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New Guidance on Computing Taxes Payable by Plan Sponsors and Insurers

Employee Benefits Law Alert John L. Barlament

On April 17, the Internal Revenue Service ("IRS") published regulations detailing how employers and insurers will calculate a new tax imposed under the Patient Protection and Affordable Care Act (now called the "ACA" by regulators). The new tax will directly apply to employers offering self-funded major medical plans and certain other self-funded plans (such as a health reimbursement arrangement ("HRA")). In addition, the new tax will apply to insurance issuers with respect to fully insured health policies, including a health maintenance organization ("HMO") contract. The tax is rather modest, starting at $1 per covered life per year.

Use of Tax Revenue. The ACA contains provisions intended to improve the quality of health care. One such provision establishes a private, nonprofit corporation called the Patient-Centered Outcomes Research Institute (the "Institute"). The Institute will help evaluate the quality and effectiveness of various medicines and treatments. This new tax (the "Research Tax") will help fund the Institute.

Plans Subject to Tax. The Research Tax generally will apply to major medical benefits. Many other benefits - such as a dental plan, vision plan and health flexible spending arrangement ("Health FSA") - will often be an "excepted benefit" and not subject to the tax. The following chart discusses how the Research Tax applies to various benefits that may be offered by an employer. See below for an important "non-duplication" rule, which can reduce the tax owed by an employer.

Benefit Type

Does Research Tax Apply?


Dental Plans Usually not. Many dental plans are an "excepted benefit" under HIPAA. If so, the Research Tax does not apply.

Excepted benefit test:  Coverage must be: (1) provided under a separate policy, certificate or contract of insurance; or (2) otherwise not be an integral part of a group health plan. The first part, (1), usually applies to a stand-alone, fully insured dental plan. The second part, (2), can apply to a self-funded dental plan if participants who elect such coverage must pay an additional premium or contribution for it.

In both situations, coverage must be limited to treatment of the mouth.

Employee Assistance Program Usually not. The Research Tax does not apply if the program does not provide "significant benefits in the nature of medical care or treatment." The Research Tax guidance does not define the critical phrase "significant benefits."
Disease Management Program Usually not. The Research Tax does not apply if the program does not provide "significant benefits in the nature of medical care or treatment." The Research Tax guidance does not define the critical phrase "significant benefits."
Expatriate Policy Usually not. The Research Tax does not apply if the facts and circumstances show the policy was designed and issued specifically to cover primarily employees working and residing outside the United States.
Governmental Plan  Generally yes, but some exceptions.  Governmental plans generally are subject to the Research Tax. However, an "exempt governmental program" is not subject to the Research Tax. An exempt governmental program includes: (1) Medicare; (2) Medicaid; (3) Children's Health Insurance Program; (4) Armed Forces or veterans' coverage; and (5) certain medical care to members of Indian tribes. 
Health FSA  Usually not. Most Health FSAs are "excepted benefits" under HIPAA. If so, the Research Tax does not apply. 

Excepted benefits test for Health FSAs usually satisfied if no employer contributions (or employer contributions are capped at $500).

Research Tax test identical to test for other purposes (so employer likely already knows whether its Health FSA is an excepted benefit). 

Health Savings Account ("HSA")  Usually not. Most HSAs are not a "plan."  The high deductible health plan ("HDHP") relating to an HSA typically would be subject to the Research Tax. 
HRA  Yes, in some situations. An HRA usually does not constitute an "excepted benefit."  The Research Tax regulations do not provide a general exception for most HRAs. However, an HRA may be excepted pursuant to the "non-duplication" rule noted below. It is unclear whether an HRA must be "integrated" with major medical coverage in order to rely on this non-duplication rule. If it must be integrated, it is unclear what steps an employer must take to "integrate" the HRA with other major medical coverage. 
Prescription Drug Plan  Generally yes.  An example in the regulations indicates that a prescription drug plan generally is subject to the Research Tax. 
Retiree Major Medical Plan Yes.  There is no exception for a retiree-only plan. There also is no exception for a plan which covers retirees along with active employees. 
Stop Loss Policy or Indemnity Reinsurance Policy  No.  Regulations contain a definition of both terms. The broad definition would seem to include most stop loss and indemnity reinsurance policies. 
Tribal Plan Covering Non-Employees  Generally no.  Plan of a federally recognized Indian tribal government providing coverage only to tribal members who are not employees is generally not subject to Research Tax. 
Vision Plan  Usually not. Many vision plans are an "excepted benefit" under HIPAA. If so, the Research Tax does not apply.  See above box, Dental Plan Comments, for "excepted benefits" test. Coverage must be limited to the treatment of the eye. 
Wellness Program  Usually not. The Research Tax does not apply if the program does not provide "significant benefits in the nature of medical care or treatment."  The Research Tax guidance does not define the critical phrase "significant benefits." 

Non-Duplication Rule. An employer may offer two or more self-funded health plans. If both the plans have the same plan year, an employer may treat them as a single health plan for purposes of calculating the Research Tax. If so, the same "life" (i.e., enrollee) covered under each arrangement would count as only one "covered life," not two covered lives.

Example of Non-Duplication Rule. Suppose an employer offers major medical benefits and a separate prescription drug benefit. Both benefits are self-funded and have the same plan year. The medical plan covers 1,000 individuals while the prescription drug plan covers 800 individuals. Of the prescription drug plan enrollees, 700 are also covered by the major medical plan, while 100 are covered only by the prescription drug plan. For simplicity, assume that no employees terminate coverage during the year and that no new employees begin participating during the year.

If both plans were considered separately, the employer generally would owe $1,800 ($1,000 for the major medical plan and $800 for the prescription drug plan). Under the non-duplication rule, the employer would consider the number of unique lives covered under both plans. Here, there are 1,100 unique lives (the 1,000 from the medical plan and the 100 who are covered under the prescription drug plan, but not the medical plan). Thus, the employer generally would owe $1,100 (not $1,800), which is $1 per unique covered life.

Who is Responsible for Fee.
The insurance issuer is responsible for the Research Tax with respect to a fully insured health plan. The "plan sponsor" of a self-funded plan is responsible for the Research Tax with respect to a self-funded plan. The "plan sponsor" is generally the employer that established or maintains the plan. The regulations provide other rules for other types of plans. For example, the board of trustees is the plan sponsor of a multiemployer plan, and the committee is the plan sponsor of a multiple employer welfare arrangement.

Calculating "Covered Lives." The proposed regulations contain detailed guidance on how an employer with a self-funded plan calculates the average number of covered lives under the plan. The determination is made once per year, after the end of the plan year. The regulations provide three possible methods: (1) the actual count method; (2) the snapshot date method; and (3) the Form 5500 method. Insurance issuers use similar methods for fully insured health plans. Special counting rules apply for HRAs and Health FSAs which are not excepted benefits.

During a special transition period relating to this year, a plan sponsor can use any "reasonable method" to determine covered lives. However, since the term "reasonable method" is not defined, we expect that plan sponsors will likely use one of the three prescribed (and better defined) methods.

All the methods approximate the "average" number of lives covered in the year. For example, the Form 5500 method typically requires a plan sponsor to add the total participants covered at the beginning and end of the plan year, as reported on the plan sponsor's Form 5500. The result is the average number of lives covered (although a different calculation applies if the only coverage offered is self-only coverage). This number is then multiplied by $1 to determine the Research Tax owed by the plan sponsor.

The Research Tax applies with respect to individuals residing in the United States. The plan sponsor may rely on the most recent address on file when making this determination. The "United States" includes Puerto Rico and certain other possessions.

Future Changes. The $1 per covered life fee increases to $2, generally next year. The $2 fee increases in future years based on certain health expenditure data. The fee ceases in approximately 2019.

Payment of Tax. The Research Tax must be paid by July 31 of the calendar year immediately following the last day of the plan year. Thus, an employer with a calendar year plan will pay its first tax by July 31, 2013. Employers will file IRS Form 720, which will be revised to reflect the new Research Tax. While the regulations do not contain specific recordkeeping requirements, IRS Form 720 does contain some recordkeeping requirements. It appears that third parties (such as a third-party administrator) will not be able to report and pay the tax on behalf of a plan sponsor.

Additional guidance from the Department of Labor is expected to clarify whether ERISA-covered plan assets can be used to pay the Research Tax. The guidance, however, is not expected to address state law issues with using plan-related funds.

Effective Date of Regulations. The regulations are only proposed, not final. However, the IRS states that the regulations may be relied upon.

Links to Further Guidance. The proposed regulations can be found here.

For more information contact the author of this alert, John Barlament, at (414) 277-5727 / [email protected]. You may also contact any of the following Quarles & Brady employee benefits attorneys: Marla Anderson at (414) 277-5453 / [email protected], Amy Ciepluch at (414) 277-5585 / [email protected], Sarah Fowles at (414) 277-5287 / [email protected], Angie Hubbell at (312) 715-5097 / [email protected], Paul Jacobson at (414) 277-5631 / [email protected], David Olson at (414) 277-5671 / [email protected] or Robert Rothacker at (414) 277-5643 / [email protected].

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