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Health Care Reform Report Card: “B” Grade Overall

An interactive graphic in yesterday’s New York Times looks at the three “Rs” of health care reform: Roll-out, Reaction (by the public and the two political parties), and Results (cost-lowering and increased coverage) and gives a solid “B” grade to the overall effort. This factors in an “F” grade for support by the Republican Party, and a “D” grade based on rulings in recent federal court challenges to the individual mandate component of PPACA. Federal activity to implement reform was given the sole “A” grade. The piece notes that portions of the law’s budget are already “embedded in mandatory tax and spending provisions” and hence would not be affected by Republican measures to “de-fund” PPACA implementation – more details on that point (e.g., what reform measures remain unfunded) would be helpful. It also observes that 27 of the 28 states whose attorneys general or governors have challeneged the constitutionality of PPACA in federal courts have also accepted federal funding towards establishment of insurance exchanges. In all the piece does a good job of differentiating the political rhetoric from the nuts and bolts of reform implementation.

DOL Extends Compliance Deadline for Plan-Level Fee Disclosure Rules

The rules governing retirement plan fee disclosures at both the plan and participant levels are undergoing a major overhaul. The complexity of the issues at hand has led the Department of Labor’s Employee Benefits Security Administration (EBSA) to extend by several months the compliance deadline applicable to interim final regulations on plan-level disclosures under ERISA Section 408(b)(2). The reason for extending the applicable date is that EBSA did not have sufficient time to take into account the many public comments it received on the interim final regulations.

The regulations, originally slated to go into effect on July 16, 2011, will now become applicable January 1, 2012. They will apply to “covered service providers” that reasonably expect to receive $1,000 or more in direct or indirect compensation from a retirement plan in a given plan year.

Covered service providers, including third party administrators, registered investment advisors, broker-dealers and recordkeepers, have always had to disclose the services they provided to plans, and the compensation they received, however such disclosures largely have been limited to the service agreement the provider entered into with the plan fiduciary (if any), and information required to be reported on Schedule C (Service Provider Information) to the Form 5500 Annual Return/Report (a Schedule only required for plans with 100 or more participants).

The new regulations will require these entities to provide a written, detailed disclosure of services provided to, and fees and expenses received from, all qualified retirement plans they serve. The new rules are intended to bring to light fees and charges that formerly were hidden to plan sponsors in a variety of ways, including “bundled” plan service arrangements.

Technically, the disclosures are required to be made to plan sponsors and other fiduciaries in order for the fiduciary to conclude that the service arrangement is “reasonable” in light of the services provided; only “reasonable” service provider arrangements are exempt from “prohibited transaction” rules that otherwise apply to the use of plan assets. In their proposed form, the regulations required that service providers enter into a specific written agreement with plan fiduciaries; the interim final regulations require that the disclosures be made in writing but do not specify the format.

The regulations are the second in a three-part effort by the Department of Labor to improve fee transparency and disclosure, particularly with respect to 401(k) fees. First, they revised Schedule C to the annual Form 5500 Return/Report, which reports Service Provider Information. The revisions, which required disclosure of indirect forms of compensation for the first time, took effect for plan years beginning on or after January 1, 2009. The second part is the plan-level disclosures discussed above, and the third part is participant-level disclosures that plan sponsors must make under ERISA Section 404(a)(1). Final regulations describing these disclosures go into effect on January 1, 2012, although it is possible that this will be pushed back as well.

Each of these developments – Schedule C revisions, plan-level disclosure rules, and participant-level disclosure rules, are extremely important and will be the subject of further discussion on this blog. In addition I hope to address the following related regulatory changes in the coming weeks and months:

• Proposed regulations expanding the definition of an ERISA fiduciary (the first such change in over 30 years);
• Proposed regulations related to target date retirement funds and “qualified default investment alternatives” or QDIAs, two categories that overlap to a degree; and
• Regulations related to lifetime income options, including recently re-introduced Senate Bill, the Lifetime Income Disclosure Act, which would require plan account balances to be reported not just in a lump sum but as a projected stream of retirement income.

If there could be said to be a common thread among all these pieces of legislation, it is that the disclosure and fiduciary rules that sufficed when traditional pension plans prevailed, are no longer adequate in the age of the 401(k). The 401(k) model largely leaves participants on their own when it comes to savings goals, investment choices, and in-service access to retirement savings, and the end result is that the average 401(k) account balance in America today is scandalously low.

DOL Disallows IRA Promissory Note Investment

Last week, the Department of Labor issued Advisory Opinion 2011-04A finding that it would be a “prohibited transaction” (“PT”) for an IRA to purchase a promissory note and deed of trust from a bank where the IRA owner and his spouse were indebted under the note, and where the IRA owner’s family trust held title to the real property at issue.

This ruling is important because the Department of Labor concluded that the proposed arrangement would be an impermissible extension of credit from the IRA to the IRA owners, even though the owners simply intended to move the existing loan over from a bank to the IRA without thereafter refinancing or otherwise taking any action that would constitute a new loan from the IRA. Also significant is that the Department of Labor classified the proposed transaction as prohibited self dealing, for reasons explained below.

The Advisory Opinion involved an IRA that the owner opened over twenty years ago. The owner was the sole account holder and his wife was the sole beneficiary. In 1993 the owners bought an eight-unit apartment building in San Diego for $200,000, financed with a loan from Chase Bank that was secured by a first deed of trust on the property, and evidenced in the form of a promissory note. Title to the property was held in the name of the owners’ family trust. The owners were the trustees and sole beneficiaries of the family trust.

What the owners proposed to do was to have the IRA purchase the promissory note and deed of trust from Chase Bank. Chase Bank would assign the note and deed over to the IRA, or more precisely to another bank serving as IRA custodian, and the owners would make all subsequent payments on the note to the IRA custodian, which in addition to receiving payments would otherwise enforce the promissory note.

The owners’ request for an advisory opinion specifically pointed out that “the transaction [was] structured to avoid any new loan or other extension of credit between the IRA and the [owners], as would occur if they refinanced the loan under different terms using the IRA as a new lender.”

This language refers to one type of prohibited “party in interest” transaction – the direct or indirect lending of money or other extension of credit between a plan (here, the IRA) and a disqualified person or persons (here, the IRA owners). ERISA and the Internal Revenue Code (“Code”) describe four other types of specific prohibited transactions as well as several general categories of prohibited “self dealing” with IRA/plan assets by a fiduciary. Of relevance here are (a) the transfer of plan assets or income to, or use of them by or for the benefit of, a disqualified person; and (b) dealing with plan assets or income for the fiduciary’s own personal account. These are set forth in Code Section 4975(c)(1)(D) and (E), respectively.

The Department of Labor analysis first identified the IRA owner as a fiduciary with regard to the IRA due to his sole discretion over IRA investments. As a fiduciary he was a “disqualified person” as that term is defined in Code Section 4975(e)(2), as were his family members (including his wife) and his family trust, as he and his wife (now both fiduciaries and disqualified persons) together owned more than 50% of the trust. (The DOL has express authority to interpret Section 4975 of the Code and also interprets parallel provisions of ERISA governing prohibited transactions.)

Then, the Department of Labor rejected the notion that simply “moving” the loan over from Chase Bank to the IRA was not a prohibited extension of credit from the IRA to the IRA owners. First, it cited Department policy that a loan is a transaction that “continued from the time it is made until all amounts due are paid,” and that the parties must be examined throughout that time for indicia of a prohibited relationship. On that basis the Department found that a prohibited extension of credit would occur as soon as the IRA acquired the note from Chase Bank, and that the IRA’s holding of the note would constitute another prohibited extension of credit so long as the IRA owners or any other disqualified persons made payments on the note.

The Department of Labor went on to determine that the transfer to and holding of the loan by the IRA would also constitute prohibited self dealing if the transaction was part of an agreement, arrangement or understanding by the IRA owner, as the IRA’s fiduciary, “to benefit himself or persons in which he has an interest that affects his best judgment as a fiduciary (e.g., the Family Trust.)” Noting that this was “generally an inherently factual question,” the Department observed that the proposed purchase of the note by the IRA from Chase Bank would be one in which the IRA owner “would have an understanding, as a fiduciary, that the assets of the IRA are being used to create a prohibited transaction (i.e., an ongoing debtor-creditor relationship between the IRA and disqualified persons) once the IRA acquires the Note.” It therefore concluded that, under those circumstances, the IRA’s purchase of the note would be a separate, self-dealing prohibited transaction under Code Section 4975(c)(1)(D) and (E).

This Advisory Opinion is a good example of how a proposed IRA investment that had been structured with an attorney’s advice and approved by a very reputable bank custodian could still be found to be three different types of prohibited transaction, once under the scrutiny of a government agency. Simply put, this is an area of the law where even the cautious can come to grief. Seeking a tax advisor’s opinion, if not agency approval, is advised before proceeding with any unorthodox IRA investment.

House Plans Amendment to De-Fund PPACA

The House plans to amend pending legislation funding the federal government to add provisions de-funding implementation of PPACA. The Hill quotes House Majority Leader Eric Cantor (R. Va.) on this point, and notes that the current government funding bill is scheduled to expire on March 4, 2011.

Presuming that the de-funding amendment to the bill passes the House, it likely will fail in the Senate just as did the House bill to repeal PPACA, a few weeks ago. Given the crushing federal debt, however, nothing is certain. I will keep readers posted on any unexpected results.

PPACA: The Graphic Novel, Coming Soon

The PPACA and its companion Reconciliation Act soon will be the subject of a graphic novel (grown-up comic book) to be authored by MIT health economist Jonathan Gruber. The book, tentatively to be titled “Health Care Reform: What It Is, Why It’s Necessary, How it Works,” is expected to be published in the fall. It will be interesting to see how the lengthy and complex federal law translates into an illustrated narrative and I look forward to reading it.

Tackling difficult subject matter is nothing new for the graphic novel. Writer Sid Jacobson and illustrator Ernie Colon did a brilliant job in “The 9/11 Report: A Graphic Adaption.” This sub-genre of the graphic novel commonly is tracked back to “Maus: A Survivor’s Tale,” in which Art Spiegelman addressed the Holocaust in illustrated format through his own family’s stories, using animals (mice, rats, dogs) instead of human forms.

In this particular instance the author will have a decidely pro-reform slant. Gruber helped design the Massachusetts health care reform system, which has been in place since 2006, and according to an interview with the Boston Herald he plans to illustrate how PPACA will lower health-care costs and curb insurance industry abuses.

The ability of PPACA to flatten or lower rapidly increasing health care costs is only hypothetical at this point, so I am curious to see how Professor Gruber boils this issue down. He warned in his interview with the Herald that there won’t be any superheroes or villains in the book, but in the real world supernatural forces may be necessary to bend the ever-increasing cost curve.

Senate Axe Falls on Expanded 1099 Reporting

The U.S. Senate failed fully to repeal PPACA in a 47 to 51 vote today, but succeeded in repealing Section 9006 of PPACA which, starting in 2012, would have expanded Form 1099 reporting to include payments of $600 or more to corporations providing services or goods. (Form 1099 currently is limited (generally) to reporting services worth $600 or more received from individuals or non-corporate entities.)

The expanded Form 1099 reporting was the lowest of the low-hanging fruit in the PPACA and even was singled out by President Obama in his State of the Union address as an expendable provision of the health care reform law.

Repeal of this measure is expected to cost approximately $22 billion over 10 years. This amount is to be restored with appropriated but unspent federal funds chosen at the discretion of the Office of Management and Budget. Defense, Veterans Affairs and Social Security funds are reported to be exempt from reductions.

California Tax Parity and PPACA

California employers who last year extended group health coverage to “overage dependents” of their employees – adult children up to age 26 – encountered some difficulties issuing W-2s to those employees in the new year. This is because the state tax definition of a dependent does not match the federal definition. To be a dependent for California tax purposes an adult child must either be disabled or a full-time student, consistent with the federal Internal Revenue Code as of January 1, 2009. (California largely follows the Code as of that date but differs from the Code in several major respects, making it a “selective” conformity state.)

However federal tax guidance that followed PPACA in 2010 now treats adult children as dependents, for federal income tax purposes, through the year in which they turn 26, whether or not they are full-time students, disabled, or meet other requirements of dependent status.

So although this means that the value of health benefits provided to overage dependents is not taxable income to an employee at the federal level, there is “imputed income” to the employee at the state level that must be reflected on Box 16 of Form W-2. Although some employers voluntarily or were required to comply with the age 26 extension last year — affecting W-2s that just went out – it is mandatory in 2011 for “non-grandfathered” group health plans. Even grandfathered plans must offer the coverage to an employee’s adult child if the child does not have other sources of group coverage.

Note that this is the exact inverse of the situation with registered domestic partners, who are the equivalent of spouses for California tax purposes, but who generally are not dependents under the federal tax code. The difficulty for employers in both instances is assigning a value to the benefits provided, this particularly is challenging when the employee is already paying a maxed-out family premium at the time the registered domestic partner or adult child is added to coverage. (Generally the Internal Revenue Service provides that the coverage be assigned a value even when it does not increase premiums; use of the individual COBRA premium less the 2% administrative fee is a good rule of thumb but employers should always consult with their trusted CPA or tax counsel in this regard.)

Fortunately, help is on the way. Late last year, Assembly Bill 1178 was introduced to make California tax law conform to federal law with regard to overage dependents, but the bill failed to pass. The bill has been reintroduced as Assembly Bill 36, sponsored by Democratic Assemblymembers Henry T. Perea and Robert J. Blumenfield. The very brief text of the bill calls for immediately effective tax parity with PPACA regarding dependents. (California law last year was amended to require insurers and HMOs to comply with the PPACA but this measure did not include tax conformity.)

I had the chance to discuss the prospects and timeline for A.B. 36 with a Sacramento legislative consultant. A vote on the bill is scheduled for February 14, 2011 and likely will go to the Senate by the end of February. The Senate could have the bill for anywhere from a week to a month but likely will vote on it by the end of March. As these events hopefully swiftly transpire I will keep you posted on developments. The bill’s prospects for passage are good, but, as with any legislation, never certain.

In the meantime, employers who abandoned the practice of tracking student status for dependents should put those measures back into place, so that employees with adult children who do meet the federal definition of “dependent” can extend coverage to them without any state tax consequences until such time as A.B. 36 becomes law.

PPACA Ruled Unconstitutional As a Whole

On January 31, 2011 Federal District Judge Robert Vinson ruled that the individual mandate and indeed the entirety of the PPACA was unconstitutional. The ruling came in State of Florida v. U.S. Department of Health and Human Services, a legal challenge to PPACA brought by governors and attorneys general in 26 states. I have not had a chance to review in detail the 78-page opinion, but understand the ruling to be based on two main points – first, that the federal government cannot regulate inactivity through the Commerce Clause, and refusing to buy health insurance is inactivity, and second that the individual mandate is so thoroughly interwoven into the PPACA as a whole that the court could not “sever” that provision and rule only as to its constitutionality. Thus, although two prior federal district court, have upheld the constitutionality of the individual mandate, and one court found the mandate to be unconstitutional only last month, this is the first time that a federal court has ruled the entirety of PPACA to violate the Constitution.

The opinion contained one pro-PPACA nugget, however: Judge Vinson found that the PPACA’s requirement that states pay for a fractional share of expanding Medicare access does not violate the state sovereignty clause of the Constitution. Note that this conclusion is not inconsistent with the court’s position on severability, namely that the court was in no position to go through PPACA’s over 2,000 pages and determine which provisions could, and which could not, function independently from the individual mandate.

The Justice Department will appeal the ruling to the 11th Circuit; appeals of the prior 3 rulings are now pending in the 4th and 6th Circuits and more challenges are moving up at the federal trial court level, with the entire matter eventually heading to the Supreme Court in a process that could take 2 or more years. The individual mandate under challenge is not slated to go into effect until 2014.

To review the status of these cases and read briefs, rulings, and trenchant commentary, visit the ACA Litigation Blog and the Constitutional Law Prof Blog. These are wonderful resources on which I rely heavily when addressing litigation challenging the PPACA.

What does the most recent ruling mean for the forward progress of PPACA? Well, the court did not enjoin enforcement of the PPACA, and the ruling soon will be under appeal, so really nothing practical has changed for employers, insurers, and health plan participants. The cloud of uncertainty over PPACA just got a bit murkier, is all.

Expanded 1099 Reporting Criticized in State of the Union Address

President Obama’s State of the Union address this evening called out expanded 1099 reporting rules – addressed earlier in this blog – as a health care reform measure he would be happy to see set aside. The full text of the address, as prepared for delivery (not a transcript) is available here. The President stood up strongly, however, for elimination of pre-existing condition exclusion rules, which is a measure that would survive the “repeal and replace” process underway in the House of Representatives. The President’s final word on PPACA was to “fix what needs fixing and move forward.”

Progress Towards Rollback of Expanded 1099 Reporting

Updated April 15, 2011: President Obama signed H.R. 4 into law today, repealing expanded 1099 reporting obligations prior to their proposed effective date of January 1, 2012.

One of the most unpopular features of PPACA removes 1099 reporting exceptions applicable to services or goods received from corporations.

Currently businesses only need to issue Form 1099-MISC in relation to payments for services totaling $600 or more in a given year. Further, payments made to corporations largely are excluded from this reporting requirement (exceptions exist for medical and health care payments and payments to an attorney). Section 9006(a) of the PPACA eliminates the exception for payments to a corporation, first effective for payments made January 1, 2012 and subsequent (reported in early 2013); it also expands reportable transactions to include sales of tangible goods and not just services. By capturing taxable transactions that otherwise were not properly being reported, this measure was intended to raise up to $19 billion over 10 years towards the cost of health care reform.

It is a truth universally acknowledged (hat tip to Jane Austen) that this measure, if implemented, will impose serious compliance burdens, particularly on small businesses. To start with, they will need to capture Tax Identification Numbers from all corporations with whom they do $600 or more in business, just in order to issue the 1099s. There is added complication from the fact that credit card purchases have a separate reporting process at the level of the card transaction vendors.

In response to general public outcry there were several unsuccessful attempt late last year to repeal this measure, one taking the form of repeal bill H.R. 144. Now H.R. 4 re-introduces the text of H.R. 144, which had been sponsored by Rep. Dan Lungren (R-Calif.) H.R. 4 has even more backers than did H.R. 144, showing that opposition to the measure is growing. Of the 245 co-sponsors of H.R. 4, twelve are Democrats, including Rep. Barney Frank (D-Mass), who heads the House Financial Services Committee.

H.R. 4 may be introduced in the House as early as Tuesday, January 25. In its support, three Democratic senators have written a letter to House Speaker John Boehner (R-Ohio) urging that the measure be repealed. The letter, which is copied below, focuses on the detriment the measure could have on job growth and other advancements needed from the small business sector, in this still fragile economy.

The response from the Speaker’s office has been lukewarm. This is consistent with Republican strategy at the moment, which is wholly to repeal PPACA, not to tinker with and tweak it. No question, expanded 1099 reporting duties won’t feature in Republican proposals to replace PPACA, but tactically they may want to “hold out” for full repeal of PPACA rather than engage in a process that improves PPACA in any way.

Luckily we have almost a year for this awkward legislative dance to progress, before the expanded reporting deadlines are a reality. A business that wants to hedge its bets in the meantime should attempt to collect Form W-9s from all corporate vendors. With any luck, they will be fodder for the shredder within a year’s time.

Here is the text of the letter to the Speaker of the House supporting H.R. 4:

January 20, 2011

Dear Speaker Boehner,

Now that you have moved past repeal of the Affordable Care Act, we encourage you to work on efforts to improve the law moving forward. In this spirit, we urge you to take up and pass H.R. 4, a bill which simply strikes the tax-reporting requirement in the health reform law. We have heard from small business men and women in our states who have voiced concern that this provision is burdensome and unnecessary, and could potentially undermine our nation’s economic recovery. Repealing this provision would be an important and practical way to improve the Affordable Care Act. We are confident that the Senate can quickly act on H.R. 4 once the House has passed it.

Section 9006 of the Affordable Care Act (P.L. 111-148) requires all business entities to file a 1099 form with the Internal Revenue Service for each vendor for whom they have cumulative transactions of $600 or more. Small businesses in our states have raised concerns that in order to comply with this new requirement, which takes effect next year, businesses will have to institute new record-keeping methods. The change is particularly onerous for small businesses, our nation’s engines of growth, who cannot afford to employ extra lawyers and accountants to comply with the new rules. The provision may also have the unintended consequence of distorting behavior in the marketplace, as large businesses will have an incentive to minimize their reporting requirements by consolidating purchases with large vendors, harming small, regional vendors.

This past November, voters sent both parties a clear message: focus on job creation. As President Obama has recently noted, our economy will recover more quickly and create more jobs if we can reduce regulations on business. Repealing this provision would be a great first step as we work together to grow the economy.

Sincerely,

Senator Amy Klobuchar

Senator Ben Nelson

Senator Maria Cantwell