IRS Cadillac Tax Rules Highlight Need for COBRA Guidance | Practical Law

IRS Cadillac Tax Rules Highlight Need for COBRA Guidance | Practical Law

The IRS has issued Notice 2015-16, which includes numerous proposed approaches for implementing the excise tax on high cost employer-sponsored health coverage under the Affordable Care Act (ACA) (also known as the Cadillac tax). The Notice addresses various issues involving the ACA excise tax, including the definition of applicable coverage, determining the cost of applicable coverage and applying statutory limits.

IRS Cadillac Tax Rules Highlight Need for COBRA Guidance

Practical Law Legal Update 0-601-6146 (Approx. 8 pages)

IRS Cadillac Tax Rules Highlight Need for COBRA Guidance

by Practical Law Employee Benefits & Executive Compensation
Published on 24 Feb 2015 • USA (National/Federal)
The IRS has issued Notice 2015-16, which includes numerous proposed approaches for implementing the excise tax on high cost employer-sponsored health coverage under the Affordable Care Act (ACA) (also known as the Cadillac tax). The Notice addresses various issues involving the ACA excise tax, including the definition of applicable coverage, determining the cost of applicable coverage and applying statutory limits.
The IRS has issued Notice 2015-16, which provides potential approaches for issues involving the Affordable Care Act's (ACA) excise tax on high cost employer-sponsored health coverage under Section 4980I of the Internal Revenue Code (Code). The excise tax is commonly referred to as the "Cadillac tax" (26 U.S.C. § 4980I). Specifically, the Notice addresses:
In general, Code Section 4980I (effective for tax years beginning in 2018) imposes a 40% excise tax on any "excess benefit" provided to employees, which is the excess of the cost of coverage for a month over the dollar limit for the month. By statute, the cost of coverage for excise tax purposes is determined using rules "similar to" those for defining applicable premiums of COBRA coverage (see Practice Note, COBRA Overview). For a discussion of the excise tax, see Practice Note, Cadillac Plan Excise Tax under the ACA.
Under a related ACA requirement, employers must report on Form W-2 the aggregate cost of applicable employer-sponsored coverage (see Practice Note, W-2 Reporting for Employer-sponsored Health Coverage).
Procedurally, the IRS envisions that Notice 2015-16 will be followed by another notice addressing excise tax issues, and then by both proposed and final regulations.

Scope of Applicable Coverage

Notice 2015-16 addresses the types of coverage that are and are not "applicable coverage" for excise tax purposes (see Practice Note, Cadillac Plan Excise Tax under the ACA: Coverage Subject to Excise Tax). For example, the IRS expects that:
  • Employer contributions to health savings accounts (HSAs) and Archer medical savings accounts (Archer MSAs), including salary reductions to HSAs, are applicable coverage.
  • Employee after-tax contributions to HSAs and Archer MSAs are excluded from applicable coverage.
  • Coverage provided through an on-site medical clinic generally is applicable coverage, though subject to a:
    • potential exception for on-site clinics that provide only de minimis medical care; and
    • a comment request regarding clinics that provide certain services besides first aid (for example, immunizations).
  • Executive physical programs and health reimbursement arrangements (HRAs) are applicable coverage.

Dollar Limits

Code Section 4980I specifies two annual dollar limits for 2018, subject to adjustments that may increase the limits:
  • $10,200 per employee for self-only coverage.
  • $27,500 per employee for non-self-only coverage (for example, family coverage) (26 U.S.C. § 4980I(b)(3)(C)).
The IRS is considering a potential approach addressing how the Section 4980I dollar limits apply when an employee simultaneously has:
  • One type of coverage that is self-only coverage.
  • Another type of coverage that is non-self-only coverage.
In this case, the applicable limit generally would depend on whether an employee's primary (major medical) coverage is self-only or non-self-only, as reflected by the majority of the coverage's cost.
The dollar limits will be subject to various adjustments to be addressed in proposed regulations, including adjustments for:
  • Cost of living and a one-time "health cost adjustment percentage."
  • Qualified retirees.
  • High-risk professions.
  • Age and gender.
As with other issues addressed in Notice 2015-16, the IRS requests comments regarding certain of the adjustment categories.

Determining the Cost of Applicable Coverage (Overview)

Notice 2015-16 indicates that the premium for COBRA qualified beneficiaries:
  • Generally is based on the average cost of providing plan coverage for similarly situated individuals for whom a qualifying event has not occurred (see Practice Note, COBRA Overview: Qualifying Events).
  • Regarding self insured plans is determined using an "actuarial basis" or "past cost" method.
  • Is determined for a 12-month period, and must be chosen before the start of that period.
The Notice also sets out specific rules under Code Section 4980I for determining the cost of coverage for excise tax purposes, for example:
  • The cost of applicable coverage must be calculated separately for self-only coverage and non-self-only coverage.
  • The cost of health flexible spending arrangements (health FSA) coverage (see Practice Note, Cafeteria Plans: Flexible Spending Arrangements) is the sum of:
    • the employee's salary reduction contributions; and
    • reimbursements exceeding the employee's salary reduction elections (thus, the cost of applicable coverage includes employer flex contributions used for the health FSA).
  • For HSAs, the cost of applicable coverage is the amount of employer contributions under the arrangement, and including salary reduction contributions (see Practice Note, Defined Contribution Health Plans: Health Savings Accounts (HSAs)).
Also, the applicable coverage for determining the excise tax is:
  • The applicable coverage in which the employee is enrolled.
  • Not coverage offered to the employee, but in which the employee does not enroll.

Potential Approaches for Determining Cost of Applicable Coverage

The IRS acknowledges in Notice 2015-16 that there are several issues regarding calculating COBRA premiums for which specific guidance has not been provided, including:

Similarly-situated Individuals: Aggregation and Disaggregation

Analogizing to rules under COBRA, the IRS has indicated that under Section 4980I the cost for a given type of applicable coverage for an employee will be based on the average cost of that type of applicable coverage for:
  • The employee.
  • All similarly situated employees.
Under a proposed approach:
  • Each group of similarly situated employees would be determined by aggregating all employees covered by a particular benefit package provided by the employer.
  • That group would then be subdivided based on "mandatory disaggregation" rules.
  • Further subdivision of the group would be allowed based on "permissive disaggregation" rules.
To start, all employees enrolled in a given benefit package would be aggregated. For example, for employees who may choose between a standard option and a high option with lower deductibles and copays, employees covered under the high option would be grouped separately from those covered under the standard option. Separate grouping would also occur for employees who may choose between:
  • An HMO option and a PPO option.
  • Several different HMO options.
  • Several different HMO and PPO options.
Next, mandatory disaggregation would separate out employees receiving self-only coverage versus those receiving non-self-only coverage (for example, family coverage). Under an additional step, an employer could treat all employees enrolled in the same benefits package for non-self-only coverage (for example, employee plus one, employee plus two or family coverage) as similarly situated for determining the cost of applicable coverage for that group.
Yet another round of disaggregation could be permitted based on either:
  • A broad standard (for example, a bona fide employment-related criteria such as a specified job category or collective bargaining status, but not criterion related to an individual's health).
  • A more specific standard under which groups of similarly situated employees enrolled in a single benefit package could be disaggregated based on geographic distinctions (for example, an employee's residence in different states or metropolitan areas).

Self-insured Methods

Self-insured plans may calculate COBRA premiums using either:

Actuarial Basis Method

In the COBRA context, the actuarial basis method requires a plan to make an actuarial estimate of the cost of providing coverage for similarly situated beneficiaries, taking into account factors described in implementing guidance (though regulations setting forth these factors have not yet been issued). As applied to Section 4980I, the IRS is considering a broad standard under which the cost of applicable coverage for a group of similarly situated individuals would:
  • Equal a reasonable estimate of the cost of providing coverage under the plan for individuals in that group (and possibly requiring accreditation of individuals making actuarial estimates).
  • Apply reasonable actuarial principles and practices.

Past Cost Method

A plan using the past cost method would determine the COBRA premium based on the cost to the plan for similarly situated beneficiaries for the same period occurring during the preceding 12-month determination period.
In the COBRA context, the IRS is considering issuing guidance under which plans may use as the 12-month measurement period any 12-month period ending not more than 13 months before the start of the current determination period. A similar standard could be adopted for purposes of Section 4980I.
Costs to be taken into account under future proposed regulations could include:
  • Claims.
  • Premiums for stop-loss or reinsurance policies.
  • Administrative expenses.
  • The employer's reasonable overhead expenses (for example, salary, rent, supplies and utilities).

HRAs

The IRS indicates in Notice 2015-16 that:
  • Future guidance will provide that HRAs are applicable coverage under Section 4980I.
  • The cost of coverage under an HRA is determined using general Section 4980I valuation rules.
Under one possible approach for determining the cost of applicable coverage under an HRA, the cost would:
  • Be based on amounts made newly available to a participant each year.
  • Exclude, in most cases, amounts that are newly available to a participant each year.
Additional (or alternative) approaches would be intended to prevent overvaluation of an HRA if total contributions are not spent during a current period (for example, if an employer provides large contributions that go unused in a particular year).

Determination Period

In the COBRA context, the method for calculating premiums must be chosen before the determination period for which the premium applies. A similar rule would likely apply in the Section 4980I context. As a result, a self-insured plan using a calendar year as its 12-month determination period would choose its method (that is, actuarial or past cost) before the start of the calendar year.

Practical Impact

As Notice 2015-16 would suggest, the process for implementing the Section 4980I excise tax rules will also require the government to fill existing regulatory holes in the COBRA context. The IRS notes, for example, that it intends for future guidance on determining COBRA premiums to be consistent, to the extent possible, with the rules for determining the cost of coverage under Section 4980I.
The process outlined in Notice 2015-16 (notices containing proposed approaches, followed by proposed and final regulations) is similar to that used in implementing the ACA employer mandate (see Employer Mandate Toolkit), and offers commenters a chance to shape the guidance and point out potential issues early on. As described in the Notice, some of the approaches proposed under Section 4980I, particularly those for determining the cost of applicable coverage and the related aggregation and disaggregation processes, could rival parts of the final employer mandate regulations in complexity. Comments in response to Notice 2015-16 are due May 15, 2015.