By Jerry J. Maginnis, CPA, and Edward J. Giniat, CPA
The passage of health care reform legislation this past March was the culmination of long, contentious public policy debates and political battles. But for companies affected by the measure and the accounting and tax professionals they rely upon for guidance, health care reform has just begun. Now, CPAs need to have a steady hand as they guide clients through their health care reform operations.
Some aspects of the Patient Protection and Affordable Care Act and its amendment, the Health Care and Education Reconciliation Act, had an immediate impact. Within days of the bills’ signings, major corporations announced charges against earnings due to changes in how Medicare subsidies are taxed. Since the new laws reduce future tax deductions relating to a company’s prescription drug cost, the “deductible temporary difference” relating to its benefit obligation is reduced, and a portion of the related deferred tax asset must be written off as a component of income tax expense from continuing operations. For these reasons, many major corporations announced a charge against earnings as soon as the bills were signed into law. Other major provisions, however, won’t take effect for years. For example, the requirement that individuals have health insurance and the creation of health insurance exchanges that allow individuals and small businesses to shop for insurance won’t kick in until 2014.
Because the laws are phased in, a timeline is probably the best way to get a full view of what happens when. It can give an overall picture of when key provisions take effect and can help you become well-informed on key dates. For CPAs and financial professionals, a range of new anti-fraud measures designed to cut down on Medicare and Medicaid abuse will be a key concern. Other changes that aren’t part of the new law will be happening concurrently, such as last year’s HITECH Act, which provides funding to increase the use of electronic health records, and new privacy and security regulations that will accompany that funding.
It is not possible to summarize every element of the sweeping health care reform legislation here, but it may be helpful to highlight the major provisions and what they mean. The focus, therefore, will be on how the reform measures will affect Pennsylvania CPAs, whether they are in public or private practice.
New taxes, fees, rebates, credits
The health care reform legislation includes myriad changes to the Internal Revenue Code to offset part of the cost of expanding health care coverage. Some of the companies most affected include drug manufacturers and medical device makers, many of which are Pennsylvania-based.
For example, drug manufacturers face an annual aggregate fee of $2.5 billion for calendar year 2011, increasing to $2.8 billion for calendar years 2012 and 2013, $3 billion for calendar years 2014 through 2016, $4 billion for 2017, $4.1 billion for 2018, and $2.8 billion for 2019 and beyond. The new non-deductible annual fees will be apportioned based on each entity’s relative share of sales in the branded prescription drug market during the previous calendar year. For March 31 fiscal-year-end companies, the fee should begin to be accrued on Jan. 1, 2011, so the fee payable in September 2011 will be recognized through the income statement over the period from January 1, 2011, through December 31, 2011, because the fee is a cost of doing business for the calendar year.
Beginning in 2013, medical device makers will face a 2.3 percent excise tax on the sale of certain devices. The tax doesn’t apply to retail products sold to the general public, such as eyeglasses, contact lenses, and hearing aids. Like similar taxes based on revenue-producing transactions, the excise tax presentation on the income statement would be an accounting policy decision to classify the fees as an expense or revenue reduction. Companies, however, should present these fees in a consistent manner with other similar fees. The excise tax would be deductible for income tax purposes.
Also in 2013, the law increases the employee portion of the Medicare hospital insurance tax on wages. It will rise to 2.35 percent from the current 1.45 percent. This increase is applied to wages exceeding a threshold of $250,000 for married couples filing a joint return, $125,000 for married individuals filing separately, and $200,000 for single filers. A 3.8 percent tax will be imposed in 2013 on unearned investment income for highly compensated individuals or couples.
Health insurance providers will face new fees in aggregate amounting to $8 billion beginning in 2014 and rising annually to $14.3 billion by 2018. The fees will be apportioned among providers each year and are based on a ratio designed to reflect relative market share of the U.S. health insurance business.
The health care law increases rebates provided for prescription drugs sold to Medicaid beneficiaries. For branded drugs, the rebate will increase to 23.1 percent from the current 15.1 percent of average manufacturer price. The generic drug rebate rises to 13 percent from the current 11 percent. Drug manufacturers will be required to pay rebates for drugs dispensed to Medicaid beneficiaries who are enrolled in a Medicaid managed care organization, thus expanding the volume of rebated drugs. The new rebate rates are effective January 1, 2010, so companies will need to reflect the higher rates in the quarter ended March 31, 2010.
Drug manufacturers must provide a 50 percent discount on branded prescription drugs to Medicare Part D participants who are in the so-called doughnut hole (the no-coverage gap in Medicare for aggregate spending of between $2,830 and $6,440). The doughnut hole will be phased out between 2010 and 2020, but the 50 percent discount begins in 2011. This would be accounted for in the period of the related sale (2011) and be charged against revenue. Estimating the amount and timing of the accrual will be challenging. Companies will need data to determine to what extent their products are being sold to someone who is eligible for the discount.
In terms of credits, the law establishes one for therapeutic discovery projects. The Treasury Department, in consultation with Health and Human Services, will award a 50 percent nonrefundable investment tax credit to projects that qualify. The credit is available to companies with 250 or fewer employees, and will go to projects designed to develop a product, process, or therapy to diagnose, treat, or prevent diseases or afflictions by conducting preclinical activities, clinical trials, clinical studies, and research protocols, or developing technology or products designed to diagnose diseases and conditions, or to further delivery or administration of therapeutics.
A qualified investment for any tax year is the aggregate amount of the costs paid or incurred in that year for expenses necessary for, and directly related to, the conduct of a qualifying discovery project. Treasury will consider only those projects that show potential to result in new therapies to treat unmet medical needs or to prevent, detect, or treat chronic or acute disease and conditions; that reduce long-term health care costs; or that significantly advance the goal of curing cancer within a 30-year period.
Employers, depending on their size, could see new credits or potential penalties beginning in 2014. For example, a small business (25 or fewer employees) that pays for at least 50 percent of the health insurance cost for its employees can receive a credit of up to 35 percent of the payments for tax years beginning in 2010 through 2013. Beginning in 2013, the credit is only available for the first two years for which the employer provides coverage and if the employer purchases the health care coverage from a state exchange plan.
Beginning in 2014, large employers (at least 50 employees) that do not offer “minimum essential coverage” at an affordable rate, or pay less than 60 percent of the cost of health care benefits, must pay a penalty if any full-time employee buys insurance from a state exchange plan. The penalty will increase based on a formula using average per capita premiums. Individuals who fail to maintain minimum coverage will be subject to penalties beginning in 2014. Such penalties are scheduled to grow annually.
New reporting provisions will also affect employers. For instance, in 2011 employers will be required to disclose on each employee’s Form W-2 the value of the employee’s health insurance coverage. Health insurers will be required to report certain health insurance coverage information both to the individual covered and to the IRS. The IRS, in turn, will be required to provide an annual notice to each individual who files an income tax return and fails to enroll in minimal coverage.
Another provision affecting business is the codification of the economic substance doctrine and the imposition of penalties. “Economic substance” is a doctrine of U.S. tax law in which transactions must have an economic purpose other than to reduce taxes if they are to be considered valid. Under the health care reform law, a 40 percent penalty applies to tax understatements attributable to transactions lacking economic substance (20 percent with adequate disclosure) or failing to meet the requirements of any similar rule of law. There is no reasonable cause and good-faith exception to the penalty.
A transaction is treated as having economic substance only if it meets the following criteria:
- The transaction changes in a meaningful way (apart from federal income tax effects) the taxpayer’s economic position.
- The taxpayer has a substantial purpose (apart from federal income tax effects) for entering into the transaction.
A transaction’s profit potential is not taken into account in evaluating whether the transaction has economic substance unless the present value of the reasonably expected pretax profit is substantial in relation to the present value of the expected net tax benefit arising from the transaction. Fees and other transaction expenses are treated as expenses in determining pretax profit.
The health care reform legislation contains many sections related to fighting health care fraud and abuse. For example, it significantly expands funding for audit, investigation, and litigation resources for the HIPAA Fraud and Abuse Control Program and the Medicare Integrity Program. These programs will receive a total of $350 million between fiscal years 2011 and 2020.
The health care industry will face new integrity provisions that will affect business operations and will require new procedures and policies. For example, there are new transparency requirements for manufacturers of devices, drugs, biologics, and medical supplies, as well as for pharmacy benefit managers, hospitals, physicians, and skilled nursing facilities.
The law takes a number of other steps to crack down on fraud, such as the creation of a national health care fraud and abuse data collection program and the consolidation of other databases. New screening procedures will be required for Medicare, Medicaid, and Children’s Health Insurance Program (CHIP) providers, including license checks and possible criminal background checks. Providers and suppliers will be required to develop compliance programs as a condition for enrollment in the Medicare program.
The law says Health and Human Services must impose an administrative penalty should an individual knowingly participate in a health care fraud offense or conspiracy. It also makes clear that, consistent with amendments to the False Claims Act, providers and insurers participating in federal health care programs are required to return overpayments from Medicare and Medicaid. Federal authorities will have more legal leverage over providers or suppliers who make false statements on enrollment applications.
In addition, the health care law expands the existing Recovery Act Contractor (RAC) program, which was established in 2005 as a demonstration program and has since collected more than $1 billion in improper Medicare payments. The law will expand RAC into Medicaid by requiring states to contract, by the end of this year, with one or more of these contractors to identify underpayments and overpayments and to recoup overpayments.
The scope and reach of the False Claims Act is broadened too, making clear that a claim involving an illegal kickback can be pursued under this act.
Suppliers of durable medical equipment and home health care services face new scrutiny. For example, providers who order durable medical equipment or home health care services must be enrolled in the Medicare program before they order supplies or services for beneficiaries.
A variety of other anti-fraud measures are also included in the law. Penalties have been increased for those who violate the law. For some provisions, the penalty is $50,000 per violation, compared with penalties as low as $10,000 under the old law. Health and Human Services is required to request that the National Association of Insurance Commissioners develop a uniform report form for private insurers to use in referring suspected fraud and abuse cases.
Health care reform will be a dynamic exercise. Expect technical corrections to the laws, regulatory actions and reactions, public policy adjustments made through federal appropriations, new studies and compliance oversight, plus activities by states, employers, and individuals that, taken collectively, will determine the trajectories of the reforms launched this year.
Regardless of how one feels about this legislation, health care reform will create an opportunity for Pennsylvania CPAs to enhance their value proposition. CPAs must become familiar with the new requirements and monitor the implementation and phase-in of these rules over the next several years.
The new legislation is complex, and it will have far-reaching implications for businesses and organizations of all sizes. Whether you are a practicing CPA serving clients as an auditor, tax advisor, or consultant, or you are a finance professional in a CFO, controller, or internal audit position, you are in an excellent position to help your clients or employers work through health care reform and its impact.
About the authors:
Jerry J. Maginnis, CPA, is managing partner of the Philadelphia office of KPMG LLP. Edward J. Giniat, CPA, is national leader of KPMG’s health care and pharmaceuticals practice, and is located in Chicago. Maginnis can be reached at [email protected]. Giniat can be reached at [email protected].
Reprinted with permission from the Pennsylvania CPA Journal, a publication of the Pennsylvania Institute of Certified Public Accountants.