Tax Changes Looming for Employers and Individuals through Health Care Reform

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Although few details about a final reform bill are settled, one fact remains certain: if there is a bill, it will have to be paid for. While both chambers of Congress are counting on some form of health care savings to defray the overall cost, it is apparent that the final bill will contain some changes to the tax code in an effort to forestall increases to the federal deficit and meet Congressional pay-go rules. Employers, among others, are well advised to pay attention to the debate on financing health reform as Congress reconvenes.

Based on the three versions of the bill that each of the three House committees of jurisdiction (Education and Labor, Energy and Commerce, and Ways and Means) reported out before the recess, it is likely that the tax proposals in the final House bill will affect both individual taxpayers and employers. The provisions embraced by these committees would impose an additional tax, not to exceed the average national premium for self-only health care coverage, on individuals who do not have “acceptable health insurance,” as well as an additional tax on individuals whose modified adjusted gross income exceeds a certain threshold (“surtax”). The proposed surtax would apply on a graduated basis starting at 1% and increasing to 5.4% and would be imposed on families and individuals with a modified adjusted gross income in excess of $350,000 and $280,000, respectively. Additionally, larger employers (i.e., those with payrolls that exceed a specified payroll threshold) will be required either to satisfy particular “health coverage participation requirements,” the details of which have yet to be finalized, or to pay an excise tax, based on the employer’s wage payments, of up to 8% of the employer’s average wages.

In the Senate, the Health, Education, Labor and Pensions (“HELP”) Committee has passed its version of the bill, but the Finance Committee has yet to do so. The HELP Committee’s version adopts less onerous tax penalties on those not complying with the coverage mandate. It requires individual taxpayers to have a statutorily specified set of benefits (“qualifying coverage”) or, alternatively, to pay a penalty in an amount at least equal to 50% of the average annual premium for a basic health plan. Additionally, the HELP bill requires that employers with more than 25 employees either provide qualifying coverage and pay at least 60% of the monthly premiums for such coverage or, as a penalty for noncompliance, pay $750 for each full time employee or $375 for each part time employee—which assessments would be less than the “percentage of wages” tax adopted on the House side.

Given the tenuous state of negotiations among the Finance Committee’s “Gang of Six,” it is impossible to predict what bill, if any, will ultimately emerge from the Committee. In particular, it is uncertain whether the Finance Committee will adopt an employer mandate or penalize employers that do not offer acceptable coverage. One alternative to the approaches adopted by the House committees and HELP is a so-called “free rider” provision. This condition would require employers to reimburse the government for the cost of government-subsidized health care coverage obtained by their low-income employees under certain circumstances.

Tax-based revenue raisers are still very much the subject of negotiations within the Senate Finance Committee. Serious consideration is being given to levying a tax on insurance companies that offer insurance policies whose value exceeds a certain threshold, on the theory that the tax would both raise revenue and help hold down costs (by discouraging high-end policies that push up demand and prices). Other tax provisions that have been mentioned and may appear in the Finance Committee’s final bill include: a limitation on or an elimination of the exclusion from taxable wages for employer-provided health care (e.g., insurance and medical expenses), a further limitation on the itemized deduction for medical expenses, and a ceiling on pre-tax health flexible spending account contributions or a limitation on the items eligible for reimbursement under those accounts.

A number of tax proposals have come and gone over the course of the health care reform debate this summer. The proposals discussed above, while far from certain, appear to reflect the direction that debate is now headed. Stay tuned for further developments once Congress reconvenes after Labor Day. If you would like to discuss the potential tax consequences of the various health proposals, please feel free to contact a member of our Tax & Benefits department or your regular Ropes & Gray advisor.