Executive Summary

Employer-provided health coverage would be taxable but enjoys a specific tax exclusion

Through discussions now underway in Congress, lawmakers are eyeing the possibility of changing tax rules to tap employer provided health coverage as a new federal revenue source. Under well-established tax rules with roots in WWII era history (when wages were frozen and tax-free health coverage was introduced as a way to boost worker income), the value of employer-provided health coverage is generally excluded from federal income and payroll taxes. Most states apply similar rules that further shield those same benefits from state and local taxes.

Significant tax revenue is at stake. Some experts peg the annual amount of lost federal revenue at a quarter trillion dollars ($250 billion). Although exposing more income to tax has the identical impact as a tax increase, some legislators like the idea of changing the exclusion because they can “technically” claim that they did not directly support a tax increase, while still effectively harvesting more revenue.

Further intensifying financial pressure on the government are “tax credits” established under the Affordable Care Act (ACA) that help enable eligible individuals to fund health coverage purchased
through the exchange “marketplace” system. The federal government must augment revenue sources in order to cover the cost of such subsidies and related cost-sharing assistance.

ACA: Repeal, Replace or Repair requires additional revenue

As part of their effort to change ACA, Republicans are now reviewing several proposals that would seek to cap, eliminate, or “phase-out” the current tax exclusion. This process was further advanced in mid-February as Republicans announced elements of a new comprehensive “replace” ACA package that favors a universal tax-credit based system. Although that new GOP proposal does not directly reference a cap, there is strong speculation that these universal credits will eventually be funded either through introduction of a cap, or full removal of the exclusion.

Industry experts well understand that the current employer-based system covers the vast majority of Americans. Although the recent ACA coverage expansion is said to have delivered health insurance to 20 million Americans, some studies estimate that almost 10x as many individuals are covered through employer sponsored health plans. Preserving a system that delivers solid health coverage to so many people is a laudable goal that should resonate with the vast majority of employers.

How does a “capped” tax-exclusion threaten the employer-based system?

If a tax exclusion cap is enacted, an important incentive driving employers to offer health insurance to employees would be weakened. For example, under a tax exclusion “cap” of just $10,000 for single coverage, an employee who received single health coverage valued at $12,000 from his or her employer would be responsible for an additional $2,000 of taxable income. In addition, the employer would be forced to treat that remaining $2,000 as ordinary income, and pay the full range of tax on that amount. Both parties would be exposed to new tax liability. The specific cap level is also an important political consideration as health coverage costs vary wildly across the country, and a uniform cap would be more painfully absorbed in high-cost areas. The pain could be further intensified if states similarly adjusted to capture more revenue, by adopting the federal position for state tax purposes.

Although ACA’s Cadillac-tax provision presented a gigantic challenge (the Cadillac-tax produced a 40 percent tax liability based on valuation amounts exceeding defined benchmarks), we believe a “cap” could actually be worse. Specifically, while the Cadillac tax posed a problem, it at least forced employers to carefully assess cost-drivers in a manner that generated useful momentum to re-design plans to ease tax liability. A cap on tax-free benefits would raise money for the federal government, but does nothing to mitigate the underlying drivers of healthcare costs.

Protecting the employer-based health coverage system

In summary, changes to the current tax free benefit structure could negatively impact your and the nation’s employer-based health care delivery system. We, in turn, are bringing this information to your attention and will continue to monitor and share any subsequent legislative developments.

NOTICE OF DISCLAIMER

The information herein is intended to be educational only and is based on information that is generally available. HUB International makes no representation or warranty as to its accuracy and is not obligated to update the information should it change in the future. The information is not intended to be legal or tax advice. Consult your attorney and/or professional advisor as to your organization’s specific circumstances and legal, tax or other requirements.