Last week, the Internal Revenue Service (IRS) released a proposed rule that would for the first time allow tax deductions for money spent for certain health care programs and arrangements, including direct primary care arrangements and health care sharing ministries.

The changes appear designed to incentivize and promote programs that may supplement – but in some cases are misconstrued as an alternative to – health insurance. These options do not provide comprehensive benefits and lack many safeguards that ensure access to services while also protecting consumers from financial liability for excessive costs of care. Comments on the proposed rule are due by Aug. 10, 2020 and may be submitted here.

The Rise of Health Insurance “Alternatives”

Rising health care costs and coverage have made health insurance too expensive for many Americans. This has driven many Americans to seek alternate ways to access the care they need. One option that has gained popularity in recent years is health care sharing ministries, organizations whose members who share a common set of religious or ethical beliefs come together to share medical expenses. It is estimated that nearly 1 million individuals currently participate in health ministries across 29 states.

Similarly, direct primary care arrangements (DPCAs) have also gained popularity. In a DPCA, a patient contracts directly with a primary care provider, or group of primary care providers, to access services at a set annual or periodic fee. These arrangements eliminate use of a third-party (a health insurer) in negotiations over care and cost, though in some cases may serve as a supplement to an individual or employer’s health insurance policy. Contracts vary as to what services might be covered under each DPCA, such as number of visits or laboratory service costs. Rarely do they include the type of specialty care services that may be necessary for treatment of diseases. More than 300,000 individuals participate in DCPAs in 48 states and Washington, DC.

Because of the limited scope of DPCA and health ministries, they are typically not classified as health insurance under state and federal laws. This means that they are exempt from many laws and regulations that govern health insurance coverage, including consumer protection laws such as mandated coverage of certain benefits (like hospitalizations) and protections for those with pre-existing conditions. These consumer laws also include financial protections like caps on out-of-pocket consumer spending and requirements that compel health insurers to spend at least 80 percent of payments they collect toward care received by members.

Direct primary care is a financial arrangement made directly between a patient and health care provider. The arrangements are separate from, though sometimes can supplement, health insurance.

Health care sharing ministries are non-insurance entities whose members share common beliefs and share medical expenses.

Neither of these alternative plans provide comprehensive health coverage that insurance plans are required to provide.

In 2019, monthly health insurance premiums on the individual insurance market averaged $580 per month per person, or $6,060 per year. Source: Kaiser Family Foundation, May 2020

Proposed Regulatory Changes

During annual tax filings, individuals may opt to either take a standardized deduction or itemize their applicable deductions. Those who opt to itemize deductions may include medical expenditures as part of their deductions if those expenses total more than 10 percent of the individual’s (or household’s) income. Allowable medical expenses include payments made for:

• The diagnosis, cure, mitigation, treatment, or prevention of disease, or for the purpose of affecting any structure or function of the body;
• Transportation to essential for medical care;
• Qualified long-term care services; and
• Insurance covering medical care or qualified long-term care (Internal Revenue Code § 213(d))

The rule proposes to include DPCAs and ministries as allowable medical care expenses for the purposes of tax deductions. Specifically, the rule interprets the definition of “insurance covering medical care” to include ministries and, in some cases, DPCAs. DPCAs would also qualify as payments made for “diagnosis, cure, etc. of disease”. In addition, the rule clarifies that payments made to government-sponsored health care programs, such as Medicare, Medicaid, the Children’s Health Insurance Program (CHIP), TRICARE, and the Veteran’s Health Program, would count as payments toward insurance and so could be included as medical care deductions. These changes would take effect as for the tax year following adoption of the final rule (likely tax year 2021).

As elaborated in the proposed rule, the classification of ministries and some DPCAs as insurance relies heavily on existing regulations governing tax deductions, which broadly define health insurance to include insurance that covers medical care and contracts “for membership in an association furnishing cooperative or so-called free-choice medical service”. This definition differs from other common definitions of insurance, including the Employee Retirement Income Security Act (ERISA) and the Public Health Service Act (PHS Act), which define insurance as “benefits consisting of medical care (provided directly, through insurance or reimbursement, or otherwise) under any hospital or medical service policy or certificate, hospital or medical service plan contract, or a health maintenance organization (HMO) contract offered by a health insurance issuer.”

In 2019, the standard deduction was $12,200 for a single individual and $18,659 for a head of household). Approximately one-third of tax filers opt to itemize their deductions. The majority of which are high-income earners (with incomes exceeding $500,000 per year) who have greater ability to spend income above the standard threshold.

The proposed rule clarifies that its definition of insurance should have no bearing on whether health ministries should be considered insurance under other state or federal laws. However, the changes have implications for how DPCAs and ministries would be treated in relation to other programs designed to support consumer spending on health care services, specifically health reimbursement arrangements (HRAs) and health savings accounts (HSAs). Because of the changes in how health ministries and DPCAs would be classified under this proposed rule:

• Health ministry participants could not contribute toward an HRA; and
• Neither DPCA nor ministry participants could contribute toward an HSA (with some narrow exceptions allowed for limited DPCAs). However, an HRA may be used to provide reimbursement for a DPCA.

Potential Impact of Proposed Changes

The changes proposed under the rule may have limited actual impact on consumers, in part because of the high threshold for spending consumers must meet to make it worth itemizing their deductions (see box). Because of this threshold, these deductions are unlikely to have any bearing for low-income earners, including those who qualify for Medicaid and CHIP and could, technically, deduct spending related to those programs as clarified under the proposed regulation. Furthermore, it is unlikely that spending on health ministries or DPCAs alone could push an individual above the standard deduction threshold. Monthly fees for DPCAs range from $50 to $200 per month. Spending on health ministries varies, with one report indicating that spending could range from a few hundred dollars to up to $1,000 per month depending on factors including age and household size.

Nonetheless, the idea of the deduction may entice more individuals to participate in these plans. While health ministries and DPCAs may serve a role in supplementing how consumers access or pay for care, there are growing concerns about their effect on consumers and health care markets when purchased in lieu of health insurance coverage. For example, these consumers will not be included in health insurance risk pools. This could result in higher premiums for those who remain in the market, as there will fewer individuals to spread risk.

Especially concerning are increasing reports of health ministries engaged in marketing practice that mislead consumers into thinking that their products are comparable to health insurance. However, because these products do not guarantee coverage of certain costs or services, they may leave consumers on the hook for high medical expenses. States, including Nevada, have issued broad warnings to consumers about health ministries and regulators in California, Colorado,  Connecticut, Maryland, New Hampshire,  New York, Texas, Rhode Island,  Vermont and Washington State have taken aggressive actions, including issuing cease-and-desist orders, against one ministry for deceptive practices.

The National Academy for State Health Policy will monitor states’ responses to the proposed regulation. Final comments on the proposed rule are due Aug. 10, 2020. The full text of the rule can be found here.