Healthcare Reform Losers: Companies Providing Retiree Benefits Face Multi-Million Dollar Tax Costs

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After sending letters of protest to Congress in the months prior to the healthcare law's approval, U.S. companies are now facing multi-million dollar after-tax hits this year due to a tax provision in the new legislation, labeling them healthcare reform losers instead of winners.

Part of the new healthcare law places a federal income tax on government subsidies given to companies that provide retirees and their spouses with drug benefit plans. The 28% subsidy was created as Medicare Part D, adding a prescription plan for senior citizens to the Medicare Act of 2003. To encourage companies to continue offering retirees a drug plan, the tax-free subsidy reduced companies' costs. Fewer senior citizens then went through Medicare's prescription program - which would have cost taxpayers much more than the subsidy price.

Caterpillar Inc (NYSE: CAT) and Deere & Company (NSYE: DE) are just two of the businesses that fought the new stipulations. The manufacturers estimate the tax will cost them $100 million and $150 million this year, respectively. Other companies who will pay handsomely include AK Steel Corp. (NYSE: AKS) with $31 million in charges, and Honeywell International Inc. (NYSE: HON) with an estimated fee of $42 million.

Consulting firm Towers Watson & Co. (NYSE: TW) estimates these taxes could cost companies about $233 per person receiving drug benefits - a hefty price tag when a company gives benefits to 40,000 retirees, like Caterpillar.

Overall, more than 3,500 companies offer drug benefits to 6.3 million retirees. Although the tax won't be effective until 2011, accounting practices force companies to recognize the fees in the period in which the law is signed. That means the tax could nab $14 billion from corporate profits in a year when companies were hoping to recover from huge losses during the recession.

"From our point of view, a tax increase like this cannot come at a worse time," Jim Dugan, Caterpillar spokesman, told The Wall Street Journal. Caterpillar's income fell 75% in 2009, and worldwide machinery sales were down 20% in the three-month period ending Feb. 28 compared to the same period last year.

Caterpillar addressed the issues last week in a letter to Congressional leaders, stating the costs will disadvantage them against global competitors who are not facing increased healthcare expenses. Industrial and manufacturing companies, like Caterpillar and Deere, will take the worst hit as their businesses are still rebuilding from slacking periods of construction activity.

"This could be a huge hit for bigger companies," Roland McDevitt, healthcare director for Towers Watson, told Bloomberg. "This will be the kind of charge that will get the CFO looking and asking what are we doing here?"

Ten chief financial officers (CFOs) foresaw the healthcare reform's consequences and sent a letter to Congress asking them to reconsider the tax treatment. In the Dec. 11 plea, companies including Caterpillar, Deere, and The Boeing Co. (NYSE: BA) claimed the changes would "negatively impact both retirees and companies."

The CFOs contested the "double-dipping" accusation that they receive a tax-deduction for the cost of coverage in addition to the 28% subsidy, saying companies are still absorbing more costs than the government or the retirees. Adding to those expenses could encourage companies to drop the coverage, leaving retirees to shift to Medicare and costing the government more than estimated.

"If more companies than predicted by the Government Accountability Office shift away from coverage, then the provision could result in a net revenue loss rather than the predicted slight revenue gain," the CFOs wrote. "The impact of the proposed Medicare Part D changes would be felt throughout the overall U.S. economy as corporate entities and investors would be forced to react."

The tax is projected to generate $4.5 billion in revenue, but that number would drastically fall if enough companies decided to drop the benefits to avoid the subsidy tax. That would push retirees on to government-funded Medicare prescription plans.

Despite the White House's claims that the changes should not affect retirees, companies are claiming otherwise. After the healthcare bill was signed into law Verizon Communications Inc. (NYSE: VZ) sent a note to employees saying the tax would make the subsidy less valuable and could have implications for retirees and employers.

Another letter sent last week to President Barack Obama and Congress from 130 economists examined how the new taxes and fees would affect employers. They looked at more than just the retiree drug subsidy tax and drew similarly negative conclusions about the effect on companies.

"While Speaker Pelosi asserts that health care reform will create four million jobs, we disagree," that letter read. "In our view, the health care bill contains a number of provisions that will eliminate jobs, reduce hours and wages, and limit future job creation."

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