The first major tax reform legislation since the 1980s is now law. How might the new law impact business decisions in 2018 and beyond? Let's break it down by sector.
Impact on not-for-profit hospitals and providers
Some not-for-profit hospitals now pay tax on unrelated business income (UBI) activities (e.g., lab services, pharmacy, research projects) that might not be provided solely to patients. Rather than offsetting profitable and money-losing activities before computing the UBI tax, the law requires hospitals to separate each of these activities and determine whether there is UBI tax on each one. This represents an added, perhaps non-recoverable, cost burden on these hospitals, which could further strain their limited resources.
The law also includes a special 21 percent excise tax on compensation that exceeds $1 million a year, and will apply to the five highest paid officers. That places not-for profit hospitals loosely on par with the requirements of publicly traded companies. Under the law, the compensation over $1 million of the five highest paid officers of publicly traded companies will not be deductible. This is a modification of the prior rule which generally exempted performance-based pay and exempted the principal financial officer.
Impact on health plans
The most substantive change for health plans is the elimination of the ACA's individual mandate penalty beginning in 2019. The ACA requires most individuals to pay a penalty (2.5 percent of annual income or $695) if they decide not to buy health insurance. The CBO estimates that removing the penalty will prompt about 4 million people to go without coverage in 2019 and 13 million by 2027. Health plans will likely factor this change into their premiums for the 2019 plan year, which are submitted in the spring. As healthy people leave the risk pool, the CBO expects that elimination of the penalty will push health care premiums up to 10 percent higher. As a result, some health plans might decide to stop selling coverage through the public insurance exchanges.
The overall lower corporate tax rate could offer health plans a bit of a counterweight. Many large health plans often pay close to the full 35 percent tax rate and are expected to benefit from the new 21 percent tax rate. The reduction could reduce premiums for consumers given that insurers must comply with the ACA's medical loss ratio rules, which mandate that at least 80 percent of individual and small-group premium revenue (85 percent for large-group plans) be spent on medical expenses.
Finally, the law reduces the threshold for the medical expense itemized deduction. For the next two years, the deduction for unreimbursed medical expenses will be available for costs exceeding 7.5 percent of income. This provision may encourage greater consumer spending on health care in some markets.
Impact on biopharma and medtech companies
The big news for life sciences companies is that the new law dropped the top corporate tax rate from 35 to 21 percent on January 1, 2018. Although this provision is applicable to all companies, I suspect it will likely have a significant impact on global biopharmaceutical and medical device firms.
Due to life sciences companies' size, profits, and the amount of taxes they pay, some manufacturers typically have more at stake from tax reform than other health care stakeholders. For example, a large pharmaceutical company might be headquartered in the US, but have a complex supply chain including international affiliates and unrelated global suppliers. But lowering the corporate tax rate might mean more than just a smaller tax bill. It could create the following new opportunities:
- Lower taxes could make the US market more competitive
- Some companies might relocate intellectual property (IP) to the US
- Worldwide profits could be reinvested domestically
In addition, tax reform includes a special tax deduction for a portion of the income reported in the US but earned from foreign sources (for example, a portion of the income earned from sales of drugs or devices to foreign customers), known as Foreign Derived Intangible Income (“FDII”).
However, there are several aspects of the new law that could increase tax costs for global life sciences companies. First, the new law includes a provision that will assess US tax on global intangible low taxed income (“GILTI”) related to foreign income that is earned offshore but low-taxed overseas. Second, foreign based multinationals and certain US based firms may be subject to a new form of minimum tax, called the base erosion anti-abuse tax (“BEAT”) which may apply to companies that make certain types of significant payments to related foreign parties.
For more on these implications, click here.