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© Employee Benefit Research Institute 2009 The Tax Treatment of Health Insurance and Out-of-Pocket Expenses Paul Fronstin, Ph.D. Director, Health Research and Education Program Employee Benefit Research Institute Copyright© - Employee Benefit Research Institute Education and Research Fund, 1978-2009. All rights reserved. The information contained herein is not to be construed as an attempt to provide legal, accounting, actuarial, or other such professional advice. Permission to copy or print a personal use copy of this material is hereby granted and brief quotations for the purposes of news reporting and education are permitted. Otherwise, no part of this material may be used or reproduced without permission in writing from EBRI-ERF.
© Employee Benefit Research Institute 2009 Current Tax Treatment For Employers Deductible as Business Expense –Employer contributions to employees health insurance are treated like compensation and deductible as a business expense No FICA Tax –The employer does not pay the employers share of FICA tax on amounts contributed to workers health insurance –Should mean employers are indifferent between wages and benefits, but employers pay payroll tax on wages, not on benefits
© Employee Benefit Research Institute 2009 Current Tax Treatment For Workers (Including Self-Employed) No Income and FICA Tax –Employer contributions to workers health insurance are excluded from income for income and FICA tax purposes Workers do not pay income and FICA taxes on employer contributions –Worker contributions for health insurance through a salary reduction arrangement reduces the workers taxable income for income and FICA tax purposes Worker payments to FSAs to pay out-pf-pocket expenses reduce taxable income
© Employee Benefit Research Institute 2009 Health Savings Accounts (HSAs) Tax preferred contributions, build up and distributions Contributions to HSA (regardless of source) reduce taxable income –Limited to $2,900 individual, $5,800 family Must have qualified HDHP –Deductible: $1,150 individual, $2,300 family –OOP Max: $5,800 individual, $11,600 family Catch-up contributions allowed for individuals 55+ HSA balances rollover Interest or earnings on HSA accumulate tax free Distributions for qualified medical expenses are tax free Contributions not subject to 7.5% AGI test
© Employee Benefit Research Institute 2009 Current Tax Treatment For Individuals Individuals who purchase health insurance on own: –Premiums and OOP expenses are tax deductible only if they exceed 7.5% of AGI –Only portion above 7.5% of AGI is tax deductible –Taxpayer must itemize to get deduction –Only 6% of all tax returns tax such a deduction HSA contributions not subject to AGI rule
© Employee Benefit Research Institute 2009 Changing Tax Treatment: Bipartisan Policy Goal: Foregone Tax Revenue Political and budgetary target –Tax credits –Tax caps FY2009 budget –$175 billion in foregone federal income tax revenue JTC (FY2009) –$147 billion Employer savings from not paying Social Security and Medicare taxes: $73 billion in 2006 State and local government income tax savings
© Employee Benefit Research Institute 2009 Theory on Current Tax Treatment Premiums excluded from taxable income OOP not excluded from taxable income –except through FSA or HSA Workers prefer health benefits with low cost sharing Low cost sharing leads to overuse of health care services, which drives up premiums and makes insurance less affordable (especially among low income)
© Employee Benefit Research Institute 2009 Proposals to Limit Tax Exclusion Presidents Advisory Panel on Federal Tax Reform (Nov. 2005) Exclusion limited to $5,000 individual, $11,500 family Sen. Baucus (D-MT) (Nov. 2008) No details other than mentioning limit or cap on tax exclusion base on value of health benefits and/or on a persons income. Exclusion can be based on a sliding scale of income
© Employee Benefit Research Institute 2009 Implementing a Tax Cap: Implications for Employers Employers report value of benefit on W-2 by Jan. of following year Employers would continue to offer benefits as they do now Workers would continue to get benefits as they do now Workers with health benefits below the cap would see no change Workers with health benefits above the cap would pay taxes on the amount above the cap –Those with a choice of plan would either Pay tax on excess value of benefits Choose less costly plan to avoid tax –Those without a choice of plan would either Pay tax on excess value of benefits Demand that employers reduce premium
© Employee Benefit Research Institute 2009 Implementing a Tax Cap: Implications for Employers Fully Insured Plans Employer pays premium to insurer for each worker coverage Premium is the same for each worker covered, regardless of worker demographics and health care use Premiums known long before W-2 is filed Self-insured Plans Premiums not paid to insurer Employers acts like own insurer Usually contracts with insurer or TPA Would have to determine Value of health benefits to report on W-2
© Employee Benefit Research Institute 2009 Valuing Benefits under a Self-Insured Plan COBRA premium – employers use actuary to estimate anticipated claims for the upcoming year in order to set a premium. Domestic partner (DP) benefits – premiums already calculated for tax purposes. –DP benefits not tax preferred. Employers must impute income and report on W- 2. Premium equivalent based on unique characteristics of worker –Age, health status, geographic region, benefits package, family status, etc Premium equivalent based on workers use of health care services. COBRA and DP premiums known by January of following year. Premium equivalent would be unknown.
© Employee Benefit Research Institute 2009 Valuing Benefits under a Self-Insured Plan Questions: On-site clinics and programs EAPs for mental health benefits Flu shots Fitness centers Smoking Cessation Disease prevention Disease management Direct payments to workers following good health habits FSA contributions HSA contributions (outside scope of employer, no tax withheld) Retirees
© Employee Benefit Research Institute 2009 Sec. 89 of Tax Reform Act (1986) Lessons Employers required to value benefits based on the benefits that workers received rather than on the benefits that were made available to them. Sec. 89 was repealed because after the regulations were released employers found it too onerous and expensive to do the benefits valuation and subsequent nondiscrimination testing Raises question on requirements for valuing benefits COBRA or DP benefits may be allowed Employers may be required to use benefits received rather than benefits available Congress could be silent Regulations may address Employers may seek IRS letters of determination
© Employee Benefit Research Institute 2009 Implication of Cap for Workers and Retirees How benefits are valued will affect workers differently. Equity issues will be created Premiums can be above the tax cap – all independent of comprehensiveness of benefits Firm size Geographic region Group composition Retirees Could not use employers to spread additional withholding across the year
© Employee Benefit Research Institute 2009 Tax Credits Replace current exclusion from income with a tax credit Could extend tax credit to coverage purchased in nongroup market Would benefit low income workers Would start the unraveling of the employment-based health benefits system
© Employee Benefit Research Institute 2009 Discussion Paul Fronstin www.ebri.org www.choosetosave.org
© Employee Benefit Research Institute 2009 1100 13 th Street NW Washington, D.C. 20005 202-659-0670 www.ebri.org www.choosetosave.org www.ebri.org
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