The next item the IRS has turned its sights on with regard to the Affordable Care Act is the “Cadillac tax” found in IRC §4980I on high cost coverage that will take effect for taxable years beginning after December 31, 2017. In Notice 2015-16 the IRS details proposed approaches to dealing with various issues under that tax.
The issues that are discussed in this notice include:
- The definition of applicable coverage,
- The determination of the cost of applicable coverage, and
- The application of the annual statutory dollar limit to the cost of applicable coverage
The notice specifically provides that it does not provide guidance under IRC §4980I upon which taxpayers may rely and that no inference should be drawn regarding any other provision of §4980I not discussed in the notice, nor regarding COBRA or any other section of the Affordable Care Act. [Notice 2015-16, Sections VIII and IX] Thus taxpayers should not start implementing plans to design programs assuming that these provisions will be the ones actually applied to 2018.
IRC §4980I will apply a 40% excise tax on the value of a health care benefit provided to an employee in excess of a dollar limit. Conceptually this program is meant to make such programs so costly that will not be feasible to continue to offer programs with costs well in excess of these limits. In theory, the claim is that such “high benefit” plans drive up the overall cost of medical care by providing a “zero cost” incentive for covered individuals to demand various costly treatments that these “Cadillac” plans will pay for.
The health care benefits measured under this tax are referred to “applicable coverage” and is determined under rules “similar” to those that are used to compute COBRA continuation premium coverage under IRC §4980B(f)(4). Such applicable coverage amounts are determined separately for self-only coverage and any other level of coverage. In addition, special rules are provided in IRC §4980I(d)(2)(B) and (C) for determining the costs of such coverage for retirees, HSAs, MSAs and FSAs.
The law provides for an initial baseline dollar limit for 2018 of $10,200 for self-only coverage and $27,500 for other than self-only coverage. The amounts may be adjusted for an age and gender adjustment applied on a per employer basis in certain circumstances, as well as cost adjustments for plans provided to retirees or is covered by a plan where the majority of those covered are “high risk” individuals.
The notice points out that current COBRA law under §4980B(f)(4) provide two mechanisms for calculating COBRA continuation premiums:
- The actuarial basis method, under which the cost is equal to a reasonable estimate of the cost of providing coverage for similarly situated beneficiaries determined on an actuarial basis, taking into account “such factors as the Secretary may prescribe in regulations”; and
- The past cost method, which may be used at the election of the plan administrator except in cases in which there has been a significant change in coverage under the plan or in employees covered by the plan.
Under Reg. §54.4980B-1, Q&A 2, employers must calculate these COBRA numbers in good faith with a reasonable interpretation of the law’s requirements.
The IRS does note that there are some similar issues found in the W-2 cost reporting rules under §6051(a)(14). While the IRS cautions that it does not expect to use the cost calculation methods provided in interim guidance for that reporting found in Notice 2012-9, the IRS does expect that methods developed in computing costs for the Cadillac tax will cause revisions in the interim guidance for W-2 reporting under IRC 6051(a)(14).
The Notice provides that the following types of programs would represent “applicable coverage” for purposes of the Cadillac tax, as specific provisions in IRC §4980I address them explicitly:
- Health FSAs (§ 4980I(d)(2)(B));
- Archer MSAs (but see section III.D of this notice for certain contributions by individuals that are not included) (§§ 4980I(c)(2)(B), 4980I(d)(2)(C));
- HSAs (but see section III.D of this notice for certain contributions by individuals that are not included) (§§ 4980I(c)(2)(B), 4980I(d)(2)(C));
- Governmental plans, defined as “coverage under any group health plan established and maintained primarily for its civilian employees by the Government of the United States, by the government of any State or political subdivision thereof, or by any agency or instrumentality of any such government” (but see section III.C of this notice for the exclusion of military coverage) (§ 4980I(d)(1)(E));
- Coverage for on-site medical clinics (but see section III.E of this notice for a potential approach that would exclude on-site medical clinics that provide only de minimis medical care) (§ 4980I(d)(1)(B)(i));
- Retiree coverage (§§ 4980I(d)(3), 4980I(b)(3)(C)(iv));
- Multiemployer plans (as defined in § 414(f)) (§§ 4980I(b)(3)(B)(ii), 4980I(c)(4)(B)); and
- Coverage described in § 9832(c)(3) (which includes coverage only for a specified disease or illness and hospital indemnity or other fixed indemnity insurance), if the payment for the coverage or insurance is excluded from gross income or a deduction under § 162(l) is allowed with respect to it (§ 4980I(d)(1)(B)(iii)).
The guidance goes on to note certain other coverage, such as HRAs and executive physical programs, meet the general definition of applicable coverage and the IRS expect such coverages to be explicitly included in the definition of applicable coverage in final guidance.
Employer contributions to HSAs and Archer MSAs are anticipated to be included as applicable coverage in future guidance, but employee after-tax contributions to both will be excluded. The amount of the employer contribution to these plans will be considered the cost of coverage for computing the excess benefit.
Excepted benefits under §9832(c)(1) are generally excluded from inclusion as applicable coverage with the exception of on-site medical clinics, which are included pursuant to §4980I(d)(1)(B)(i). While the benefit from such clinics will generally be included as applicable coverage, the IRS anticipates excluding on-site medical clinics that provide only a de minimis benefit.
The notice goes on to note that the COBRA regulations exclude certain clinics from the definition of a group health plan if “if—(1) [t]he health care consists primarily of first aid that is provided during the employer's working hours for treatment of a health condition, illness, or injury that occurs during those working hours; (2) [t]he health care is available only to current employees; and (3) [e]mployees are not charged for the use of the facility.”
The IRS is interested in comments on the treatment under these rules of such clinics that provide services in addition to or in lieu of first aid such as:
- Injections of antigens (for example, for allergy injections) provided by employees;
- Provision of a variety of aspirin and other nonprescription pain relievers; and
- Treatment of injuries caused by accidents at work (beyond first aid).
Similarly, IRC §4980I by statute excludes specific coverages from the definition of applicable coverage. These include:
- Coverage described in § 9832(c)(1) (other than sub-paragraph (G) thereof), whether through insurance or otherwise. Section 9832(c)(1) (other than § 9832(c)(1)(G)) includes:
- Coverage only for accident, or disability income insurance, or any combination thereof (§ 9832(c)(1)(A));
- Coverage issued as a supplement to liability insurance (§ 9832(c)(1)(B));
- Liability insurance, including general liability insurance and automobile liability insurance (§ 9832(c)(1)(C));
- Workers’ compensation or similar insurance (§ 9832(c)(1)(D));
- Automobile medical payment insurance (§ 9832(c)(1)(E));
- Credit-only insurance (§ 9832(c)(1)(F)); and
- Other insurance coverage, as specified in regulations, similar to the coverage listed in § 9832(c)(1) and under which benefits for medical care are secondary or incidental to other insurance benefits (§ 9832(c)(1)(H));
- Coverage, whether through insurance or otherwise, for long-term care;
- Any coverage under a separate policy, certificate, or contract of insurance which provides benefits substantially all of which are for treatment of the mouth (including any organ structure within the mouth) or for treatment of the eye (but see section III.F of this notice for a potential approach to exclude all limited scope dental and vision benefits that qualify as excepted benefits (insured and self-insured)); and
- Coverage described in § 9832(c)(3) (which includes coverage only for a specified disease or illness and hospital indemnity or other fixed indemnity insurance), if the payment for the coverage or insurance is not excluded from gross income or a deduction under § 162(l) is not allowed with respect to it.
The notice goes on to observe that §4980I(d)(1)(E) implies the various coverages are also excluded from “applicable coverage” for the Cadillac tax. This would include plans maintained primarily for “members of the military or for members of the military and their families by the Government of the United States, the government of any State or political subdivision thereof, or any agency or instrumentality of any such government…”
The notice also asks for comments on dealing with the exception for limited scope dental and vision benefits, as well as employee assistance programs as provided for in Reg. §54.9831-1(c)(3)(vi).
In computing the cost of applicable coverage, the notice describes the following additional calculation rules provided by IRC §4980I that modify the “standard” COBRA calculations:
- § 4980I Tax Not Included in Cost. Section 4980I(d)(2)(A) provides that the cost of applicable coverage under § 4980I does not take into account “any portion of the cost of such coverage which is attributable to the tax imposed under this section.”
- Separate Costs for Self-Only and Other-than-Self-Only Coverage. Section 4980I(d)(2)(A) provides that the cost of applicable coverage must be calculated separately for self-only coverage and other-than-self-only coverage. Section 4980I(b)(3)(B)(iii) provides that any coverage under a multiemployer plan (as defined in § 414(f)) is treated as other-than-self-only coverage for purposes of § 4980I.
- Retirees. Section 4980I(d)(2)(A) provides that, in the case of applicable coverage provided to retired employees, the plan may elect to treat a retired employee who has not attained the age of 65 and a retired employee who has attained the age of 65 as similarly situated beneficiaries.8
- Health FSAs. Section 4980I(d)(2)(B) provides for health FSAs that the cost of applicable coverage is equal to the sum of salary reduction contributions plus the amount determined under the general calculation rule with respect to any reimbursement under the arrangement in excess of the salary reduction contributions. Thus, the cost of applicable coverage under a health FSA includes employer flex contributions used for the health FSA.
- HSAs and Archer MSAs. Section 4980I(d)(2)(C) provides for HSAs and Archer MSAs that the cost of applicable coverage “shall be equal to the amount of employer contributions under the arrangement.” For this purpose, employer contributions include salary reduction contributions.
- Monthly Costs. Section 4980I(d)(2)(D) provides that for applicable coverage for which the cost is determined “on other than a monthly basis, the cost shall be allocated to months in a taxable period on such basis as the Secretary may prescribe.”
The notice clarifies in Section V.B. that even though the statute uses terms that look both at employees offered coverage and those actually covered under such programs, the statute clearly limits the tax to apply only to benefits provided to those actually covered under the program.
The notice observes that a number of issues exist for computing the COBRA applicable premium on which guidance has not yet been provided. Specifically it notes issues regarding:
- How to determine which nonCOBRA beneficiaries are similarly situated,
- The specific methods self-insured plans may use to determine the COBRA applicable premium, and
- How to determine the COBRA applicable premium for HRAs.
The notice goes on to describe potential approaches the IRS is considering in each of these areas in Section IV.C of the notice.
In dealing with the applicable dollar limit, IRC §4980I provides for separate dollar limits for “self-only” and “other than self-only” coverage. But the notice points out it is possible that one employee may simultaneously have coverage that is both “self-only” and “other than self-only” coverage—for instance, the notice suggests an employee might have self-only major medical coverage but have family coverage under an HRA.
The notice discusses two alternatives to dealing with these situations. One would apply the limit appropriate to the employee’s major medical coverage, which is the coverage that accounts for the majority of the aggregate cost of the package. Alternatively, the IRS is considering using a composite dollar limit that would prorate the limits for each type of coverage based on the ratio of the costs of each type of coverage provided.
The cost level is adjusted for “qualifying retirees” under IRC §4980I. A qualifying retiree is an individual who:
- Is receiving coverage by reason of being a retiree,
- Has attained age 55, and
- Is not entitled to benefits or eligible for enrollment under the Medicare program under title XVIII of the Social Security Act
The IRS is asking for comments on how an employer may determine if an employee meets that final criterion—that the employee is not eligible for enrollment in Medicare, which is different from simply not being enrolled in the program.
The law also provides adjustments for situations where a majority of covered employees are either employed to repair or install electrical or telecommunication lines or in “high risk” occupations. Such high-risk occupations include:
- Law enforcement officers (as such term is defined in section 1204 of the Omnibus Crime Control and Safe Streets Act of 1968),
- Employees in fire protection activities (as such term is defined in section 3(y) of the Fair Labor Standards Act of 1938),
- Individuals who provide out-of-hospital emergency medical care (including emergency medical technicians, paramedics, and first-responders),
- Individuals whose primary work is longshore work (as defined in section 258(b) of the Immigration and Nationality Act (8 U.S.C. 1288(b)), determined without regard to paragraph (2) thereof), and
- Individuals engaged in the construction, mining, agriculture (not including food processing), forestry, and fishing industries
Retirees who satisfied the above requirements for at least 20 years will also be included in this class.
The IRS is asking for comment in this area on:
- How an employer determines whether the majority of employees covered by a plan are engaged in a high-risk profession;
- What the term “plan” means in that context and
- How an employer determines that an employee was engaged in a high-risk profession for at least 20 years
The IRS is also asking for comments on how to handle the adjustments for work forces whose age and gender makeups differ substantially from the general population.