BILL ANALYSIS Ó
AB 854
Page 1
Date of Hearing: May 16, 2011
ASSEMBLY COMMITTEE ON REVENUE AND TAXATION
Henry T. Perea, Chair
AB 854 (Garrick) - As Introduced: February 17, 2011
VOTE ONLY
Majority vote. Tax levy. Fiscal committee.
SUBJECT : Income tax: health savings accounts.
SUMMARY : Conforms to federal tax law with respect to health
savings accounts (HSAs) for taxable years beginning on or after
January 1, 2012. 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
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
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calendar year.
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) Imposes a penalty for a disqualified distribution equal
to 2 % of the distribution amount, rather than 10% as
provided by federal law.
i) Does not conform to the federal 6% excise tax on excess
contributions.
j) Imposes a $50 penalty for failing 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)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.
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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.
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 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 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 2011 tax year.
Those limits are indexed for inflation.
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,
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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
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-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 20% 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.
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FISCAL EFFECT : The Franchise Tax Board (FTB) staff estimate a
revenue loss from this bill of $33 million in fiscal year (FY)
2011-12, $65 million in FY 2012-13, and $70 million in FY
2013-14.
COMMENTS :
1)The author states, "Health Savings Accounts ÝHSAs] were
created with the passage of the 2003 Medicare bill signed by
President Bush. HSA's allow for individuals to plan ahead for
qualified medical expenses on a tax free basis. HSA's have
also been used to defray the costs associated with High
Deductible Health Plans. HDHP's & HSA's give individuals
further flexibility when determining what type of health care
coverage is best for them. HSA's and HDHP's offer consumers
security, affordability, flexibility and they are 100%
portable. By encouraging contributions to HSA's we make
insurance that much more affordable.
"AB 854 encourages the use of HSA's by allowing for a tax
deduction for contributions made to an HSA by, or on behalf
of, an eligible individual. AB 854 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. Reducing healthcare
costs will make healthcare insurance more affordable for all.
Furthermore, allowing employers to contribute to
tax-deductible HSA's on behalf of their employees provides a
low-cost mechanism to offer their employees an additional
benefit. Many employers would provide some form of health
benefit to their employees if it were cost efficient.
"This is a simple conformity measure, bringing California in
line with federal HSA provisions. Given our current healthcare
crisis and impending Federal changes, we should be creating
options for people to save for future healthcare costs
unknowns, and AB 854 creates one such option."
2)Arguments in Support . Proponents state that HSAs, when
combined with HDHPs, present an option for business to provide
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some health insurance for employees rather than none at all.
According to the proponents, use of HSAs help individuals take
control of how their health care dollars are spent and enable
them to save for future medical expenses and retiree-health
expenses on a tax-free basis. In fact, HSAs improve upon
existing tax-deductible saving options because both the
employer and employee may contribute to an employee's HSA
without increasing the employee's taxable income. Also,
unspent funds roll over from year to year and move with an
employee.
Proponents also point out that HSAs provide one the fastest
growing coverage options for those currently lacking health
insurance coverage. Proponents argue that, in light of the
skyrocketing cost of healthcare, California taxpayers are
continually searching for help in easing the high price of
health services. Finally, the proponents believe that this
measure, by providing conformity to federal tax laws, will
save California taxpayers much confusion and heartache in
filling out their state income tax forms.
3)Arguments in Opposition . Opponents state that this bill
amounts to a tax giveaway for holders of HSAs because they
already have the financial resources to afford health
insurance. Opponents argue that HSAs in many cases "become a
tax shelter for the wealthy who can afford to stash large
amounts in an HSA and do not require frequent care."
According to the opponents, this bill would do nothing to make
health care more affordable for the uninsured and low-income
earners.
Opponents also argue that HSAs actually limit consumer choice
and ultimately cost low- and middle-income workers more money
because HSAs must be coupled with HDHPs. Opponents contend
that HDHPs are bad for workers as they discourage sick workers
and their families from seeking care for routine illnesses,
potentially leading to subsequent health care costs that are
much higher than they would have been with early treatments.
Opponents believe that this cycle of high barriers to care and
worsening illnesses hurts working families.
Additionally, opponents assert that HSAs hurt the health system
as a whole because the health system needs to spread its risk.
Taking healthy individuals out of the insurance pool
increases the cost to those in need of more extensive health
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insurance. Finally, the opponents believe that this measure
would result in a revenue loss that could impact the provision
of critical firefighting and public safety services, at times
when California is facing a projected $29 billion budget
shortfall.
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 and 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
limitation 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 . The recent federal
health care reform legislation will require most citizens and
legal residents of the U.S. to have health insurance by
January 1, 2014. The legislation outlines the minimum
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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. For example, all insurance policies
will be required to provide first dollar coverage for
preventive care services. While HSAs are currently allowed to
provide such coverage, in the future, all plans will be
required to do so. It is a matter of time before we know the
final outcome but some experts feel the "considerable
uncertainties" surrounding HSA offerings may be enough to
drive them out of business. Because significant uncertainty
exists regarding the future treatment of HSAs under federal
health care reform, previous policy objections to HSAs have
not yet been overcome.
7)California Adjustments . As of September 2010, only three
states (among those that impose an income tax) do not conform
to the federal HSA deduction rules: California, New Jersey,
and Wisconsin). The State of 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
2012, 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 the 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.
9)Conformity Bill. This bill fully conforms California law to
federal HSA provisions beginning with tax year 2012.
California does not automatically conform to federal law but
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instead considers each provision individually. The last
California-federal conformity bill was enacted in 2010 ÝSB 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
available 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 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 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, is 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.
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
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session, is nearly identical to this bill. That bill would
have conformed to federal HSA provisions starting with taxable
year 2008, which is 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, is identical to AB 142. AB 245 was held in this
committee.
SB 25 (Maldonado and Runner), introduced in the 2007-08
legislative session, is 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, is 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.
12)Suggested Technical Amendments . The FTB staff suggests the
following technical amendments to address the FTB's technical
concerns regarding the unnecessary references.
AMENDMENT 1
On page 2, strike out lines 1 to 16, inclusive, and insert:
SECTION 1. Section 17072 of the Revenue and Taxation Code is
repealed.
SEC. 2. Section 17072 is added to the Revenue and Taxation
Code, to read:
17072. (a) Section 62 of the Internal Revenue Code, relating
to adjusted gross income defined, shall apply, except as
otherwise provided.
(b) Section 62(a)(2)(D) of the Internal Revenue Code, relating
to certain expenses of elementary and secondary school
teachers, shall not apply.
(c) Section 62(a)(21) of the Internal Revenue Code, relating
to attorneys fees relating to awards to whistleblowers, shall
not apply.
(d) The deduction allowed by Section 17216, relating to health
savings accounts, is allowed in computing adjusted gross
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income.
(e) The amendments made to this section by the act adding this
subdivision shall apply only to taxable years beginning on or
after January 1, 2012.
AMENDMENT 2
On page 3, line 23, strikeout "as added by", strikeout lines
24 through 25, inclusive, and insert:
as
AMENDMENT 3
On page 3, line 29, strikeout "as added", strikeout line 30,
and on line 31, strikeout "and Modernization Act of 2003
(Public Law 108-173),"
AMENDMENT 4
On page 3, line 35, strikeout "as added", strikeout line 36,
and on line 37, strikeout "and Modernization Act of 2003
(Public Law 108-173)"
AMENDMENT 5
On page 4, line 13, strikeout "as added by", strikeout line
14, on line 15, strikeout "and Modernization Act of 2003
(Public Law 108-173)", and on line 16, strikeout "health
savings accounts, and insert:
Reports
REGISTERED SUPPORT / OPPOSITION :
Support
California Chamber of Commerce
California Grocers Association
California Taxpayers Association
Engineering & Utility Contractors Association
California Association of Health Underwriters
California Medical Association
Opposition
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American Federation of State, County & Municipal Employees,
AFL-CIO
California Labor Federation
California Professional Firefighters
California School Employees Association
California Tax Reform Association
Health Access California
Analysis Prepared by : Oksana G. Jaffe / REV. & TAX. / (916)
319-2098