BILL ANALYSIS �
AB 2576
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Date of Hearing: April 21, 2014
ASSEMBLY COMMITTEE ON REVENUE AND TAXATION
Raul Bocanegra, Chair
AB 2576 (Harkey) - As Introduced: February 21, 2014
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, 2014. 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 an employee's gross income 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.
c) Eliminating the requirement to prorate the amount of HSA
contribution based on the number of months of enrollment in
a high-deductible health plan (HDHP) for an individual who
becomes covered under the HDHP during the taxable year in a
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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 20% 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 "HAS" 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 individuals with an HDHP, and no other health plan
other than a plan that provides certain permitted coverage, to
establish an HSA.
4)Allows a deduction for contributions to HSAs when computing
AGI, if made by an eligible individual. Distributions from an
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HSA for qualified "medical expenses" of the eligible
individual, spouse or dependents are not includible in gross
income.
5)Allows any balance in an HSA to grow on a tax-free basis.
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, for the 2014 taxable year, 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 for 2013 tax year. 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.
10) 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 that is no more than $6,350 in the
case of self-only coverage and $12,700 in the case of family
coverage.
11)Allows employers to make larger HSA contributions for
non-highly compensated employees than for highly compensated
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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
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
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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 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 $80 million in fiscal year (FY)
2014-15, $55 million in FY 2015-16, and $55 million in FY
2016-17.
COMMENTS :
1)The Author's Statement . The author states, "AB 2576 would
bring California into conformity with federal tax law
regarding health savings accounts by providing a tax deduction
based on contributions. California is currently one of only
three states that do not conform.
"AB 2576 encourages the use of HSAs by allowing for a tax
deduction for contributions made to an HSA by, or on behalf
of, an eligible individual. AB 2576 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."
2)Arguments in Support . Proponents state that since their
inception in 2003, HSAs "have helped make healthcare more
affordable for working families by allowing them to pay lower
premiums under a high-deductible plan, while saving money for
medical emergencies in a tax-advantaged accounts." The
utilization of HSAs has increased with the rising costs of
healthcare, according to a 2007 survey conducted by America's
Health Insurance Plans. The proponents predict that, with some
"healthcare premiums estimated to rise by as much as 41
percent under the Affordable Care Act [ACA], more Californians
likely will look to high-deductible plans and HSAs to mitigate
these cost increases." The proponents argue that AB 2576
would make HSA-qualified plans offered through CoveredCA more
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affordable and could "encourage more uninsured individuals to
purchase health coverage, thereby reducing State costs
associated with providing healthcare to the uninsured."
Proponents also point out that AB 2576 would conform California
to the federal HSA rules, thereby eliminating the need for
many tax return adjustments to address state and federal
differences and will help California taxpayers in filling out
their state income tax returns. Finally, proponents state that
this bill "would ease compliance for taxpayers, and facilitate
administration and enforcement by the state's tax agencies -
saving both parties time and money."
3)Arguments in Opposition . Opponents argue that "HSAs are bad
health policy because they encourage underinsurance by
shifting cost risk to consumers," and that high-deductible
plans, accompanied by HSAs, "work well for higher income
taxpayers but not for those of low or moderate income who lack
the ability to accumulate assets and do not benefit from the
same degree of tax savings as higher income individuals."
The opponents also state that HSAs are "often paired with high
deductible health plans (HDHP), which are promoted as a
strategy to reduce health care spending. However, HSAs and
HDHP are most effective at reducing utilization of health
care, rather than addressing the root program of the rising
cost of care."
Opponents acknowledge that the Affordable Care Act (ACA)
contains some "provisions for containing health care costs and
increase quality for better health outcomes for all
Californians." However, as "the policy makers work to
implement comprehensive strategies for health care value, the
state should not reward failed policies, like HSAs, with a tax
preference."
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 "families and individuals
enrolled in high-deductible health insurance plans delay or
forgo health care for chronic conditions at higher rates than
those on traditional plans."
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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
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 adjusted gross income (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 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.
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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
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.
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
2014, 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
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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 2014.
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
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 1129 (Gaines) would have conformed California PIT law to the
federal HSA deduction rules. AB 1129 was held under
submission in this Committee.
12)Related Legislation .
a) AB 1510 (Garrick), of the 2011-12 Legislative Session,
was identical to this bill. AB 1510 was held in this
Committee.
b) 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
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854 was held in this Committee.
c) 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.
d) 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 in this Committee.
e) 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.
f) SB 1262 (Aanestad), of the 2009-10 Legislative Session,
was similar to this bill. SB 1262 was held in the Assembly
Rules Committee.
g) SBx6 13 (Dutton), of the 2009-10 Legislative Session,
was similar to this bill. SBx6 13 was held in the Senate
Rules Committee.
REGISTERED SUPPORT / OPPOSITION :
Support
California Association for Health Services at Home (CAHSAH)
California Association of Health Underwriters (CAHU)
California Association of Joint Powers Authorities (CAJPA)
California Chamber of Commerce
California Chapter of the American College of Emergency
Physicians
California Taxpayers Association
Opposition
American Federation of State, County and Municipal Employees
(AFSCME), AFL-CIO
California Labor Federation
California Tax Reform
Health Access California
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Analysis Prepared by : Oksana G. Jaffe / REV. & TAX. / (916)
319-2098