MEDICARE AND CALIFORNIA SALES TAX
by
Joseph F. Micallef
If your firm has been treating all sales under Medicare Part B (“Medicare B”) as exempt from California sales tax, it is sitting on a fiscal time bomb. The California State Board of Equalization (“Board”) has been assessing sales tax on Medicare B transactions in amounts ranging up to several hundred thousand dollars for routine three year audits. Even businesses reporting correctly are generally confused about why sales under Medicare B are treated differently from sales under Part A. This article will discuss the different treatments and explain how sales tax applies to Medicare receipts in general.
Some sales under Medicare are always exempt, simply because the products involved fall under the general California exemption for prescription medicines. However, such transactions are outside the scope of this article, which solely addresses products ordinarily considered taxable when sold to patients.
In order for an otherwise taxable product to be exempted from sales tax under Medicare, the product must be considered sold to the United States government rather than to the patient. Sales to the U.S. government are exempt from sales tax for Constitutional reasons. This exemption has been codified in California Revenue and Taxation Code Section 6381 and is further delineated by Sales and Use Tax Regulation 1614.
Whether a Medicare transaction is considered an exempt sale to the U.S. government or a taxable sale to an individual patient depends on whether the sale falls under Medicare Part A or Part B. All sales under Part A are exempt sales to the U.S. government. Sales under Part B are not considered made to the U.S. government, and they are taxable unless some other exemption applies (such as the exemption for sales for resale or sales in interstate commerce). Differences between Parts A and B which result in this sales tax distinction are discussed below.
Financing and Participation
Medicare A is financed through payroll withholding and self-employment taxes. Participation is mandatory for anyone within the Social Security system. Most people who pay the taxes that fund Medicare A are under retirement age and not yet eligible for Medicare coverage.
Medicare B is financed partly (about 25 percent) through monthly premiums paid by those covered under the program. The rest of the financing comes from general funds of the federal government. Anyone covered by Part A is eligible for Part B, but participation in Part B is optional. Once participants enroll in the Medicare B program, they are required to pay the monthly premiums, generally through withholding from their Social Security checks.
Costs to Participants
Medicare A is funded entirely through self-employment taxes and the FICA taxes withheld from employee paychecks and matched by employers. There are no costs specific to participants.
Medicare B costs each participant about $30 per month which in most cases is deducted from the participant’s Social Security check. The monthly costs are considered medical insurance premiums and may be claimed as an itemized deduction on the participant’s income tax return.
Payment of Claims
Medicare A payments are made directly to the providers of medical products or services. This procedure is mandated by U.S. Codes Title 42, Chapter 7, Subchapter XVIII, Section 1395g(a). Since federal law requires direct payment by the government to providers, medical supplies sold by providers under Medicare A are considered sold to the U.S. government.
Medicare B payments may be made either to the provider or to the patient. If the provider has agreed to accept assignment of Medicare benefits (which essentially constitutes agreement to accept Medicare’s version of “reasonable charges”), the provider prepares and submits a claim form and is reimbursed directly by the insurer acting on behalf of the U.S. government. The patient pays only the deductible, co-insurance or non-allowable costs.
If the patient uses a provider who has not agreed to accept assignment of benefits, the patient pays the entire charge and then files a claim for reimbursement. Any such reimbursement goes directly to the patient.
Under Medicare B, payments are considered reimbursements of charges to the patient, whether the payments go directly to the patient or are made to the provider on the patient’s behalf.
The U.S. Government’s Position
Medicare A does not allow reimbursement for sales taxes charged on medical supplies, based on the theory that providers are selling to the U.S. government and the sales are therefore exempt.
Medicare B has built sales taxes into its calculation of “reasonable charges,” as stated in Medicare Carriers Manual section 5213. In accepting sales taxes as allowable charges under Medicare B, the U.S. Department of Health and Human Services has taken the position that sales under the program are not sales to the U.S. government.
Sales Tax Effect
Medicare A payments are made directly by the U.S. government to providers under federal law, which theoretically results in sales to the United States as discussed above.
Medicare B payments may be made either directly to patients or to providers for the benefit of patients, depending on each patient’s choice of provider. The patient’s ability to make this choice has been interpreted to mean that payments under Medicare B are simply reimbursements to patients. Under this “patient reimbursement” theory, any sale by the provider under Medicare B is made to the patient rather than the United States, regardless of which party prepares the claim form or receives the reimbursement check.
Both the U.S. Department of Health and Human Services and the State Board of Equalization have accepted these legal interpretations, and it appears unlikely that an effort to recharacterize sales under Medicare B as sales to the U.S. government would prevail. If the law is changed to make direct payments to providers mandatory under Part B, the application of sales tax might well change with it.
Although subject to tax, amounts claimed for 80 percent reimbursement under Medicare B are considered to include applicable sales taxes, because the Medicare Carriers Manual defines “reasonable charges” as including such taxes. Accordingly, when providers report their taxable sales to the Board, they are entitled to claim a deduction for sales taxes included in Medicare B reimbursements.
Conclusion
The theoretical justification for distinguishing sales under Medicare A from sales under Medicare B may not be entirely logical, but compliance with the Board’s interpretation is the only prudent approach under present circumstances. If you have been treating all sales under Medicare B as exempt, you should now begin reporting those sales as you would report sales to any private party.
But what about the earlier periods? If your firm is selected for a Board audit, you undoubtedly will be billed for additional taxes for those periods. However, the amount of additional taxes may be subject to adjustment. This is true not only for Medicare sales but for any area where tax changes are recommended by Board auditors. Audits incorporate assumptions and tests which often can be modified and occasionally can be overcome. Always remember that you have the right to review any Board auditor’s working papers or have a sales tax expert review the audit on your behalf. Exercising that right will at least bring you peace of mind. It might also result in significant tax savings. |
Audit Division