Il. DESCRIPTION OF MEDICAL SAVINGS ACCOUNT PROPOSAL

In general

In general, the proposal would permit individuals who are covered only by a catastrophic
health plan to maintain a medical savings account ("MSA"). Within limits, contributions to an
MSA would be deductible if made by the individual, or alternatively, would be excludable from an
employee's income if made by the employer. An individual would not be eligible to make
deductible contributions if the individual's employer makes contributions to an MSA for the
individual. In general, the aggregate amount of individual or employer contributions that could be
deducted or excluded for a taxable year would be the lesser of (1) the deductible under the
catastrophic health plan, or (2) $2,500 if the catastrophic health plan only provides individual
coverage or $5,000 if the catastrophic health plan also covers the individual's spouse and/or
dependents. These dollar limits would be indexed annually based on the medical care component
of the Consumer Price Index (rounded to the nearest multiple of $50). Income earned on
amounts held in an MSA would be currently includible in income. Withdrawals from an MSA
would be excludable from income if used for medical expenses for the individual and his or her
spouse or dependents.

Deductible contributions to MSAs

Under the proposal, a deductible contribution could be made to an MSA for any month in
which the individual is an eligible individual. In general, a person would be an eligible individual
for a month if, as of the first day of the month, he or she is covered under a catastrophic health
plan. However, an individual would not be eligible if the individual is also covered by another
health plan (other than a plan that provides certain permitted coverage) which is not a
catastrophic health plan and which provides coverage for benefits provided by the catastrophic
health plan. An individual with other coverage in addition to a catastrophic plan would still be
eligible to make deductible contributions to an MSA if such other coverage is certain permitted
insurance” or is coverage (whether provided through insurance or otherwise) for accidents, dental
care, vision care, or long-term care. Thus, for example, an individual whose only health plan
coverage is a catastrophic health plan and a flexible spending arrangement under which the only
health expenses that may be reimbursed are expenses for dental and vision care would be an
eligible individual.

? The following types of insurance would be permitted insurance and therefore would not
preclude an individual from making a deductible contribution to an MSA: (1) Medicare
supplemental insurance; (2) insurance if substantially all of the coverage provided under such
insurance relates to (a) liabilities incurred under workers’ compensation laws, (b) tort liabilities,
(c) liabilities relating to ownership or use of property (e.g., auto insurance), (d) credit insurance,
or (e) such other similar liabilities as the Secretary may prescribe by regulations; (3) insurance for
a specified disease or illness; and (4) insurance that provides a fixed payment for hospitalization.

3.



the time of the distribution. Distributions for qualified medical expenses of the individual's
spouse and dependents would be permitted even if the catastrophic health plan only covers the
individual. Qualified medical expenses would generally be defined as under the rules relating to
the itemized deduction for medical expenses (sec. 213). However, for this purpose qualified
medical expenses would not include any insurance premiums (including premiums for the
catastrophic health plan), except for premiums for long-term care insurance. Distributions from
an MSA that are excludable from gross income under the proposal could not be taken into
account for purposes of the itemized deduction for medical expenses.

Distributions for purposes other than qualified medical expenses would be subject to an
ordering rule so that such distributions would be includible in income until the amount of
previously deducted or excluded contributions have been exhausted. Under the proposal,
amounts not used for qualified medical expenses would be included in gross income to the extent
such distributions do not exceed the excess of (1) the aggregate contributions to such account
which were deductible or excludable from gross income, over (2) the aggregate prior payments
from such account which were includible in gross income. For this purpose, all MSAs of the
account holder would be aggregated and all distributions during a taxable year would be treated
as a single distribution. An additional tax of 10 percent of the amount includible in income also
would apply unless the distribution is made after the individual attains the age of 59-1/2 , dies or
becomes disabled.

Distributions upon the death of the account holder would be subject to rules similar to the
tules applicable to IRAs.

Rollovers from one MSA to another MSA would be permitted without income inclusion if
made within 60 days of distribution.

The proposal would include a correction mechanism so that if contributions for a year
(whether made by the individual or the employer) exceed the deduction limit for the year, the
excess contribution can be withdrawn tax free. In order for tax-free treatment to apply, the
excess contributions would have to be withdrawn before the due date (including extensions) for
filing the individual's tax return for the year and be accompanied by the amount of income
attributable to such contribution.

Effective Date

The proposal would be effective with respect to taxable years beginning after
December 31, 1995.

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I. PRESENT LAW

Under present law, the tax treatment of health insurance expenses depends on whether the
taxpayer is an employee or self-employed individual, and whether the taxpayer is covered under a
health plan paid for by the employee's employer. An employer's contribution to a plan providing
accident or health coverage for the employee and the employee's spouse and dependents is
excludable from an employee's income. In addition, businesses generally can deduct, as an
employee compensation expense, the full cost of any health insurance coverage provided for their
employees. The exclusion and deduction are generally also available in the case of owners of
subchapter C corporations who are also employees.

In the case of self-employed individuals (sole proprietors or partners in a partnership) no
equivalent exclusion applies. However, present law provides a deduction for 30 percent of the
amount paid for health insurance for a self-employed individual and the individual's spouse and
dependents. The 30-percent deduction is also available to more than 2-percent shareholders of
subchapter S corporations.

Individuals who itemize deductions may deduct amounts paid during the taxable year (if
not reimbursed by insurance or otherwise) for medical care (including medical insurance) of the
taxpayer and the taxpayer's spouse and dependents, to the extent that the total of such expenses
exceeds 7.5 percent of the taxpayer's adjusted gross income (AGI).

There are no specific tax provisions for medical savings accounts.



A catastrophic health plan would be defined as a health plan that has a deductible amount
of at least $1,500 (or $3,000 if the plan provides coverage for more than one individual). These
dollar amounts would be indexed annually for medical inflation provided to the nearest multiple of
$50.

No deduction would be allowed for a taxable year if any employer contributions are made
to an MSA on behalf of an individual during such year. (As discussed below, such employer
contributions would be excludable from income, subject to the same limits as deductible
contributions.)

The maximum annual deductible contribution to an MSA would be determined separately
for each month based on the individual's status as of the first day for each month, including: (1)
whether the individual is an eligible individual, (2) whether the catastrophic health plan covers
only the individual or also a spouse and dependents, and (3) the amount of the deductible under
the catastrophic health plan. In general, the maximum annual deductible contribution would be
the sum of the following amounts determined separately for each month: (1) 1/12 of the lesser of
$2,500 or the deductible under the catastrophic health plan for each month in which the individual
is an eligible individual and the catastrophic health plan covers only the individual; and (2) 1/12 of
the lesser of $5,000 or the deductible under the catastrophic health plan for each month in which
the individual is an eligible individual and the catastrophic health plan also covers the individual's
spouse and/or dependents.

The deduction limit generally would be determined separately for each spouse of a married
couple. If both spouses are covered under the same catastrophic health plan, then the $5,000
deduction limit would be divided equally between the spouses unless they agree on a different
division (in the time and manner prescribed by the Secretary). In such a case, no deduction would
be allowed with respect to either spouse if an employer contribution is made to an MSA on behalf
of either of the spouses. If either spouse or any dependent is covered under another catastrophic
health plan, the maximum deductible contribution for each spouse would be no more than $2,500.

Permitted deductions for contributions to an MSA would be taken in arriving at adjusted
gross income (i.e., "above the line"). No deduction would be allowed to an individual if any other
person is entitled to a personal exemption on account of such individual, whether or not such
personal exemption is actually taken.

Contributions to an MSA for a taxable year could be made until the due date for filing the
individual's tax return for the year (determined without regard to extensions).

Employer contributions to an MSA

Employer contributions to an MSA on behalf of an eligible individual would be excludable
from gross income and would not be considered wages for employment tax purposes. The
amount excludable could not exceed the deduction limit applicable to the individual. The

4.



Legislative Background
The proposal is similar to H.R. 1818, the "Family Medical Savings and Investment Act of

1995", introduced by Chairman Archer and others on June 13, 1995. The Committee on Ways
and Means held hearings on H.R. 1818 on June 27, 1995.

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DESCRIPTION OF AN AMENDMENT
IN THE NATURE OF A SUBSTITUTE TO THE
CHAIRMAN'S MARK
RELATING TO MEDICAL SAVINGS ACCOUNTS

Scheduled for Markup
by the
HOUSE COMMITTEE ON WAYS AND MEANS

on September 18, 1995

Prepared by the Staff
of the

JOINT COMMITTEE ON TAXATION

September 18, 1995

ICX-34-95



exclusion would apply whether or not the employee may choose to have the amounts contributed
to an MSA or another health plan. For example, there would be no income inclusion merely
because the employee may choose between a catastrophic health plan with an employer
contribution to an MSA and coverage under another (noncatastrophic) health plan. Employer
contributions to an MSA would not be excludable from income if made at the election of the
employee (i.e., pursuant to a salary reduction arrangement under a cafeteria plan). Any employer
contribution to an MSA (if otherwise allowable as a deduction) would be allowed only for the
taxable year in which paid.

The proposal does not specify the timing of employer contributions. Thus, for example,
an employer could make monthly contributions or a single annual contribution to an MSA.

Definition and tax treatment of MSAs

In general, an MSA would be a trust (or a custodial account) created exclusively for the
purpose of paying the qualified medical expenses of the account holder (or his or her spouse or
dependents) that meets requirements similar to those applicable to individual retirement
arrangements ("IRAs").> The trustee of an MSA could be a bank, insurance company, or other
person that demonstrates to the satisfaction of the Secretary that the manner in which such person
will administer the trust will be consistent with applicable requirements.

The holder of an MSA would have to currently include earnings on MSA assets in gross
income. Any capital losses on MSA assets could be used only to offset capital gains on MSA
assets. Unused capital losses could be carried forward to succeeding taxable years to offset future
gains on MSA assets.

An MSA trustee would be required to make such reports as may be required by the
Secretary. A $50 penalty would be imposed for each failure to file without reasonable cause.

Distributions from an MSA

Distributions from an MSA that are used to pay the qualified medical expenses (not
reimbursed by insurance or otherwise) of the individual or the individual's spouse or dependents
would be excludable from gross income whether or not the individual is an eligible individual at

3 For example, MSA contributions (other than amounts rolled over from another MSA)
would have to be in cash, no MSA assets could be invested in life insurance contracts, MSA
assets could not be commingled with other property.except in a common trust fund or common
investment fund, and an account holder's interest in an MSA would be required to be
nonforfeitable. In addition, if an account holder engages in a prohibited transaction with Tespect
to an MSA or pledges assets in an MSA, rules similar to those for IRAs would apply, and any
amounts treated as distributed to the account holder under these rules would be treated as not
used for qualified medical expenses.

5.



INTRODUCTION

CONTENTS

L DESCRIPTION OF PRESENT LAW ...................

I. DESCRIPTION OF MEDICAL SAVINGS ACCOUNT
PROPOSAL ... 22.02 neces

@



INTRODUCTION

The House Committee on Ways and Means has scheduled a markup on various revenue
provisions beginning on September 18, 1995. This document, prepared by the staff of the Joint
Committee on Taxation, provides a description of the medical savings account ("MSA") proposal
scheduled for markup.’

* This document may be cited as follows: Joint Committee on Taxation, Description of
an Amendment in the Nature of a Substitute to the Chairman's Mark Relating to Medical Savings
Accounts (JCX-34-95), September 18, 1995.

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