HEALTH INSURANCE PORTABILITY AND ACCOUNTABILITY ACT OF 1996 REFERENCES AND BACKGROUND Acronym: HIPAA Bill Reference: H.R. 3103 Law Reference: P.L. 104-191 Date of Enactment : August 21, 1996 TAX-RELATED HEALTH PROVISIONS Medical Savings Accounts: Beginning in 1997, medical savings account ("MSA") are available to employees covered under an employer-sponsored high deductible plan of a small employer and self-employed individuals. An employer is a small employer if it employed, on average, no more than 50 employees during either the preceding or the second preceding year.. Within limits, contributions to MSAs are deductible if made by an eligible individual and are excludable if made by the employer of an eligible individual. Earnings on amounts in an MSA are not currently taxable. The maximum annual contribution that can be made to an MSA for a year is 65 percent of the deductible under the high deductible plan in the case of individual coverage and 75 percent of the deductible in the case of family coverage. No other dollar limits on the maximum contribution apply. A high deductible plan is a health plan with an annual deductible of at least $1,500 and no more than $2,250 in the case of individual coverage and at least $3,000 and no more than $4,500 in the case of family coverage. In addition, the maximum out-of-pocket expenses with respect to allowed costs (including the deductible) must be no more than $3,000 in the case of individual coverage and no more than $5,500 in the case of family coverage. Beginning after 1998, these dollar amounts are indexed for inflation in $50 dollar increments based on the consumer price index. Distributions from an MSA for medical expenses are not taxable. Distributions that are not for medical expenses are includible in income. Such distributions are also subject to an additional 15- percent tax unless made after age 65, death, or disability. Upon death, any balance remaining in the decedent's MSA is includible in his or her gross estate. There are caps on the number of taxpayers that will be allowed to participate in MSAs. After December 31, 2000, no new contributions may be made to MSAs except by or on behalf of individuals who previously had MSA contributions and employees who are employed by a participating employer. Effective for taxable years beginning after December 31, 1996. HIPAA §301 adding new IRC §220 and redesignating old §220 as §221. Increase In Deduction For Health Insurance Expenses Of Self- Employed Individuals: The deduction for health insurance of self- employed individuals is increased as follows: 40 percent in 1997; 45 percent in 1998 through 2002; 50 percent in 2003; 60 percent in 2004; 70 percent in 2005; and 80 percent in 2006 and thereafter. also provides that payments for personal injury or sickness through an arrangements having the effect of accident or health insurance (and that are not merely reimbursement arrangements) are excludable from income. In order for the exclusion to apply, the arrangement must be insurance (e.g., there must be adequate risk shifting). This provision equalizes the treatment of payments under commercial insurance and arrangements other than commercial insurance that have the effect of insurance. Under this provision, a self-employed individual who receives payments from such an arrangement could exclude the payments from income. Effective for taxable years beginning after December 31, 1996. HIPAA §311 amending IRC §162(1) and §104(a). Treatment Of Long-Term Care Insurance And Services: A long-term care insurance contract generally is treated as an accident and health insurance contract. Amounts (other than policyholder dividends or premium refunds) received under a long-term care insurance contract generally are excludable as amounts received for personal injuries and sickness, subject to a cap of $ 175 per day, or $ 63,875 annually, on per diem contracts only. If the aggregate amount of periodic payments under all qualified long- term care contracts exceeds the dollar cap for the period, then the amount of such excess payments is excludable only to the extent of the individual's costs (that are not otherwise compensated for by insurance or otherwise) for long-term care services during the period. The dollar cap is indexed by the medical care cost component of the consumer price index. A plan of an employer providing coverage under a long-term care insurance contract generally is treated as an accident and health plan. Employer-provided coverage under a long-term care insurance contract is not, however, excludable by an employee if provided through a cafeteria plan; similarly, expenses for long-term care services cannot be reimbursed under an FSA. A long-term care insurance contract is defined as any insurance contract that provides only coverage of qualified long-term care services and that meets other requirements. Unreimbursed expenses for qualified long-term care services provided to the taxpayer or the taxpayer's spouse or dependents are treated as medical expenses for purposes of the itemized deduction for medical expenses (subject to the present-law floor of 7.5 percent of adjusted gross income). For this purpose, amounts received under a long- term care insurance contract (regardless of whether the contract reimburses expenses or pays benefits on a per diem or other periodic basis) are treated as reimbursement for expenses actually incurred for medical care. Unreimbursed expenses for qualified long-term care services provided to the taxpayer or the taxpayer's spouse or dependents are treated as medical expenses for purposes of the itemized deduction for medical expenses (subject to the present-law floor of 7.5 percent of adjusted gross income). For this purpose, amounts received under a long- term care insurance contract (regardless of whether the contract reimburses expenses or pays benefits on a per diem or other periodic basis) are treated as reimbursement for expenses actually incurred for medical care. Long-term care insurance premiums that do not exceed specified dollar limits are treated as medical expenses for purposes of the itemized deduction for medical expenses The limits are as follows: Not more than 40 - $200; More than 40 but not more than 50 - $375; More than 50 but not more than 60 - $750; More than 60 but not more than 70 - $2,000; More than 70 - $2,500. Because the law treats payments of eligible long- term care insurance premiums in the same manner as medical insurance premiums, the self-employed health insurance deduction applies to eligible long- term care insurance premiums. Effective generally for taxable years beginning after December 31, 1996. The provision relating to life insurance company reserves is effective for contracts issued after December 31, 1997. HIPAA §321-327. Treatment Of Accelerated Death Benefits Under Life Insurance Contracts: The House bill provides an exclusion from gross income as an amount paid by reason of the death of an insured for (1) amounts received under a life insurance contract and (2) amount received for the sale or assignment of a life insurance contract to a qualified viatical settlement provider, provided that the insured under the life insurance contract is either terminally ill or chronically ill. The provision applies to amounts received after December 31, 1996. The provision treating a qualified accelerated death benefit rider as life insurance for life insurance company tax purposes takes effect on January 1, 1997. The issuance of a qualified accelerated death benefit rider to a life insurance contract, or the addition of any provision required to conform an accelerated death benefit rider to these provisions, is not treated as a modification or material change to the contract (and is not intended to affect the issue date of any contract under section 101(f)). HIPAA §331-332 Exemption From Income Tax For State-Sponsored Organizations Providing Health Coverage For High-Risk Individuals: The new law provides tax-exempt status to any membership organization that is established by a State exclusively to provide coverage for medical care on a nonprofit basis to certain high-risk individuals, provided certain criteria are satisfied. The organization may provide coverage for medical care either by issuing insurance itself or by entering into an arrangement with a health maintenance organization ("HMO"). The provision applies to taxable years beginning after December 31, 1996. HIPAA §341. Exemption From Income Tax For State-Sponsored Workers' Compensation Reinsurance Organizations: The new law provides tax- exempt status to any membership organization that is established by a State before June 1, 1996, exclusively to reimburse its members for workers' compensation insurance losses, and that satisfies certain other conditions. A State must require that the membership of the organization consist of all persons who issue insurance covering workers' compensation losses in such State, and all persons and governmental entities who self- insure against such losses. In addition, the organization must operate as a nonprofit organization by returning surplus income to members or to workers' compensation policyholders on a periodic basis and by reducing initial premiums in anticipation of investment income. The provision applies to taxable years ending after the date of enactment. HIPAA §342. Health Insurance Organizations Eligible For Benefits Of Section 833: The new law applies the special rules under section 833 to the same extent they are provided to certain existing Blue Cross or Blue Shield organizations, in the case of any organization that (1) is not a Blue Cross or Blue Shield organization existing on August 16, 1986, and (2) otherwise meets the requirements of section 833(c)(2) (including the requirement of no material change in operations or structure since August 16, 1986). Under the provision, an organization qualifies for this treatment only if (1) it is not a health maintenance organization and (2) it is organized under and governed by State laws which are specifically and exclusively applicable to not-for-profit health insurance or health service type organizations. The provision is effective for taxable years ending after December 31, 1996. HIPAA §351. Penalty-Free Withdrawals From IRAs For Medical Expenses : Under present law, amounts withdrawn from an individual retirement arrangement ("IRA") are includible in income (except to the extent of any nondeductible contributions). In addition, a 10- percent additional tax applies to withdrawals from IRAs made before age 59- 1/2, unless the withdrawal is made on account of death or disability or is made in the form of annuity payments. A similar additional tax applies to early withdrawals from employer- sponsored tax-qualified pension plans. However, the 10- percent additional tax does not apply to withdrawals from such plans to the extent used for medical expenses that exceed 7.5 percent of adjusted gross income ("AGI"). The new law extends the exception to the 10- percent tax for medical expenses in excess of 7.5 percent of AGI to withdrawals from IRAs. The 10-percent additional tax does not apply to withdrawals for medical insurance (without regard to the 7.5 percent of AGI floor) if the individual (including a self- employed individual) has received unemployment compensation under Federal or State law for at least 12 weeks, and the withdrawal is made in the year such unemployment compensation is received or the following year. If a self-employed individual is not eligible for unemployment compensation under applicable law, then, to the extent provided in regulations, a self- employed individual is treated as having received unemployment compensation for at least 12 weeks if the individual would have received unemployment compensation but for the fact that the individual was self- employed. The provision is effective for taxable years beginning after December 31, 1996. HIPAA §361 IRS Required To Include Organ And Tissue Donation Information With Tax Refunds : The new law requires Treasury to include organ and tissue donation information, and requires that the organ donor card be included to the extent practicable, with any payment of a refund of individual income taxes made on or after February 1, 1997, through June 30, 1997. HIPAA §371. Application And Enforcement Of Group Health Plan Portability, Access, And Renewability Requirements: Under present law, the health care continuation rules (referred to as "COBRA" rules, after the Consolidated Omnibus Budget Reconciliation Act of 1985 in which they were enacted) require that most employer-sponsored group health plans must offer certain employees and their dependents ("qualified beneficiaries") the option of purchasing continued health coverage in the case of certain qualifying events. Under the new law, group health plans are subject to certain requirements regarding portability through limitations on preexisting condition exclusions, prohibitions on excluding individuals from coverage based on health status, and guaranteed renewability of health insurance coverage. The new law incorporates these requirements into the IRC and generally imposes a tax with respect to any failure of a group health plan to comply with the requirements. The tax may generally be imposed on the employer sponsoring the plan. However, the tax may be imposed on the plan in the case of a multiemployer plan, and, with respect to violations of the requirements relating to guaranteed renewability, on the arrangement in the case of a multiple employer welfare arrangement. The group health plan requirements contained in the Code do not apply to governmental plans and plans which on the first day of the plan year cover less than 2 current employees. In addition, no tax may be imposed on a small employer (defined as an employer who employed an average of 50 or fewer employees on business days during the preceding calendar year) that provides health care benefits through a contract with an insurer or HMO and the violation is solely because of the coverage offered by the insurer or HMO. The amount of the tax is generally equal to $ 100 per day for each day during which a failure occurs until the failure is corrected. The tax applies separately with respect to each individual affected by the failure. In general, a tax will not be imposed if the violation was unintentional and is corrected within 30 days. The maximum tax for unintentional violations that can be imposed generally is the lesser of (1) 10 percent of the employer's payments during the taxable year in which the failure occurred under group health plans (or 10 percent of the amount paid by the multiemployer plan or multiple employer welfare arrangement during the plan year in which the failure occurred for medical care, if applicable), or (2) $ 500,000. The Secretary may waive all or part of the tax to the extent that payment of the tax would be excessive relative to the failure involved.. Applicable to plan years beginning after June 30, 1997. HIPAA §401 adding Subtitle K - Group Health Plan Portability, Access, and Renewability Requirements to the IRC. REVENUE OFFSETS Disallow Interest Deduction For Corporate-Owned Life Insurance Policy Loans: Under the new law, no deduction is allowed for interest paid or accrued on any indebtedness with respect to one or more life insurance policies or annuity or endowment contracts owned by the taxpayer covering any individual who is (1) an officer or employee of, or (2) financially interested in, any trade or business carried on by the taxpayer, regardless of the aggregate amount of debt with respect to policies or contracts covering the individual. An exception is provided retaining present law for interest on indebtedness with respect to life insurance policies covering up to 20 key persons. A key person is an individual who is either an officer or a 20-percent owner of the taxpayer. The number of individuals that can be treated as key persons may not exceed the greater of (1) 5 individuals, or (2) the lesser of 5 percent of the total number of officers and employees of the taxpayer or 20 individuals. Generally effective with respect to interest paid or accrued after December 31, 1995 (subject to a phase-in rule and exceptions). HIPAA §501. Expatriation Tax Provisions: The new law expands and substantially strengthens in several ways the present-law provisions that subject U.S. citizens who lose their citizenship for tax avoidance purposes to special tax rules for 10 years after such loss of citizenship (secs. 877, 2107, and 2501(a)(3)). First, the law extends the expatriation tax provisions to apply not only to U.S. citizens who lose their citizenship but also to certain long-term residents of the United States whose U.S. residency is terminated. Second, the law subjects certain individuals to the expatriation tax provisions without inquiry as to their motive for losing their U.S. citizenship or residency, but allows certain categories of citizens to show an absence of tax-avoidance motives if they request a ruling from the Secretary of the Treasury as to whether the loss of citizenship had a principal purpose of tax avoidance. Third, the law expands the categories of income and gains that are treated as U.S. source (and therefore subject to U.S. income tax under section if earned by an individual who is subject to the expatriation tax provisions and includes provisions designed to eliminate the ability to engage in certain transactions that under current law partially or completely circumvent the 10-year reach of section 877. Further, the law provides relief from double taxation in circumstances where another country imposes tax on items that would be subject to U.S. tax under the expatriation tax provisions. The law also contains provisions to enhance compliance with the expatriation tax provisions. The law imposes information reporting obligations on U.S. citizens who lose their citizenship and long-term residents whose U.S. residency is terminated at the time of expatriation. HIPAA §§421-423. Repeal Of Financial Institution Transition Rule To Interest Allocation Rules: For foreign tax credit purposes, taxpayers generally are required to allocate and apportion interest expense between U.S. and foreign source income based on the proportion of the taxpayer's total assets in each location. Such allocation and apportionment is required to be made for affiliated groups (as defined in sec. 864(e)(5)) as a whole rather than on a subsidiary- by-subsidiary basis. However, certain types of financial institutions that are members of an affiliated group are treated as members of a separate affiliated group for purposes of allocating and apportioning their interest expense. Section 1215(c)(5) of the Tax Reform Act of 1986 (P.L. 99-514, 100 Stat. 2548) includes a targeted rule which treats a certain corporation as a financial institution for this purpose. The new law repeals section 1215(c)(5) of the Tax Reform Act of 1986 effective on the date of enactment. Under the conference agreement, a taxpayer will perform two computations with respect to its taxable year that includes the enactment date. Under the first computation, the taxpayer's pre-effective date interest expense is allocated and apportioned taking into account the targeted rule, and under the second computation, the taxpayer's post-effective date interest expense is allocated and apportioned without regard to the targeted rule. These computations will not require a closing of a taxpayer's books and records and it is intended that an administratively simple approach be used in applying this rule. HIPAA §521.