February 26, 2014
- Comprehensive Tax Reform Proposal Includes Changes to Employee Benefit Tax Policy
- Council Submits Comments on Proposed Rules Amending Excepted Benefits Regulations
- Senate Finance Subcommittee Examines Retirement Savings for Low-Income Workers
Comprehensive Tax Reform Proposal Includes Changes to Employee Benefit Tax Policy
A newly released draft proposal for comprehensive federal tax reform would affect numerous tax incentives supporting employer-sponsored health and retirement benefits. Statutory text is available in addition to a detailed explanatory document and a section-by-section summary.
U.S. House of Representatives Ways and Means Committee Chairman Dave Camp (R-MI) released the draft on February 26, calling it “a comprehensive plan that reflects input and ideas championed by Congress, the Administration and, most importantly, the American people.” He called for all stakeholders to “take a close look at this plan and share their thoughts and ideas,” suggesting that the proposal represents a starting point for future discussion.
The proposal is the culmination of several years of work for Camp and some members of his committee, which designated 11 tax reform working groups in 2013 to evaluate ideas for comprehensive tax reform. (The Council provided a statement and recommendations to the Pensions/Retirement Tax Reform Working Group.) The Joint Committee on Taxation summarized the findings of the working groups in an extensive 568-page document in May 2013.
The primary goal of the new proposal is to lower overall individual and corporate tax rates by reducing tax expenditures attributable to targeted exclusions, deductions and deferrals. Of course, employer sponsorship of health and retirement benefit plans is supported by important tax incentives, such as the exclusion of employer-paid health care premium contributions and deferrals of tax on contributions to retirement plans.
Most notably, as it relates to retirement benefits, Camp’s tax reform plan would limit employee pre-tax deferrals to 401(k), 403(b) and 457(b) plans to one-half of the overall limit, with any remaining contributions designated as “Roth” (post-tax) contributions. Since the limits on employee deferrals for 2014 are $17,500 if under age 50 and $23,000 if age 50 or older, the pre-tax limits would be $8,750 and $11,500, respectively. A separate provision suspends indexing of the limits until 2024 and bases indexing on the current amounts when indexing starts up again.
All pre-tax contributions to defined contribution retirement plans and employer-provided health benefits, as well as HSA contributions, are considered “tax preferences” under the proposal and are subject to a special 10 percent “surtax” to the extent that the taxpayer’s modified adjusted gross income (which takes into account the tax preferences) exceeds $400,000 for single filers and $450,000 for joint married filings. The proposal would also effectively reduce current tax brackets down to three: 10, 25 and 35 percent (see (Sections 1001-1003). The 35 percent bracket would start at the $400,000/$450,000 income previously mentioned but the tax preferences would only be subject to the 10 percent tax (regular income would generally be subject to 35 percent tax if it exceeds those amounts). The measure also establishes a 25 percent corporate tax rate, subject to a phase-in through 2018 ((Section 3001).
Some of the provisions previously rumored to be in the proposal were not included in the final draft, such as a trade-off between elimination of the 40 percent “Cadillac” health plan excise tax in return for taxing some portion of the cost of employer-provided health coverage. As mentioned above, the proposal would apply a 10 percent tax to the employer-provided health coverage for participants with incomes above $400,000/$450,000 but it does not provide any relief from the Cadillac health plan tax.
Camp’s tax reform plan contains numerous other retirement provisions and some health provisions. The following are some of the provisions that could have implications for benefit plans:
- Simplification of individual income tax rates; deduction for adjusted net capital gain; conforming amendments related to simplification of individual income tax rates (Secs. 1001-1003)
- Standard deduction; increase and expansion of child tax credit; modification of earned income tax credit; repeal of deduction for personal exemptions (Sec. 1101-1104)
- No new contributions to Coverdell education savings accounts (Sec. 1206)
- Repeal of exclusion for education assistance programs (Sec. 1209)
- Repeal of exception to 10 percent penalty for higher education expenses (Sec. 1210)
- Repeal of deduction for medical expenses (including long-term care insurance premiums) (Sec. 1409)
- Repeal of disqualification of expenses for over-the-counter drugs under certain accounts and arrangements (Sec. 1410)
- Termination of deduction and exclusions for contributions to medical savings accounts (Sec. 1413)
- Repeal of exclusion of net unrealized appreciation in employer securities; note that this repeal applies to distributions after 2014, and thus applies to amounts currently held in employer securities (Sec. 1421)
- Elimination of income limits on contributions to Roth IRAs; no new contributions to traditional IRAs; inflation adjustment for Roth IRA contribution limit suspended until 2024; contributions to traditional IRAs would only be permitted in the case of rollovers, SIMPLE IRAs, and SEPs. (Secs. 1601-1603)
- Repeal of special rule permitting re-characterization of Roth IRA contributions as traditional IRA contributions (Sec. 1604)
- Repeal of exception to 10 percent penalty for first home purchases (Sec. 1605)
- Termination for new Simplified Employee Pensions (SEPs); Termination for new SIMPLE 401(k)s; existing SEPs and SIMPLE 401(k)s may continue (Secs. 1611-1612)
- Employers with more than 100 employees required to offer Roth accounts and total elective deferrals to traditional 401(k), 403(b) and other CODAs limited to one-half of applicable maximum (with any additional contributions required to go into Roth account); 401(k) plans, 403(b) plans, and governmental 457(b) plans would be required to include Roth features (Sec. 1613)
- Required Minimum Distribution (RMD) rules modified for certain beneficiaries (“Stretch IRA” restrictions); in addition to the effects on IRAs and defined contribution plans, this proposal raises problems for defined benefit plans (Sec. 1614)
- Defined benefit plans permitted to make in-service distributions starting at age 59½ (current law is age 62) (Sec. 1615)
- Modification of rules governing hardship distributions; eliminates the temporary suspension of contributions following a hardship distribution (Sec. 1616)
- Extended period for the rollover of plan loan offset amounts in certain cases (until due date of tax return) (Sec. 1617)
- Contribution limitations for 403(b) plans and governmental 457(b) plans reduced; contribution limits coordinated; repeals the special catch-up contribution rules for 403(b) plans and governmental 457(b) plans (Sec. 1618)
- Application of 10-percent early distribution tax to governmental 457 plans (Sec. 1619)
- Suspend inflation adjustments until 2024 for (Section 415 qualified plan benefit and contribution limitations; maximum 401(k), 403(b) and 457 plans; thereafter, adjustments would be based on C-CPI (Secs. 1620-1624)
- Repeal of credit for small employer pension plan startup costs (Sec. 3210)
- Repeal of employer-provided child care credit (Sec. 3211)
- Repeal of credit for employee health insurance expenses of small employers (Sec. 3222)
- Repeal of work opportunity tax credit (Sec. 3229)
- Nonqualified deferred compensation taxed when no substantial risk of forfeiture – this has potentially significant effects on deferred compensation arrangements; the provision would apply to amounts earned after 2014, thus grandfathering previously earned amounts; the grandfather would expire in 2022 (Sec. 3801)
- Commission and performance-based compensation exception to the $1 million deduction limit would be repealed, applicable after 2014; the rules would be changed so that once an employee is covered by the provision with respect to an employer, he or she is permanently subject to the provision with respect to compensation from the employer; applies to CEO, CFO and three other highest paid employees (Sec. 3802)
- Tax exempt companies subject to 25 percent excise tax for payments in excess of the $1 million deduction limit (Sec. 3803)
- Modification of worker classification rules adding a safe harbor (Sec. 3811)
- Repeal of medical device excise tax (Sec. 7001)
- Excise tax on “systemically important” financial institutions (Sec. 7004)
In addition to the statutory language and explanatory text, Camp released a Joint Committee on Taxation analysis of the bill, which states that “under most modeling assumptions, the proposal is projected to increase overall economic activity, as measured by changes in gross domestic product … over the 10-year budget period.”
While Camp had been working closely with Max Baucus, former chairman of the Senate Finance Committee, on comprehensive tax reform, Baucus has since been appointed ambassador to China. His successor, Senator Ron Wyden (D-OR), has not committed to comprehensive tax reform, suggesting his priorities are more focused on incremental reform including an “extenders” package addressing expired or expiring tax provisions.
Camp is expected to hold hearings on the measure. It is much less clear whether he will be able to schedule a mark-up of the bill in the Ways and Means committee or whether the House Republican leadership would allow the full House to vote on it. In anticipation of the proposal, congressional Democrats objected to what they perceive as exclusion from the process.
The Council has, for the past several months, been meeting extensively with lawmakers and their staffs to explain the long-term value of health and retirement tax incentives for employers and employees, as well as the far-reaching implications of possible modifications. Your participation in ongoing meetings would be extremely helpful; we urge you to participate in meetings with Capitol Hill staff and to provide input for our discussions with lawmakers. For more information, contact Lynn Dudley, senior vice president, retirement and international benefits policy, or Diann Howland, vice president, legislative affairs, at (202) 289-6700.
Council Submits Comments on Proposed Rules Amending Excepted Benefits Regulations
On February 24, the Council filed written comments on proposed regulations amending existing regulations regarding “excepted benefits.” The proposed regulations, issued December 20, 2013 by the U.S. departments of Treasury, Labor, and Health and Human Services (HHS) include certain changes related to limited scope vision and dental benefits, limited “wraparound” coverage and Employee Assistance Programs (EAPs).
“Excepted benefits” are excluded from the portability provisions established under HIPAA as well as certain health plan requirements of PPACA. “Excepted benefits” generally do not constitute “minimum essential coverage” under PPACA, and thus would not disqualify an individual for premium tax credits for the purchase of individual insurance through a health exchange.
The proposed regulations include an important clarification with respect to when dental and vision benefits qualify as excepted benefits. Under existing regulations, such benefits are excepted benefits if they are limited in scope and (1) are provided under a separate policy, certificate, or contract of insurance; or (2) otherwise not an integral part of a group health plan. Currently, only insured coverage can qualify under the first test. With respect to the second test, either insured or self-insured coverage can qualify, so long as participants have the right to elect not to receive coverage for the benefits, and, if participants elect coverage, they pay an additional premium or contribution.
The Council letter strongly supports the proposed regulations’ elimination of the requirement that participants pay an additional premium or contribution for dental or vision benefits in order for such benefits to constitute excepted benefits. The Council also requested that final regulations confirm that participants will be considered to have the right to elect not to receive coverage if such coverage automatically enrolls participants but provides an opportunity for opt-out. In addition, the comment letter notes that many employers use Administrative Services Only (ASO) arrangements to administer self-funded limited scope dental and vision benefits and urged that such arrangements be considered as satisfying the first test, noted above.
The proposed regulations also requested comment with respect to when benefits under an EAP constitute “significant benefits in the nature of medical care” and thus would not qualify as excepted benefits. Specifically, the departments asked whether an EAP that provides no more than 10 outpatient visits for mental health or substance use disorder counseling, an annual wellness checkup, immunizations, and diabetes counseling, with no inpatient care benefits, should be considered to provide significant benefits in the nature of medical care. The Council recommended that plans be permitted flexibility in setting a limit on outpatient visits, but to the extent final regulations establish a specific limit on the number of visits, that a “safe harbor” be provided, whereby an EAP that provides no more than the safe harbor limit is deemed not to provide significant benefits in the nature of medical care, and a facts-and-circumstances analysis apply in the event an EAP offers more than a safe harbor limit. The Council also requested that any limit on outpatient visits apply on a per issue basis given that EAPs are problem-focused and typically structured to allow individuals to use up to a specified number of visits for a given category of short-term counseling, evaluation and/or referral (e.g., substance abuse, grief, or family issues).
The Council also requested clarifications regarding the proposed new wrap around coverage, as well as the definition of “supplemental benefits,” to help ensure that employees continue to have access to important supplemental coverage that may provide benefits not offered by an employer’s primary group health plan. For more information, contact Kathryn Wilber, senior counsel, health policy, at (202) 289-6700.
Senate Finance Subcommittee Examines Retirement Savings for Low-Income Workers
In a February 26 hearing, Retirement Savings for Low-Income Workers, the Senate Committee on Finance’s Subcommittee on Social Security, Pensions, and Family Policy discussed the unique challenges low-income workers face in saving for retirement.
In a Council news release issued in conjunction with the hearing, Council President James Klein emphasized that “employer-sponsored retirement plans are an essential component of financial security. Research has shown that the current system of tax incentives for defined contribution plans benefits workers all along the income spectrum, including low-income workers.”
As the Council detailed in the December 2013 report Our Strong Retirement System: An American Success Story, released jointly with the American Council of Life Insurers (ACLI) and Investment Company Institute (ICI), the employer-sponsored system not only provides low-income workers with substantial tax benefits from tax deferral, it also offers the convenience of payroll deduction, the economies of scale that reduce the cost of investing, and the professional investment management and financial education offered through employer plans.
In his opening statement, Subcommittee Chairman Sherrod Brown (D-OH) characterized current workplace retirement arrangements as benefiting only the wealthiest individuals. He cited a number of statistics arguing that less than half of American workers have employer-provided retirement plans (although this includes part-time workers) and suggesting that the median retirement account balance is $3,000 for all working-age households and $12,000 for those nearing retirement (although these numbers include all households, even those with zero savings). He voiced his support for Senator Tom Harkin’s (D-IA) USA Retirement Funds Act (S. 1979) as a way to improve retirement coverage.
Senator Johnny Isakson (R-GA), who also serves on the Senate Health, Education, Labor and Pensions (HELP) Committee, also provided an opening statement, saying “if our goal is to increase the number of Americans saving for retirement, we should be expanding the options available to employers through existing structures, rather than creating a new mandate or a new program, which seems overly complicated.”
The panel heard testimony from the following witnesses:
- J. Mark Iwry, senior advisor to the secretary and deputy assistant secretary (tax policy), retirement and health policy for the Department of the Treasury, outlined the administration’s recent “MyRA” proposal (described in the January 29 Benefits Byte) designed for workers without workplace plans. MyRAs “are intended to complement and not compete with employer-sponsored plans,” Iwry said. He also suggested that 401(k) plans could be further improved by making them more efficient and automatic.
- Diane Oakley, executive director of the National Institute of Retirement Security, said that “employer sponsored plans are the most important source of retirement income” for workers, but noted the lack of access – particularly to defined benefit plans – for lower-income workers.
- Stephen P. Utkus, principal and director of the Vanguard Center for Retirement Research, discussed different levels of preparedness in retirement savings and highlighted the importance of ensuring Social Security is fiscally sustainable as a critical way to strengthen retirement security for low-income workers in the long run. In addition, Utkus addressed how automatic enrollment in the defined contribution system is gradually expanding benefits for low-income workers with rising income prospects.
- Judy A. Miller, director of retirement policy and executive director for the American Society of Pension Professionals and Actuaries (ASPPA), suggested that certain proposals now under consideration, such as Senator Orrin Hatch’s Secure Annuities for Employee (SAFE) Retirement Act (S. 1270) and the president’s automatic IRA proposal, could improve workplace coverage for low-income workers. She criticized efforts to reduce or restructure contribution limits, citing a number of myths that wrongly characterized the employer-sponsored system as inadequate or inequitable.
During the question-and-answer session, Brown sought more detail on the dimensions and the severity of the “retirement crisis” and asked the panel about a broad range of peripheral issues including the importance of home equity, the success of the Saver’s Credit and the availability of lifetime income options.
Isakson asked about the potential impact of a new “fiduciary definition” rule – expected to be re-proposed later this year – on employer retirement plans. Miller expressed strong concern about the proposal, saying that significant changes to the original proposal would be necessary to avoid “disaster.”
Isakson also raised the matter of the “independent contractor” test, under which the provision of a retirement plan could disqualify an employee from contractor status, and whether it should be reformed to expand coverage for these workers.