duction for the taxable year under section 213 but
for the threshold based on adjusted gross income.
‘‘(3) ACCOUNT
BENEFICIARY.—The term ‘ac-
count beneficiary’ means the employee for whose
benefit the medical incentives account is established.
‘‘(d) TAX TREATMENT OF DISTRIBUTIONS.—
‘‘(1) IN GENERAL.—Any amount paid or dis-
tributed out of a medical incentives account shall be
included in the gross income of the account bene-
ficiary unless such amount is used exclusively to pay
(or reimburse) the medical expenses of such bene-
ficiary, the spouse of such beneficiary, or any de-
pendent (as defined in section 152) of such bene-
ficiary. The preceding sentence shall not apply to the
extent that the aggregate of such payments and dis-
tributions during any taxable year which are not so
used does not exceed the account balance as of the
close of the preceding taxable year.
‘‘(2) PENALTY FOR AMOUNTS INCLUDED IN IN-
COME.—If any amount is includible in the gross in-
come of the account beneficiary for any taxable year,
such beneficiary’s tax imposed by this chapter shall
be increased by 10 percent of the amount so includ-
ible.
‘‘(e) TAX TREATMENT OF ACCOUNTS.—
‘‘(1) EXEMPTION FROM TAX.—Any medical in-
centives account is exempt from taxation under this
subtitle unless such account has ceased to be a med-
ical incentives account by reason of paragraph (2) or
(3). Notwithstanding the preceding sentence, any
such account shall be subject to the taxes imposed
by section 511 (relating to imposition of tax on un-
related business income of charitable, etc. organiza-
tions).
‘‘(2) ACCOUNT TERMINATES IF INDIVIDUAL EN-
GAGES IN PROHIBITED TRANSACTION.—
‘‘(A) IN GENERAL.—If, during any taxable
year of the individual for whose benefit the
medical incentives account was established,
such individual engages in any transaction pro-
hibited by section 4975 with respect to the ac-
count, the account ceases to be a medical incen-
tives account as of the first day of that taxable
year.
‘‘(B) ACCOUNT TREATED AS DISTRIBUTING
ALL ITS ASSETS.—In any case in which any ac-
count ceases to be a medical incentives account
by reason of subparagraph (A) on the first day
of any taxable year, paragraph (1) of subsection
(d) shall be applied as if there were a distribu-
tion on such first day in an amount equal to
the fair market value (on such first day) of all
assets in the account (on such first day) and no
portion of such distribution were used to pay
medical expenses.
‘‘(3) EFFECT OF PLEDGING ACCOUNT AS SECU-
RITY.—If, during any taxable year, the individual for
whose benefit a medical incentives account was es-
tablished uses the account or any portion thereof as
security for a loan, the portion so used is treated as
distributed to that individual and not used to pay
medical expenses.
‘‘(f) CUSTODIAL ACCOUNTS.—For purposes of this
section, a custodial account shall be treated as a trust if—
‘‘(1) the assets of such account are held by a
bank (as defined in section 408(n)) or another per-
son who demonstrates to the satisfaction of the Sec-
retary that the manner in which he will administer
the account will be consistent with the requirements
of this section, and
‘‘(2) the custodial account would, except for the
fact that it is not a trust, constitute a medical incen-
tives account described in subsection (c).
For purposes of this title, in the case of a custodial ac-
count treated as a trust by reason of the preceding sen-
tence, the custodian of such account shall be treated as
the trustee thereof.
‘‘(g) REPORTS.—The trustee of a medical incentives
account shall make such reports regarding such account
to the Secretary and to the individual for whose benefit
the account is maintained with respect to contributions,
distributions, and such other matters as the Secretary
may require under regulations. The reports required by
this subsection shall be filed at such time and in such
manner and furnished to such individuals at such time and
in such manner as may be required by those regulations.’’
(b) EXCLUSION APPLIES
FOR EMPLOYMENT TAX
PURPOSES.—
(1) SOCIAL SECURITY TAXES.—
(A) Paragraph (20) of section 3121(a) of
such Code is amended by striking ‘‘or 132’’ and
inserting ‘‘132, or 137’’.
(B) Paragraph (17) of section 209(a) of
the Social Security Act is amended by striking
‘‘or 132’’ and inserting ‘‘132, or 137’’.
(2) RAILROAD RETIREMENT TAX.—Paragraph
(5) of section 3231(e) of such Code is amended by
striking ‘‘or 132’’ and inserting ‘‘132, or 137’’.
(3) UNEMPLOYMENT TAX.—Paragraph (16) of
section 3306(b) of such Code is amended by striking
‘‘or 132’’ and inserting ‘‘132, or 137’’.
(4) WITHHOLDING
TAX.—Paragraph (19) of
section 3401(a) of such Code is amended by striking
‘‘or 132’’ and inserting ‘‘, 132, or 137’’.
(c) TAX ON PROHIBITED TRANSACTIONS.—Section
4975 of such Code (relating to prohibited transactions)
is amended—
(1) by adding at the end of subsection (c) the
following new paragraph:
‘‘(4) SPECIAL RULE FOR MEDICAL INCENTIVES
ACCOUNTS.—An individual for whose benefit a medi-
cal incentives account (within the meaning of section
137(c)) is established shall be exempt from the tax
imposed by this section with respect to any trans-
action concerning such account (which would other-
wise be taxable under this section) if, with respect
to such transaction, the account ceases to be a medi-
cal incentives account by reason of the application of
section 137(e)(2)(A) to such account.’’, and
(2) by inserting ‘‘or a medical incentives ac-
count described in section 137(c)’’ in subsection
(e)(1) after ‘‘described in section 408(a)’’.
(d) FAILURE TO PROVIDE REPORTS ON MEDICAL IN-
CENTIVES ACCOUNTS.—Section 6693 of such Code (relat-
ing to failure to provide reports on individual retirement
account or annuities) is amended—
(1) by inserting ‘‘OR ON MEDICAL INCEN-
TIVES
ACCOUNTS’’ after ‘‘ANNUITIES’’ in the
heading of such section, and
(2) by adding at the end of subsection (a) the
following: ‘‘The person required by section 137(g) to
file a report regarding a medical incentives account
at the time and in the manner required by such sec-
tion shall pay a penalty of $50 for each failure un-
less it is shown that such failure is due to reasonable
cause.’’
(e) CLERICAL AMENDMENTS.—
(1) The table of sections for part III of sub-
chapter B of chapter 1 of such Code is amended by
striking the last item and inserting the following:
‘‘Sec. 137. Medical incentives accounts.
‘‘Sec. 138. Cross references to other Acts.’’
(2) The table of sections for subchapter B of
chapter 68 of such Code is amended by inserting ‘‘or
on medical incentives accounts’’ after ‘‘annuities’’ in
the item relating to section 6693.
(f) EFFECTIVE DATE.—The amendments made by
this section shall apply to taxable years beginning after