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President Obama Signs Health Care Reform Law

April 1, 2010

On March 23, 2010, President Obama signed into law the first piece of major health care reform legislation, the Patient Protection and Affordable Care Act ("PPACA"). In addition, on March 30, 2010, the President signed into law the Health Care and Education Reconciliation Act of 2010 ("Reconciliation Act") that makes many changes and additions to the health care reform law contained in the PPACA.

The new health care reform law, composed of the PPACA and the Reconciliation Act (collectively, the "Act") makes sweeping changes to group health coverage, the creation of insurance exchanges, individual and employer responsibilities, and revenue provisions. While many of the important details of the Act will be explained through regulations, administrative rulings, and likely with future clarifying legislation, the following summarizes some of the highlights of the Act.

Changes Affecting Group Health Coverage and Employers

The Act operates to improve available health care coverage by preventing certain practices by group health plans ("GHPs"), including GHPs or health insurance coverage under which an individual was enrolled on March 23, 2010 ("Grandfathered Health Plans"), whether self-insured or insured, by increasing the number of individuals with health coverage through employer mandates and imposing reporting requirements. Some of the notable changes include:

  • Lifetime and Annual Limits. Generally beginning in 2011, the Act prohibits GHPs from imposing lifetime and annual dollar limits on "essential health benefits." Prior to 2014, GHPs may establish restricted annual limits (to be determined by the Department of Health and Human Services ("HHS")) on the dollar value of these "essential health benefits," (to be defined by HHS).1 After 2014, no such annual limits are permitted. To the extent that GHPs offer specific benefits not considered to be "essential health benefits," the imposition of annual or lifetime limits on such benefits is permissible (to the extent not otherwise prohibited under Federal law).
  • No Rescission of Coverage. Generally effective in 2011, GHPs are prohibited from rescinding coverage for individuals who are enrolled under the GHP, except for cases where the individual has engaged in fraud or intentional misrepresentation of a material fact.
  • Pre-existing Conditions. Generally effective in 2011, GHPs may not impose pre-existing condition limitations on enrollees under the age of nineteen (19). This requirement applies to all enrollees, regardless of age, beginning in 2014.
  • Wellness Programs. The Act codifies the wellness program rules, currently found in the HIPAA regulations, and changes the cap on wellness program rewards from 20% to 30% of the cost of coverage. Additionally, it gives the Department of Labor, HHS and the Department of Treasury ("Treasury") the power to increase this reward cap to up to 50% of the cost of coverage.  This change is generally effective beginning in 2014.
  • Extension of Dependent Coverage. Under the Act, GHPs offering dependent coverage must continue to permit dependent adult children (whether married or not) to continue coverage until they turn age twenty-six (26). This requirement is generally effective in 2011. Grandfathered Health Plans are not exempt from this requirement, however Grandfathered Health Plans do not have to offer this extended dependent coverage before 2014 to adult children eligible for coverage under another employer-sponsored health plan.
  • Coverage for Preventative Care. Generally effective in 2011, GHPs must cover the following services without cost sharing: preventative services with an "A" or "B" rating from the U.S. Preventative Services Task Force ("Task Force"), immunizations, preventative care and screenings for infants, children, and adolescents, and additional preventative care for women. Specifically, if the Task Force or HHS makes a recommendation or issues a guideline regarding preventative services, there must be at least a one-plan year interval between the recommendation and its required application under the plan.
  • Limited Waiting Periods. Generally beginning in 2014, GHPs offering group coverage may not impose waiting periods in excess of 90 days.
  • Coverage for Emergency Services. Generally effective in 2011, GHPs providing or covering any "emergency services" (as defined in the Social Security Act) must cover emergency services without the need for any prior authorization determination and may not impose any additional co-payment or coinsurance requirements if the emergency facility is not part of the plan's network.
  • Uniform Summary of Benefits. No later than March 23, 2011, HHS must develop standards for GHPs to provide summaries of benefits and coverage explanation to participants and beneficiaries.  The summaries must meet requirements related to appearance, language, and content. The GHP plan sponsor, whether the employer or the insurer, must provide such summaries prior to enrollment or reenrollment in the plan beginning March 23, 2012 and the Act imposes significant fines for a GHP's or insurer's willful failure to comply with this requirement. Any material modifications made to the benefits and coverage must be provided in this summary at least 60 days before they become effective.
  • Expanded Non-Discrimination Rules. Generally beginning in 2011, all GHPs, including insured plans, are prohibited from discriminating in favor of "highly compensated individuals" as to eligibility to participate in the plan and in providing benefits under the plan. This new rule is identical to the current non-discrimination rules imposed on self-insured medical plans and found in the Internal Revenue Code.
  • Expanded Appeals Process. Generally effective in 2011, GHPs must provide for appropriate plan appeals processes, beginning with the claims procedures outlined in ERISA as the initial claims procedures.  However, these plans are also required to establish an effective external review process. Notice of the appeals processes must be provided to enrollees in a "culturally and linguistically appropriate manner" and enrollees must be allowed to review their file, present evidence and testimony as part of the appeals process, and receive continued coverage pending the outcome of the appeals process.
  • Health Flexible Spending Accounts. Beginning in 2013, employees may only contribute up to $2,500 to a health flexible spending account each year (the monetary limit to be increased yearly for cost-of-living adjustments). Additionally, over-the-counter drugs will no longer be reimbursed through these arrangements unless prescribed by a doctor. This change will have an impact on those individuals who over estimate their annual reimbursable medical expenses and lose the amounts not spent.
  • Creation of Simple Cafeteria Plan. Effective for calendar year 2011, the Act establishes a new employee benefit cafeteria plan known as a Simple Cafeteria Plan. The Simple Cafeteria Plan is available to small employers and is subject to certain participation and employer contribution requirements.
  • W-2 Reporting. Beginning in calendar year 2011, employers must report the aggregate per employee cost of applicable employer-sponsored coverage on each employee's Form W-2.
  • Employer Mandated Coverage. Generally beginning in 2014, most employers with fifty (50) or more employees must offer coverage to employees meeting certain requirements. Employers that do not may be subject to significant penalties. Further, employers with two-hundred (200) or more full-time employees that provide GHPs will be required to automatically enroll all new employees and continue the enrollment of current employees. Employers will be required to notify employees of this automatic enrollment program and to provide the employees with the ability to opt out of the employer coverage.

Revenue Provisions

The Act contains several revenue raising provisions including the imposition of additional taxes on unearned income of certain individuals, wages, and self employment income effective for taxable years beginning after December 31, 2012. In addition, the Act codifies the common law doctrine of economic substance, denying tax benefits from transactions that do not materially alter the taxpayer's economic position exclusive of the purported reduction in federal taxable income. Some of the revenue provisions include:

  • New Medicare Tax on Unearned Income. Under the Act a new tax is imposed on individuals with modified adjusted gross income greater than $250,000 for taxpayers filing joint returns, $125,000 for married taxpayers filing separately and $200,000 for all others, each referred to as the "threshold amount." The tax is imposed at a rate of 3.8% on the lesser of the taxpayer's (i) net investment income or (ii) modified adjusted gross income over the applicable threshold amount.  Net investment income generally is defined as gross income from interest, dividends, annuities, royalties, rents and net gains not received in connection with an active trade or business (but including such income earned in connection with a passive activity or trading in financial instruments or commodities) less deductions properly allocable to such items.
  • Additional Hospital Insurance Taxes. A new hospital insurance tax of 0.9% will be imposed on individuals' wages and self employment income in excess of $250,000 for taxpayers filing joint returns, $125,000 for married taxpayers filing separately and $200,000 for all others. The 50% deduction generally available for self employment taxes is not allowed with respect to this additional tax. Both taxes apply to all wages or self employment income over the specified threshold amounts and are not subject to a cap. There is no change to the hospital insurance tax applicable to employers.
  • Codification of the Economic Substance Doctrine and the Imposition of Penalties. The courts have developed several doctrines to deny tax benefits arising from tax-motivated transactions even when those transactions may otherwise satisfy the applicable statutory requirements. One doctrine, the "economic substance" doctrine, generally denies tax benefits when the transaction or series of transactions does not meaningfully alter the taxpayer's economic position other than a purported reduction in federal income taxes. 

The Act codifies the economic substance doctrine and provides that a transaction or series of transactions is treated as having economic substance only if (i) the transaction changes in a meaningful way (apart from federal income tax effects) the taxpayer's economic position and (ii) the taxpayer has a substantial purpose (apart from federal income tax effects) for entering into such transaction. The potential for profit from the transaction is taken into account in establishing whether each of the requirements is met only if the present value of the reasonably expected pre-tax profit from the transaction is substantial in relation to the present value of the expected net tax benefits that would be allowed if the transaction were respected. Fees and other transaction expenses are taken into account as expenses in determining pre-tax profits. State and local income tax effect which is related to the federal income tax effect shall be treated in the same manner as the federal income tax effect. For purposes of determining whether there is a substantial business purpose, financial accounting benefit shall not be taken into account if the origin of the financial accounting benefit is a reduction in federal income tax. The codified economic substance test does not apply to transactions engaged in by individuals unless such transactions are in connection with a trade or business or an activity engaged in for the production of income. 

The Joint Committee on Taxation technical explanation of the provision adds that the provision is not intended to alter the tax treatment of certain basic business decisions that have historically been respected merely because the choice between meaningful economic alternatives is based upon comparative tax advantages. Such transactions include the decision to raise capital through the issuance of debt or equity, the decision to use a domestic or foreign entity to hold a foreign investment, the decision to effect a transaction qualifying as a corporate reorganization or the choice to include a related party in a transaction provided certain arm's length standards and other applicable concepts are satisfied.

The Act also imposes a penalty of 20% on any underpayment attributable to a disallowance of a claimed tax benefit because a transaction was determined to lack economic substance. This penalty is increased to 40% if the taxpayer does not adequately disclose the relevant facts affecting the tax treatment in its return or a statement attached to the return. The penalty is based on strict liability and there is no reasonable cause exception, thus an opinion of counsel would not protect a taxpayer if the transaction were determined to lack economic substance. 

The codified economic substance doctrine and related penalties on underpayments shall apply to transactions entered into after the date of enactment.


1 These "essential health benefits" shall include at least ambulatory and patient services, emergency services, hospitalization, maternity and newborn care, mental health and substance use disorder services including behavioral health treatment, prescription drugs, rehabilitative and habilitative services and devises, laboratory services, preventative and wellness services, chronic disease management, and pediatric services including oral and vision care.

IRS Circular 230 Disclosure: As required by United States Treasury Regulations, you should be aware that this communication is not intended or written by the drafter to be used, and it cannot be used, by any recipient for the purpose of avoiding penalties that may be imposed on the recipient under United States federal tax laws.