The Internal Revenue Service (IRS) recently issued Notice 2015-16 commencing the regulatory process to develop guidance on what’s been called the Cadillac Tax, i.e., the excise tax on high cost employer-sponsored health coverage.
Employers and plan sponsors, especially those with negotiated collective bargaining agreements, need to start actively planning now to mitigate exposure to the Patient Protection and Affordable Care Act’s (“PPACA”) Cadillac Tax under Code section 4980I, which is scheduled to go into effect for taxable years beginning on or after January 1, 2018.
Pursuant to Code section 4980I, if the aggregate cost of applicable employer-sponsored coverage (“applicable coverage”) provided to an employee exceeds a statutory dollar limit (baseline $10,200 per employee for self-only coverage and $27,500 per employee for other-than-self only coverage, adjusted annually), then the excess is subject to a 40% excise tax.
The IRS recently issued initial guidance on potential approaches to implementing this Cadillac Tax in Notice 2015-16 (the “Notice”). The Notice is intended to “initiate and inform” the process under which the government will be developing regulatory guidance under the Cadillac Tax. While the Notice does not offer official guidance on which the taxpayer may rely, it does provide necessary information related to potential approaches for implementation of the Cadillac Tax on important issues including but not limited to (1) the definition of applicable coverage; (2) the determination of the cost of applicable coverage; and (3) the application of the annual statutory dollar limit to the cost of applicable coverage. The Notice also provides insight to plan sponsors of self-funded plans and HRAs related to potential new developments in determining COBRA premiums.
Some highlights of the Notice include:
- Definition of applicable coverage. The Code generally defines “applicable coverage” to mean coverage under any group health plan made available to the employee by an employer which is excludable from the employee’s gross income under Code section 106, or would be so excludable if it were employer-provided coverage. Pursuant to the Code, examples of applicable coverage include: health FSAs; archer MSAs; HSAs; governmental plans; coverage for on-site medical clinics; retiree coverage; multiemployer plans; and certain specified illness and indemnity plans which are excludable from gross income. Additionally, the Code expressly excludes the following coverage from the definition of applicable coverage: coverage for accident and disability income insurance only; supplemental liability insurance; liability insurance; workers’ compensation and similar insurance; automobile medical payment insurance; coverage for long-term care; dental and vision insurance issued under a separate policy, certificate or contract of insurance; and coverage for specified disease or illness and hospital indemnity or fixed indemnity which is not excludable from gross income. The Notice indicates several outstanding questions associated with the Code’s definition of applicable coverage. For example, future guidance is expected to:
- Provide that executive physical programs and HRAs are applicable coverage;
- Provide that (a) employer contributions to HSAs and archer MSAs, including salary reduction contributions to HSAs, are included in applicable coverage; and (b) employee after-tax contributions to HSAs and archer MSAs are excluded from applicable coverage;
- Provide that applicable coverage does not include on-site medical clinics that offer only de minimus medical care to employees [however the IRS is also seeking comments on a number of issues related to the treatment of on-site medical clinics]; and
- Address whether the government will exercise its regulatory authority to propose an approach under which (a) self-insured limited scope dental and vision coverage that qualifies as an excepted benefit and/or (b) EAPs that qualify as excepted benefits will be excluded from the applicable coverage definition.
- Determining the cost of applicable coverage. A 40% excise tax on the excess, if any, of the aggregate cost of the applicable coverage of an employee for a month over the applicable dollar limit for the month will be imposed. For Cadillac Tax purposes, the cost of applicable coverage is generally expected to be determined under rules similar to the applicable premium for COBRA continuation coverage (i.e., generally based on the average cost of providing coverage for those covered under the plan who are similarly situated, instead of the cost of providing coverage based on the characteristics of each individual), with certain additional statutory elements (for example, section 4980I tax is not included in the cost; the cost of applicable coverage must be calculated separately for self-only coverage and other-than-self-only coverage; the plan may elect to treat a retiree who has not attained age 65 and a retiree who has attained age 65 as similarly situated beneficiaries; and special rules applicable to determining the applicable coverage for health FSAs, HSAs, and archer MSAs). The Notice clarifies that for purposes of determining the excise tax, the government will look to the applicable coverage in which the employee is enrolled, rather than coverage offered to the employee but in which the employee does not enroll. The Notice also acknowledges that a number of issues arise when computing the COBRA applicable premium on which guidance has not been provided, including but not limited to (1) how to determine which non-COBRA beneficiaries are similarly situated; (2) the specific methods that self-insured plans may use to determine the COBRA applicable premium; and (3) how to determine the COBRA applicable premium for HRAs. In this regard, the Notice describes potential approaches with respect to these issues for purposes of the Cadillac Tax. The Notice also seeks comment on whether the potential approaches should also be relevant for determining the COBRA applicable premium. For example, with respect to determining who are similarly situated individuals, the government is considering a specific disaggregation methodology: each group of similarly situated employees would be determined by starting with all employees covered by a particular benefit package provided by the employer, then subdividing that group based on mandatory disaggregation rules related to whether the employee was enrolled in self-only coverage or other-than-self only coverage, and then allowing further subdivision of the group based on permissible disaggregation rules. Likewise, the Notice provides possible adjustments to the existing self-funded plan methodology (actuarial basis and past cost methods) for computing COBRA premiums. The Notice also includes a discussion of a possible approach for using actual costs incurred during the plan year to calculate the cost of coverage under the past cost method for purposes of section 4980I (but not COBRA). Finally, with respect to HRAs, the government is considering various methods that future guidance might permit for use in determing the cost of applicable coverage, including determining the cost of applicable coverage under an HRA based on (1) the amounts made newly available to a participant each year (disregarding carry-over amounts or certain amounts made newly available before 2018); (2) by adding together all claims and administrative expenses attributable to HRAs for a particular period and dividing that sum by the number of employees covered for that period; and/or (3) using the actuarial basis method.
- Applicable dollar limits. The Code provides two annual dollar limits: one for an employee with self-only coverage (baselined for 2018 at $10,200) and one for an employee with other-than-self-only coverage (baselined for 2018 at $27,500). The Notice provides potential approaches for application of the dollar limit to employees with both categories of coverage (e.g., if the employee has self-only major medical coverage and supplemental coverage (such as an HRA) that covers the employee’s entire family). Under one potential approach, the applicable dollar limit for an employee would depend on whether the employee’s primary coverage/major medical coverage is self-only coverage or other-than-self–only coverage. Under another potential approach, the government would apply a composite dollar limit determined by prorating the dollar limits for each employee according to the ratio of the cost of the self-funded coverage and the cost of the other-than-self-only coverage provided to the employee. The government also intends to include rules regarding adjustments to the dollar limit in proposed regulations, including but not limited to a health cost adjustment percentage for 2018.
Clearly, the government still has a lot to determine prior to the effective date of the Cadillac Tax. Nonetheless, the Notice provides much anticipated guidance on the Cadillac Tax which employers and plan sponsors need to begin considering now. Employers, especially those with collective bargaining agreements, need to be thinking about how to keep their plans (and collective bargaining agreements) from triggering the Cadillac Tax and incurring potentially significant liability. This may require substantial restructuring of current plan terms, negotiations with insurers, and employee communications, all of this may take considerable time to effectively complete.
This alert is solely intended to be a summary of highlights of the lengthy and comprehensive IRS Notice 2015-16. The entire text of the Notice is available at: http://www.irs.gov/pub/irs-drop/n-15-16.pdf. The IRS is accepting comments to the Notice (including related issues to applicable premiums under COBRA) through May 15, 2015. Future guidance is anticipated regarding procedural issues relating to the calculation and assessment of the excise tax.