“IRS Gives Good Directions On ACA Cadillac Tax”
Law360 03/25/15 John L. Barlament, Amy A. Ciepluch, Sarah L. Fowles
Law360, New York (March 25, 2015, 5:36 PM ET) -- On Feb. 23, the Internal Revenue Service released its first publication on the so-called Cadillac tax, a nondeductible 40 percent excise tax on high-cost health coverage that is scheduled to take effect in 2018. IRS Notice 2015-16 describes possible approaches for defining the coverage that is counted, determining the cost of that coverage and applying the annual dollar limits. In the notice, the IRS requests comments on the proposed approaches and also indicates that it will issue a second notice that will also be open to public comment before issuing proposed regulations.
The Affordable Care Act added Internal Revenue Code Section 4980I. Under IRC Section 4980I, beginning Jan. 1, 2018, employers will be subject to a nondeductible 40 percent excise tax on health coverage in excess of certain annual dollar limits. These annual dollar limits vary depending on whether the coverage involved is for an employee or retiree and for single or family coverage. For active employees, the annual dollar limit for single coverage is $10,200 and for coverage other than single (e.g., employee plus one, employee plus children, family), referred to herein as "self-plus coverage," is $27,500. There are some exceptions and adjustments based on job classification, age and other criteria.
Definition of Applicable Coverage
IRC Section 4980I applies to "applicable coverage," which is generally defined to include any group health plan coverage that an employer offers to its employees. The notice reiterates some things that the statute already told us — applicable coverage includes a broad array of coverage, such as major medical coverage, health flexible spending accounts (including employee salary reduction contributions), health savings accounts, on-site medical clinics, retiree medical and multiemployer plan medical. The notice also yields some insight on what might be excluded and included in applicable coverage beyond what we know from the statute:
- Employer contributions to HSAs, including employee salary reduction contributions to HSAs, will be included.
- Employee contributions to HSAs outside of payroll or on an after-tax basis will not be included.
- Health reimbursement accounts will be included.
- Executive physical programs will be included.
- On-site medical clinics that provide only "de minimis" benefits will not be included.
- Limited scope insured dental and vision programs will not be included.
- Self-funded dental and vision programs that are otherwise "limited scope" may be excluded.
- EAPs that meet certain criteria may be excluded.
Determination of the Cost of Applicable Coverage
IRC Section 4980I provides that the cost of applicable coverage will generally be determined under rules similar to those used for setting Consolidated Omnibus Budget Reconciliation Act premiums. We know from the statute that the cost does not include any Section 4980I excise tax, requires separate calculations for the costs of self-only and other-than-self-only coverage, includes employee salary reduction flexible spending accounts and HSA contributions and employer "flex credits," and HSA contributions in the cost of applicable coverage.
The notice described the following as possible approaches to determining the cost of applicable coverage:
- Determining cost of coverage on a benefit package basis (e.g., cost of high-deductible coverage, cost of health maintenance organization coverage, cost of preferred provider organization coverage).
- Further mandatory breakdown of the cost of each benefit package into the cost of self-only coverage and the cost self-plus coverage, without further breakdown of cost based on the number of individuals covered under self-plus coverage.
- Further optional breakdown of the cost of each benefit package and level of coverage into permitted groups based on standards, such as salaried employees, hourly employees, employees by job classification, collectively bargained employees, current and former employees or other classifications that do not tie to health status.
- Determining the cost of coverage in advance of the taxable year with the potential to generate any Cadillac tax liability.
- Use of either an actuarial basis method or past cost method for calculating self-insured plan premiums (as is currently permitted for self-insured plan COBRA premium calculations) and a requirement that a self-funded plan lock in to an approach for at least five years. Some rules could apply to these methods:
Under the actuarial basis method, the calculation must estimate the actual cost that the plan is expected to incur rather than minimum (or maximum) exposure.
Under the past cost method, there may be flexibility in the measurement period used to determine cost.
Under the past cost method, the cost calculation must include claims, premiums for stop loss or reinsurance policies, administrative expenses and overhead expenses such as salary and rent.
The cost of HRA coverage may include the amount newly available each year and exclude carryover amounts or calculating costs by dividing each year's claims and administrative expenses by the number of participants.
Application of the Annual Dollar Limit
IRC Section 4980I provides that the general annual dollar limit for single coverage is $10,200 and for coverage other than single (e.g., employee plus one, employee plus children, family), referred to herein as "self-plus coverage," or multiemployer plan coverage is $27,500. We know from the statute that each year the general annual dollar limit may be increased by the "health cost adjustment percentage" in 2018 and by cost-of-living adjustments for 2019 and beyond. The HCAP is equal to any amount in excess exceeding 55 percent of the percentage by which the per employee cost of coverage under the Blue Cross/Blue Shield standard benefit option under the Federal Employees Health Benefits Plan (standard FEHBP coverage) for plan year 2018 exceeds the per employee cost for the plan year 2010. It is too early to determine whether the HCAP will result in an increase to the annual dollar limits in 2018.
The statute also provided that the annual dollar limits will be increased for:
- Pre-Medicare retirees receiving retiree coverage.
- Employees engaged in high-risk professions, such as fire protection, emergency medical care, longshore work, construction, mining, agriculture, forestry and fishing, but only if the employer has a majority of employees engaged in such high-risk professions.
- Age and gender adjustments if the age and gender characteristics of an employer's workforce are different from those of the national workforce.
The notice described the following as possible approaches to determining the applicable dollar limits for an employee:
- If an employee has one type of coverage that is single coverage and another type of coverage that is self-plus coverage, the applicable dollar limit would depend on whether the employee's primary coverage (i.e., the coverage that accounts for the majority of the aggregate cost of applicable coverage) is single or self-plus coverage. Alternatively, the IRS might allow or require employers to use a "composite dollar limit" approach that establishes the dollar limits according the ratio of the cost of single coverage and self-plus coverage.
- The IRS might consider developing safe harbors to adjust the annual dollar limits for employee populations with age and gender characteristics that are different from those of the national workforce.
- An employer can use this new guidance to "guesstimate" the cost of coverage for employees. Because the cost of coverage likely will vary from employee to employee, the employer may want to estimate the cost of coverage under different coverage scenarios that represent the range of coverage scenarios among the employer's employees.
- Although it is still too early for an employer to know what the annual dollar limits will be in 2018, an employer can begin to estimate its maximum excise tax liability. For example, it could compare the costs of coverage among its employees to the general annual dollar limits of $10,200 and for single coverage $27,500 for multiemployer plan coverage or self-plus coverage. Excise tax liability generally can be estimated by multiplying the excess of employees' costs of coverage over employees' annual dollar limits by 40 percent.
- If an employer estimates that it will have a significantly high excise tax, it should work with its benefits consultants to develop potential plan design changes that will minimize or eliminate excise tax liability in 2018 and beyond.
- Because an employee's contributions through a cafeteria plan to a HSA will count toward the employee's cost of coverage, an employer might consider whether to eliminate the HSA contribution option from its cafeteria plans. Eliminating a HSA contribution option from a cafeteria plan can reduce the excise tax risk, but also limits an employer's ability to make employer contributions to employees' HSAs due to special "comparability" rules that apply to HSAs outside of cafeteria plans. Employers interested in pursuing this option should consult with their benefit advisors.