Applicable large employers offering their employees higher compensation in exchange for waiving employer-sponsored group health plan coverage could be walking into a Pay or Play trap. Specifically, the government recently released new guidance clarifying that Pay or Play penalties related to opt-out payment programs may be looming unless such programs are redesigned as set forth below.
As you know, applicable large employers must comply with the Employer Shared Responsibility Mandate (i.e., Pay or Play). Under Pay or Play, such employers are required, among other things, to offer affordable medical coverage which provides minimum value to their full-time employees.
Coverage is generally deemed affordable for an employee if the employee’s required contribution does not exceed 9.5% (indexed, 9.66% for 2016 and 9.69% for 2017) of the employee’s household income (safe harbors apply under Pay or Play). Although numerous guidance exists regarding determining whether coverage offered is affordable, this Client Alert focuses on the impact of payments in lieu of group health plan coverage (“opt-out arrangements”).
On November 26, 2014, the government issued final regulations regarding the individual shared responsibility mandate and addressed how affordability is affected by Code section 125 plans, as well as contributions toward health reimbursement arrangements (HRAs) and wellness program incentives. These final regulations set forth that amounts made available for the current plan year under a cafeteria plan, within the meaning of section 125, are taken into account in determining an employee’s or a related individual’s required contribution if: (1) The employee may not opt to receive the amount as a taxable benefit; (2) The employee may use the amount to pay for minimum essential coverage; and (3) The employee may use the amount exclusively to pay for medical care, within the meaning of section 213. This means that cashable credits (i.e., employer contributions through a cafeteria plan that can be taken in cash in lieu of nontaxable medical benefits) cannot be used to lower the employee required contribution. Yet it was not clear whether contributions under the individual shared responsibility mandate would be treated similarly for Pay or Play affordability purposes.
Employers often offer opt-out arrangements to employees who waive the employers’ group health plan; and such arrangements must be provided under the employers’ Section 125 cafeteria plans. However, many employers were using only the employee’s share of the premium when determining affordability of their coverage. With Code section 6055/6056 Employer Reporting requirements around the corner, and possible substantial Pay or Play penalties being imposed for failure to offer affordable coverage, IRS clarification on the subject was desperately needed.
In December of 2015, the IRS initially answered by issuing IRS Notice 2015-87, Q/A-9, directly addressing the effect of opt-out arrangements on affordability of an employer’s offer of group health plan coverage under Pay or Play. See Q/A-9:
An opt-out payment may have the effect of increasing an employee’s contribution for health coverage beyond the amount of any salary reduction contribution. For example, if an employer offers employees group health coverage through a § 125 cafeteria plan, requiring employees who elect self-only coverage to contribute $200 per month toward the cost of that coverage, and offers an additional $100 per month in taxable wages to each employee who declines the coverage, the offer of $100 in additional compensation has the economic effect of increasing the employee’s contribution for the coverage. In this case, the employee contribution for the group health plan effectively would be $300 ($200 + $100) per month, because an employee electing coverage under the health plan must forgo $100 per month in compensation in addition to the $200 per month in salary reduction.
The IRS had determined that unconditional opt-out arrangements (those offered to employees who decline coverage without imposing other conditions (such as proof of other coverage)) were to be treated in the same manner as salary reductions for determining an employee’s required contribution for affordability purposes under Pay or Play (Code section 4980H(b)).
The Notice indicated that until regulations are issued, opt-out payment arrangements do not have to be considered when calculating affordability for purposes of Employer Reporting or for Pay or Play or in Form 1095-C (Employer Reporting), unless the arrangement was adopted after December 16, 2015 and was not conditioned on meeting factors other than waiving coverage.
With regard to conditional opt-out arrangements (such as those requiring proof of other coverage), the Notice indicated that the IRS intended on issuing proposed regulations. These regulations were just issued and are the subject of this Client Alert.
New Proposed Regulations: Eligible Opt-Out Arrangements – Careful Examination and Action Required to Avoid Penalties
Just this month, in July of 2016, the IRS and Department of Treasury released proposed regulations affecting affordability determinations with respect to opt-out payments. While the main purpose of these regulations is to address an individual’s qualifications to receive premium tax credits, the affordability determinations also impact employers in that Pay or Play penalties may result if applicable affordable coverage is not offered.
Significantly, these regulations impose additional requirements on opt-out arrangements to avoid affecting affordability.
As previously advised, the IRS generally considers opt-out arrangements as increasing the employee’s required contribution for purposes of determining Pay or Play affordability. This is because an employee who elects an employer’s group health plan coverage would have to forgo any opt-out payment, thereby reducing his/her compensation. By way of the above example, if an employee is required to contribute $200 per month for self-only coverage or could receive an extra $100 per month in taxable wages for waiving such coverage, the employee’s required contribution is deemed to be $300 per month (the $200 reduction in compensation for premium payment by the employee plus the $100 reduction in compensation for not waiving coverage). The arrangement has this affect regardless of whether the employee actually enrolls in the employer’s group health plan or declines enrollment and receives extra taxable compensation.
However, if the arrangement meets certain conditions (“eligible opt-out arrangement”), affordability determinations will not be affected. Again, this is true whether or not the employee actually enrolls in the employer’s group health plan or instead opts-out and receives the payment.
Eligible Opt-Out Arrangement
Although IRS Notice 2015-87 indicated that conditional opt-out arrangements (requiring proof of other coverage) may not affect affordability, these proposed regulations add numerous factors in order to avoid adverse affordability determinations.
To avoid having opt-out payments increase the employee’s required contribution, the arrangement must meet the requirements of an “eligible opt-out arrangement.”
To be an “eligible opt-out arrangement,” the following must be true:
- The employee must provide reasonable evidence that the employee and each member of the employee’s expected tax family have or will have minimum essential coverage (that is not through the individual market) during the period of coverage to which the opt-out arrangement applies in order to receive an opt-out payment.
- This is a significant difference in the way cash out programs typically have been offered. Generally an employer will require proof of other coverage for the employee, but not for other family members.
- The “employee’s expected tax family” encompasses all other individuals for whom the employee reasonably expects to claim a personal exemption deduction for the taxable year or years that begin or end in or with the employer’s plan year to which the opt-out arrangement applies.
- “Minimum essential coverage” includes coverage under an eligible employer-sponsored plan, as well as coverage under government-sponsored programs such as most Medicaid coverage, Medicare part A, the Children’s Health Insurance Program (CHIP), most TRICARE programs, most coverage provided to veterans under title 38 of the United States Code, and the Nonappropriated Fund Health Benefits Program of the Department of Defense.
- However, for these purposes, minimum essential coverage will not include coverage in the individual market, whether or not obtained through the Marketplace.
- Please also note that excepted benefits (i.e., most limited-scope vision or dental benefits) are not considered minimum essential coverage.
- Reasonable evidence that the employee and all members of the employee’s expected tax family have alternative minimum essential coverage for the relevant period can include the employee’s attestation.
- Acceptable conditions under an opt-out arrangement include a requirement that the employee (and the employee’s expected tax family) have alternative coverage through the employer-sponsored coverage of the employee’s spouse or a parent.
- An “opt-out payment” means a payment that is available only if an employee waives coverage under an eligible employer-sponsored plan. Such payment also must not be permitted to be used to pay for eligible employer-sponsored plan coverage. This clarifies the difference between an “opt-out payment” and employer contributions made under a cafeteria plan, which were previously described in the Individual Shared Responsibility Mandate final regulations mentioned above.
- The arrangement must provide that the employer will not make the opt-out payment if it knows or has reason to know that the employee or any employee’s expected tax family member does not (or will not) have the alternative minimum essential coverage.
- The arrangement must require that the employee provide reasonable evidence of the alternative coverage at least one time each plan year to which the eligible opt-out arrangement applies.
- Such evidence must be provided no earlier than a reasonable period of time before the period of coverage (to which the eligible opt-out arrangement applies) begins. For example, an employee attestation given during the annual open enrollment process occurring within a few months of the beginning of the plan year is acceptable.
- Alternatively, the arrangement may require evidence to be provided at a later date, such as after the plan year starts. This would allow the employer to receive evidence that the employee and all expected tax family members actually had enrolled in alternative coverage.
- While the regulations allow an employee attestation to suffice as reasonable evidence, an employer can require other reasonable evidence, such as proof of actual enrollment.
- Additionally, the employee must have at least an annual opportunity to enroll in the employer-sponsored coverage.
If the above factors are met, the opt-out payment amount will be excluded from the employee’s required contribution. This will be the case for the period of coverage to which the opt-out payment originally applied even if the alternative coverage subsequently terminates for the employee or for a member of the employee’s expected tax family. However, keep in mind that an employer cannot make an opt-out payment if it knows or has reason to know the employee (or family member) does not have the requisite alternative coverage.
Examples Directly From Regulations
The regulations also provide us the following examples. See Treas. Prop. Reg. 1.36B-2 (c)(3)(v)(A)(7)(iv):
Example 1. Taxpayer B is an employee of Employer X, which offers its employees coverage under an eligible employer- sponsored plan that requires B to contribute $3,000 for self-only coverage. X also makes available to B a payment of $500 if B declines to enroll in the eligible employer-sponsored plan. Therefore, the $500 opt-out payment made available to B under the opt-out arrangement increases B’s required contribution under X’s eligible employer-sponsored plan from $3,000 to $3,500, regardless of whether B enrolls in the eligible employer-sponsored plan or declines to enroll and is paid the opt-out payment.
Example 2. The facts are the same as in Example 1, except that availability of the $500 opt-out payment is conditioned not only on B declining to enroll in X’s eligible employer-sponsored plan but also on B providing reasonable evidence no earlier than the regular annual open enrollment period for the next plan year that B and all other members of B’s expected tax family are or will be enrolled in minimum essential coverage through another source (other than coverage in the individual market, whether or not obtained through the Marketplace). B’s expected tax family consists of B and B’s spouse, C, who is an employee of Employer Y. During the regular annual open enrollment period for the upcoming plan year, B declines coverage under X’s eligible employer-sponsored plan and provides X with reasonable evidence that B and C will be enrolled in Y’s employer-sponsored plan, which is minimum essential coverage. The opt-out arrangement provided by X is an eligible opt-out arrangement, and, therefore, the $500 opt-out payment made available to B does not increase B’s required contribution under X’s eligible employer-sponsored plan. B’s required contribution for self-only coverage under X’s eligible employer-sponsored plan is $3,000.
Example 3. The facts are the same as in Example 2, except that B and C have two children that B expects to claim as dependents for the taxable year that coincides with the upcoming plan year. During the regular annual open enrollment period for the upcoming plan year, B declines coverage under X’s eligible employer-sponsored plan and provides X with reasonable evidence that B and C will be enrolled in Y’s employer-sponsored plan, which is minimum essential coverage. However, B does not provide reasonable evidence that B’s children will be enrolled in minimum essential coverage (other than coverage in the individual market, whether or not obtained through the Marketplace); therefore, X determines B is not eligible for the opt-out payment, and B does not receive it. The $500 opt-out payment made available under the opt-out arrangement does not increase B’s required contribution under X’s eligible employer-sponsored plan because the opt-out arrangement provided by X is an eligible opt-out arrangement. B’s required contribution for self-only coverage under X’s eligible employer-sponsored plan is $3,000.
Example 4. Taxpayer D is married and is employed by Employer Z, which offers its employees coverage under an eligible employer-sponsored plan that requires D to contribute $2,000 for self-only coverage. Z also makes available to D a payment of $300 if D declines to enroll in the eligible employer-sponsored plan and provides reasonable evidence no earlier than the regular annual open enrollment period for the next plan year that D is or will be enrolled in minimum essential coverage through another source (other than coverage in the individual market, whether or not obtained through the Marketplace); the opt- out arrangement is not conditioned on whether the other members of D’s expected tax family have other coverage. This opt-out arrangement is not an eligible opt-out arrangement because it does not condition the right to receive the opt-out payment on D providing reasonable evidence that D and the other members of D’s expected tax family have (or will have) minimum essential coverage (other than coverage in the individual market, whether or not obtained through the Marketplace). Therefore, the $300 opt-out payment made available to D under the opt-out arrangement increases D’s required contribution under Z’s eligible employer-sponsored plan. D’s required contribution for self-only coverage under Z’s eligible employer-sponsored plan is $2,300.
These proposed regulations are applicable for taxable years beginning after December 31, 2016, and the preamble clarifies that for Pay or Play and Employer Reporting purposes, they are effective the first of the plan year beginning on or after January 1, 2017. Until then, employers may rely on IRS Notice 2015-87. Final regulations are expected to be released yet this year.
Limited Relief for Certain Collective Bargaining Agreements
The regulations do provide limited relief for certain collective bargaining agreements. For purposes of Pay or Play (section 4980H(b)) and Employer Reporting (section 6056, Form 1095-C), employers participating in collective bargaining agreements that were in effect before December 16, 2015 (disregarding any extensions on or after December 16, 2015) will not be required to add the opt-out payment to the employee’s required contribution until the first plan year that begins following the expiration of the agreement (or until the applicability date of these regulations if later).
Due to the increased requirements to qualify as an eligible opt-out arrangement, employers should carefully review their Section 125 cafeteria plans and opt-out designs, ensure plan documents are amended and implement administrative procedures to ensure proper compliance. As employers are typically re-evaluating benefits now for the upcoming plan, now is the time to address opt-out arrangements.
Employers are also allowed to continue with their current opt-out design; however, if the requisite factors are not met, any cash offered in lieu of health care coverage must be included in the employee’s required contribution for both Pay or Play and Employer Reporting purposes.
This correspondence is intended to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.
Questions? Contact us to learn more.
Elizabeth H. Latchana specializes in employee health and welfare benefits. Recognized for her outstanding legal work, in both 2018 and 2015, Beth was selected as “Lawyer of the Year” in Lansing for Employee Benefits (ERISA) Law by Best Lawyers, and in 2017 as one of the Top 30 “Women in the Law” by Michigan Lawyers Weekly. Contact her for more information on this reminder or other matters at 517.377.0826 or firstname.lastname@example.org.