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(From the February 11, 2008 issue of Deloitte's Washington Bulletin, a periodic update of legal and regulatory developments relating to Employee Benefits.)
For good or ill, in the last year of any president's term, not much newly-introduced legislation from the White House sees the light of day. The Bush Administration's fiscal year 2009 proposed revenue sources outlined in the General Explanations of the Administration's FY 2009 Revenue Proposals, released by the Treasury Department on February 5, 2008, appears to be headed down the same road, given other economic concerns and looming elections in the fall. Nevertheless, the "The Blue Book," as it is generally called, includes summaries of all revenue proposals in the Administration's proposed FY 2009 budget.
Permanence or Extension of Existing Laws and Introduction of New Items
The Pension Protection Act of 2006 (PPA) permanently extended the extensive pension provisions included in the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA). Treasury's Blue Book recommends that Congress permanently extend all the other tax provisions scheduled to sunset on December 31, 2010, including the rest of EGTRRA and the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA). (This would include two other laws expanding the expensing of property and lowering tax rates on qualifying dividends and capital gains enacted in 2005 and 2007.) In addition, the President's FY '09 budget includes a number of proposals on employee benefits, most of which have been submitted in past years.
Recommending AMT Relief
Among the broadest relief recommended by Treasury would be an extension of relief from the alternative minimum tax. The past minimum tax relief expired at the end of 2007. Without an extension, as of tax year 2008, the AMT would apply to the permanent income levels of $33,750 for single and head of household filers, $45,000 for married filing jointly, and $22,500, for married taxpayers filing separate returns. The FY '09 Bush budget proposes to increase the 2008 AMT exemption levels to $46,250 for single and head of household filers, $70,050 for married taxpayers filing joint returns, and $35,025 for married taxpayers filing separate returns. In addition, the proposal would allow an individual to reduce CY 2008 tax liability by the full amount of nonrefundable personal credits, even if tax liability is reduced to an amount that is less than the individual's tentative minimum tax. Projections show from 2008 through 2009, this change would decrease revenues by $72.581 billion, but would add $14.216 billion in revenues in 2010. Over the period from FY 2009 through FY 2018 the revenue loss is estimated to be $46.692 billion.
The following summary of other relevant tax provisions in the Administration's budget is based on descriptions provided in the Treasury Department's "Blue Book" for FY 2009.
HEALTH AND WELFARE BENEFITS
New Standard Deduction for "Qualifying" Health Insurance; Repeal of Tax-Free Employer Health Coverage, FSAs and HRAs
As in calendar year 2007, the President's FY 2009 budget proposes to replace the existing income exclusion for employer-provided health insurance, the self-employed premium deduction, and the itemized deduction for medical expenses (except for those enrolled in Medicare) with a new "standard deduction for health insurance" (SDHI). Additionally, the budget proposes to repeal rules permitting employees to pay out-of-pocket medical expenses on a tax-favored basis through health flexible spending arrangements (FSAs) and health reimbursement arrangements (HRAs). Tax-favored Health Savings Accounts (HSAs) would be retained.
The SDHI generally would be available to all families who purchase "qualifying health coverage," whether directly or through an employer. The SDHI generally would not be available to individuals enrolled in Medicare, Medicaid, or SCHIP. Additionally, individuals could not claim the SDHI if they claimed the health coverage tax credit (HCTC), or use HSA or Archer Medical Savings Account (MSA) distributions to pay premiums. In 2009 the SDHI would be $15,000 for family coverage and $7,500 for single coverage, and adjusted for general price inflation in subsequent years.
Eligibility for the SDHI -- which would apply to both income and payroll taxes -- would be determined on the first day of each month. The SDHI available to an individual would be reduced by one-twelfth for each month s/he does not have "qualifying health coverage."
However, an individual could claim the full SDHI s/he is eligible for, regardless of the cost of his or her "qualifying health coverage."
"Qualifying health coverage" would have to meet certain minimum requirements, including the following:
In a bow to the states, the minimum coverage rule would not preempt state law coverage mandates that are more stringent than the minimum requirements for "qualifying health coverage."
Because the proposal would repeal the income exclusion for employer-provided health benefits, employers would have to report the value of such benefits as income on employees' Forms W-2. These amounts also would be subject to income and withholding taxes. However, employers would be permitted to exclude a pro-rated portion of the SDHI for employment tax purposes for employees with "qualifying health coverage." Employees could adjust their withholding and estimated taxes to reflect the SDHI. Significantly, employers could continue taking a deduction for the cost of providing health benefits to their employees.
The Bush Administration believes the SDHI proposal would help control health insurance costs by eliminating the tax incentive to purchase more expensive insurance, and "level the playing field" between individuals who get health insurance through their employers and those who purchase it on the individual market. The Administration also believes it will increase the number of Americans with health insurance by eight million from last year's budget estimate of 3 to 5 million people -- a significant number, but not enough to dramatically reduce the number of uninsured Americans, which now stands at 47 million. The proposal would cost approximately $106 billion over the first five years, but would raise revenues by $32.5 billion over the period from 2009 to 2018 years.
Family Coverage and Embedded Deductibles
To qualify as a high deductible health plan (HDHP), a health plan must have a minimum deductible of $1,100 for single coverage and $2,200 for family coverage. Some family health plans have an overall deductible that meets this minimum deductible, but also have lower embedded deductibles for each covered individual. These health plans generally are not HDHPs under current rules because they can begin paying benefits before the minimum deductible for family coverage is met. The President's budget would change the rules to qualify these plans as HDHPs if each individual embedded deductible is at least the minimum deductible for individual
HDHP coverage and the overall deductible is at least the minimum deductible for family HDHP coverage.
HEALTH SAVINGS ACCOUNTS
Plans with 50 Percent Coinsurance as HDHPs
The President's budget proposes to permit individuals to fund HSAs if they are covered by health plans with a 50 percent (or higher) coinsurance requirement, even if those plans do not meet the minimum deductible requirements for HDHPs. The plan would have to satisfy all other requirements for HDHPs and meet other guidelines that may be established by the Treasury Department.
Liberalized Rules on HSA Payments for Medical Expenses
Under the FY 2009 proposals, permissible uses of HSA funds would be expanded to permit HAS funds to pay medical expenses incurred on or after the first day of HSA eligibility in a particular year so long as the HSA is established no later than the date for filing the tax return for that taxable year. In addition, employer contributions to HSAs on behalf of chronically ill employees (or on behalf of employees who have chronically ill spouses or dependents) would be excluded from the comparable contribution rules to the extent they exceed comparable contributions for other employees.
HSA Catch-up Contributions
Eligible individuals who are at least 55 years old may make an additional $800 "catch-up contribution" to their HSAs in 2008. In the case of married couples, each spouse must maintain his or her own HSA in order to make contributions -- including catch-up contributions. However, the President's budget proposes to allow each spouse to contribute the catch-up amount to a single HSA owned by one spouse, if both are otherwise eligible to make catch-up contributions.
Coordinating HSAs with HRAs and Health FSAs
Individuals covered by HRAs or Health FSAs could contribute to HSAs if they otherwise would be eligible to do so. Their maximum allowable HSA contribution would be offset by the level of HRA or Health FSA coverage. (Note the President's proposed standard deduction for health insurance would eliminate HRAs and Health FSAs. However, Congress obviously is free to adopt some provisions recommended by the President and ignore others. )
PENSIONS AND RETIREMENT SAVINGS -- THE "SA" SISTERS, ERSA, LSA AND RSA, RETURN TO THE STAGE!
ERSAs -- Employer Defined Contribution Retirement Plans
Once again, the President's budget proposes to consolidate defined contribution plans that include employee deferrals or contributions, including 401(k), SIMPLE 401(k), Thrift, 403(b), and governmental 457 plans, as well as SIMPLE IRAs and SARSEPs, into a single retirement savings vehicle: the Employer Retirement Savings Account (ERSA), which virtually all employers could adopt. ERSAs generally would operate under the same rules that now apply to 401(k) plans, but some of those rules would be modified and simplified. The ERSA proposal would not affect defined benefit plans.
In a true benefit to plan sponsors and participants alike, the new proposed nondiscrimination rules for ERSA contributions would be greatly stream lined by repealing the ridiculously complicated -- and costly -- actual contribution percentage (ACP) and average deferral percentage (ADP) tests. These tests would be replaced with the requirement that average contribution percentage of Highly Compensated Employees (HCEs) could not exceed 200 percent of Non- Highly Compensated Employees' (NHCEs) percentage if the NHCEs' average contribution percentage is six percent or less of their compensation. In cases in which the NHCEs' average contribution percentage exceeds six percent, the goal of increasing contributions among NHCEs would be deemed satisfied, and no nondiscrimination testing would apply. (Note that with the increasing use of automatic enrollments coupled with "automatic" increases in the amount withheld and contributed to the 401(k) plan, the number of plan participants deferring six percent of earnings is likely to increase considerably, making this change one that could be especially helpful for plan sponsors.) A design-based safe harbor for satisfying this test also would be available.
Analysis: The ERSA proposal is designed to encourage more employers to adopt retirement plans for their employees by making these plans less difficult (and, therefore, less costly) to set up and administer. Whether the proposal would actually result in more employers (particularly small employers) adopting plans is an open question, but many of the proposed changes almost certainly would be welcomed by existing 401(k) plan sponsors. The estimated revenue loss associated with the ERSA proposal is $623 million over five years, and $1.484 billion over ten years.
Individual Savings Accounts -- LSAs and RSAs
Once again, the President's budget also proposes to replace traditional, nondeductible, and Roth IRAs with two new accounts: Lifetime Savings Accounts (LSAs) and Retirement Savings Accounts (RSAs). In general, these accounts would enjoy the same tax advantages as the current rules afford to Roth IRAs. That is, contributions would be nondeductible, but earnings would accumulate tax-free and distributions (subject to certain exceptions that would apply only to RSAs) would not be taxable.
The annual contribution cap would be $5,000 for RSAs and $2,000 for LSAs. Married couples filing joint tax returns could contribute up to $10,000 per year. The annual contribution cap for both RSAs and LSAs would be indexed for inflation. LSAs could be funded with gifts and other non-wage income (including investment income), but RSAs could be funded only with wage income. RSA contributions would be eligible for the SAVERS credit. No income limits would apply to LSA or RSA eligibility.
All LSA distributions would be tax exempt, as would RSA distributions made after the account owner turns 58, becomes disabled, or dies. Other RSA distributions would be subject to income taxes and a ten percent penalty tax. Neither LSAs nor RSAs would be subject to minimum required distribution rules during the account owner's lifetime.
The proposal would allow existing balances in Coverdell Education Savings Accounts and Qualified State Tuition Plans (i.e., section 529 plans) to be converted to LSAs, subject to limits. Likewise, traditional and nondeductible IRAs could be converted to RSAs (Roth IRAs would be converted automatically). However, because traditional IRAs are funded with deductible contributions, conversions of these accounts would be taxable events.
Analysis: Conversions of traditional IRAs into RSAs would generate revenue in the shortterm. But the new LSAs and RSAs could have significant adverse effects on government revenue in the long-term because accumulated earnings generally would not be taxed. According to the Blue Book, the proposals would generate approximately $7.9 billion in additional revenues during the first five years, but lose all of that gain over the next five years. The net revenue effect over ten years would be a loss of $592 million.
Other relatively technical proposed tax law changes also could affect employers and their employees indirectly or marginally, including the following changes.
Outlook for Action
The overall effect of these proposals -- worthy though they may be -- would be to reduce income to the federal coffers at a time when a number of other needs may take precedence. The continuing war in Iraq requires considerable funding and the sharply slowing economy suggests that tax revenues are likely to decline, not increase, over the coming year. Each of these factors may further limit the chances for tax reductions or additional tax "incentives" for even the most laudable goals.
Recognizing these challenges, the document states, "Our most pressing immediate economic priority is for the Administration and the Congress to work together to enact a temporary economic stimulus package to keep our economy growing and create jobs. The package should take effect as quickly as possible, provide broad-based tax relief for individuals, and include tax incentives for business investments." Congress finished work on an economic stimulus bill late on Thursday, February 7. The President is expected to sign it.
The Blue Book can be downloaded from the Treasury Department's Web site at www.treas.gov/offices/tax-policy/library/bluebk08.pdf. Other budget documents are available from the Office of Management and Budget's Web site at www.omb.gov.
|The information in this Washington Bulletin is general in nature only and not intended to provide advice or guidance for specific situations.
If you have any questions or need additional information about articles appearing in this or previous versions of Washington Bulletin, please contact: Robert Davis 202.879.3094, Elizabeth Drigotas 202.879.4985, Mary Jones 202.378.5067, Stephen LaGarde 202.879-5608, Erinn Madden 202.572.7677, Bart Massey 202.220.2104, Mark Neilio 202.378.5046, Martha Priddy Patterson 202.879.5634, Tom Pevarnik 202.879.5314, Sandra Rolitsky 202.220.2025, Tom Veal 312.946.2595, Deborah Walker 202.879.4955.
Copyright 2008, Deloitte.
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