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Tax-free health benefit may change
The tax reform panel may propose capping workers' tax subsidy on health insurance premiums.
October 12, 2005: 6:28 PM EDT
By Jeanne Sahadi, CNN/Money senior writer

WASHINGTON, D.C. (CNN/Money) When you work for a company, your employer typically foots a large portion, if not all of your health insurance premiums. That money, which is not reported on your W2, is tax-free to you.

That may change in the future.

A bipartisan tax reform panel, appointed by President Bush to suggest ways to make the tax code simpler, fairer and more geared to promoting economic growth, said at a public meeting on Tuesday that it may recommend curbing the amount of tax-free health insurance contributions your employer makes on your behalf.

Anything paid above the threshold would be treated as taxable income to you. One possibility is to cap the amount of tax-free contributions at $11,000, said panalist Timothy J. Muris, a law professor at George Mason and a former Federal Trade Commission chairman.

The average cost of family coverage is now $10,880, of which employers pay an average of 74 percent or $8,051, according to the Kaiser Family Foundation

For those workers whose employers do not provide health insurance at all, the panel said it also may propose that those workers be allowed to deduct the premiums they pay for health insurance coverage. Currently, only self-employed workers (e.g., freelancers and small-business owners) may deduct their premiums.

With healthcare costs climbing at three to four times the rate of inflation every year since 2000, premiums have increased 73 percent, according to Kaiser changing any tax subsidy related to healthcare is a hot-button issue.

There are a few reasons the panel said it may propose limiting the healthcare break to workers:

The break disproportionately benefits higher-income workers: Forty-eight percent of the tax benefits go to families making more than $75,000; 27 percent goes to those making more than $100,000, Muris said.

It may help make health insurance more affordable: Some panelists, like Charles Schwab chief investment strategist Liz Ann Sonders, argued that curbing the tax subsidy on healthcare may have a trickle-down effect on insurance prices.

Here's part of their reasoning: Employees will be less inclined to pay for expensive policies if they know they're going to be taxed on some portion of their employer's contribution, and health insurance companies may be forced to become more competitive in their pricing as a result.

It can help make up for lost revenue if AMT is abolished: The panel's tax-code-reform proposals must be revenue-neutral meaning they may not alter the aggregate amount of revenue the current tax code generates. In July, they said they would recommend getting rid of the alternative minimum tax (AMT) a move estimated to cost $1.3 trillion over 10 years. (For more on why, click here.)

The income-tax exclusion of employer contributions to medical insurance premiums and medical care is the No. 1 revenue loser among all federal tax breaks available to individuals, costing over $100 billion in 2004, according to the General Accounting Office.

So reducing that exclusion could help pay, in part, for the loss of the AMT.

The No. 2 revenue loser is the mortgage interest deduction, something the panel also said it was considering reducing. (For more on that, click here.)

It should be noted, however, that the panel was instructed to assume that President Bush's tax cuts would be made permanent in all of their proposals. The estimated cost of making those cuts permanent is more than $1 trillion over the next 10 years.

So their calculations for revenue neutrality might be different if they didn't have to assume the permanency of those cuts, which is something Congress has yet to approve.

Other healthcare tax breaks available to workers

Even if the panel does propose to curb how much employers can pay in tax-free dollars for employees' healthcare, and the idea passes muster with Treasury, President Bush and Congress, there are still other tax subsidies in place that can help workers curb the costs of healthcare.

Employees pay their share of health insurance premiums with pre-tax dollars if they get their plan through work.

They also may be allowed to fund a flexible spending account with pre-tax dollars that may be used to pay for uncovered medical expenses incurred within a given period of time (currently a calendar year plus a few months).

And a relatively new account, the Health Savings Account (HSA), is being made available to workers in high-deductible health plans. It operates much like a 401(k) in that you may contribute dollars pre-tax up to an annual federal limit (currently $2,650 for individuals; $5,250 for families) and those dollars may be invested in stocks, bonds and mutual funds.

The money must be used for medical expenses, but those expenses can include insurance premiums, co-payments and deductibles. Unlike a flex spending plan, however, there is no requirement that the funds be used within a specific period of time.  Top of page

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