings Accounts, nor does
it allow the Franchise Tax Board to assess the erroneous
claims for refund penalty as the Internal Revenue Service
can.
I. Annuity Contracts. Taxpayers can enter into deferred
annuity contracts with an insurance company where the
taxpayer buys the contract by paying periodic premium, in
exchange for a distribution later. Currently, earnings and
profits on amounts invested in a deferred annuity contracts
are not subject to tax during the deferral period.
However, once the taxpayer starts receiving annuity amounts
under the contract, any earnings that exceed contributions
are generally subject to tax. If the taxpayer withdraws
amounts before the annuity start date, the amounts are
generally included as ordinary income.
II. Life Insurance Contracts. Tax law treats life
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insurance policies more favorably than annuities by
generally not taxing earnings. However, policies must meet
either the cash accumulation test or the guidelines premium
tax and the corridor test. Federal law applies a
"seven-pay" test on modified endowment contracts, which
limits contributions in the first seven years. Failing to
meet the tests disqualifies the policy from the favorable
tax treatment.
III. Long-Term Care Insurance. A long-term care insurance
contract is an insurance contract that only provides
coverage for specified services, such as rehabilitation and
personal care services required by a chronically ill
individual. Generally, up to $300 per day may be
distributed for services from the policy tax-free.
Long-term care insurance may be included as a "rider" on or
part of a life insurance contract, allowing for the same
tax treatment for distributions made for long-term care
services.
In 2006, Congress enacted the Pension Protection Act (PPA),
which changed the tax treatment of annuity and life
insurance contracts. PPA's changes applied to contracts
entered into on or after January 1, 1996, but delayed
implementation until the 2009 taxable year. SB 401 did not
include these changes, likely due to the fiscal impacts.
Proposed Law
Senate Bill 1552 conforms state law to federal law relating
to annuity and life insurance contracts in six ways. The
measure takes effect in the 2012 taxable year:
The measure excludes from income any charge made
against the cash value of an annuity contract or the
surrender value of an insurance policy.
The bill allows for like-kind exchange treatment
for exchanging a life insurance contract, an endowment
contract, an annuity contract, or a qualified
long-term care insurance contract for a qualified
long-term care contract by providing that no loss or
gain is realized when taxpayers change one policy for
one that provides for long-term care.
SB 1552 ensures that an annuity contract or a life
insurance policy doesn't lose its preferable tax
status simply because it provides for long-term care
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insurance.
The measure disallows the medical expense deduction
for any payment made for coverage under a qualified
long-term care insurance contract if the payment is
made as a charge against the cash value of the annuity
contract or the surrender value of the insurance
contract.
The bill deems tax-exempt trust arrangements not to
be annuity contracts for the purposes of long-term
coverage.
SB 1552 excludes from the guideline premium test
any charges against the cash value of a life insurance
policy.
State Revenue Impact
According to FTB, revenue losses from SB 1552 are estimated
to be $30 million in 2012-13, $30 million in 2013-14, and
$38 million in 2014-15.
Comments
1. Purpose of the bill . According to the author, "SB 1552
will bring state law into full conformity regarding long
term insurance coverage ensuring equal tax treatment for
Californians. Additionally, more people being covered under
long term care policies will help relieve the strain on
state and federal programs like MediCal and Social Security
which will increase efficiency and expediency for others
who utilize these programs. "
2. Fitting In . Conformity helps taxpayers and tax
enforcement authorities alike by reducing differences
between state and federal tax codes. However, the process
for enacting conformity bills is difficult despite its
advantages and reduced tax compliance costs, because the
state may disagree with Congress's tax policy changes, and
conformity can also significantly impact state revenues -
the federal government can run large deficits and print
money if need be, but the state cannot. While the policy
elements of SB 1552 aren't controversial except to the
extent that the principal beneficiaries will be taxpayers
with sufficient income to be able to purchase annuities,
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life insurance contracts, and long-term care policies, its
effect on revenue may be. The Committee may wish to
consider whether SB 1552's conformity is worth the cost.
Support and Opposition (5/3/12)
Support : Association of California Life, Health, and
Insurance Companies, California Taxpayers' Association.
Opposition : California Tax Reform Association.