IRS Issues Second Notice on Cadillac Tax Implementation
In late July, the IRS issued Notice 2015-52 addressing the 40% excise tax on high-cost employer-sponsored health coverage. Popularly known as the “Cadillac tax,” this particular provision of the Affordable Care Act is set to take effect in 2018. It generally will apply to the extent that coverage exceeds certain thresholds.
Supplementing Notice 2015-16 that was issued in February, the new notice describes additional proposals regarding the cost of applicable coverage — particularly with respect to account-based arrangements. Here are some highlights of the guidance.
Contributions to account-based plans
Certain Health Savings Accounts (HSAs), Health Flexible Spending Arrangements (Health FSAs), and Health Reimbursement Arrangements (HRAs) are deemed “applicable coverage” under the Cadillac tax and, thus, employer contributions to these plans will be factored into the valuation of coverage for purposes of the tax. The IRS is considering an approach under which contributions to these account-based plans would be allocated on a pro rata basis over the period to which the contribution relates (generally, the plan year), regardless of the timing of the contributions during the period.
For example, if an employer contributes a lump-sum amount to an HRA at the beginning of the year, that contribution would be allocated ratably to each calendar month of the plan year. The IRS has requested comments on this and alternative approaches.
Health FSAs with employer flex credits
The Cadillac tax provides that the cost of applicable coverage of a Health FSA for any plan year is the greater of the employee’s salary reduction amount or the total reimbursements under the Health FSA. If an employer contributes nonelective flex credits to the Health FSA, the cost of applicable coverage would be the amount of the employee’s salary reduction plus the amount of the flex credit that’s actually used for reimbursements.
To avoid double counting when Health FSA amounts are carried over to a subsequent plan year, the IRS is considering a safe harbor under which carryovers are disregarded for purposes of the cost of applicable coverage. For plans with nonelective flex credits, use of the safe harbor would be limited.
The IRS anticipates that the determination period for the excise tax will be the calendar year for all employers, and that employers will be required to determine the cost of applicable coverage sufficiently soon after year end to allow coverage providers to timely pay any tax due. The IRS acknowledges that potential timing issues will be different depending on the plan type.
For example, self-insured plans won’t be able to determine the cost of coverage for the year until all claims have been submitted, and Health FSAs will have to wait until the end of any applicable run-out period. Insured plans will also need to consider payments or premium discounts attributable to experience ratings, and these may not occur until the next coverage period.
The IRS has requested comments on these timing issues — including how employers currently factor in experience-related payments or discounts for purposes of determining the COBRA applicable premium.
Reimbursement of excise and income taxes
If the coverage provider responsible for paying an excise tax is an entity other than the employer (for example, an insurer or third-party administrator), that entity will likely pass the amount of the tax back to the employer through increased service fees — which will mean additional taxable income for the coverage provider. Because the excise tax is nondeductible for the coverage provider, that entity will likely pass through not only the amount of the excise tax, but also the amount of the additional income tax that the coverage provider will incur because of the excise tax reimbursement.
The Cadillac tax provision provides that any portion of the cost of coverage attributable to the excise tax itself is excluded in determining the amount of the excise tax. The IRS is considering whether amounts reimbursed for additional income tax may also be excluded from the cost of coverage.
The agency has requested comments on administrable methods for excluding income tax reimbursements and on the appropriate tax rate to use. The IRS anticipates that coverage providers will be permitted to exclude the amount of excise tax or income tax reimbursement only if it’s separately billed and identified as attributable to the cost of the excise tax.
Excess reimbursements under a discriminatory self-insured health plan are includable in a highly compensated individual’s gross income. Previous IRS guidance on Form W-2 health coverage reporting specified that excess reimbursements aren’t included in the reportable cost of coverage.
However, according to the Notice, the IRS anticipates that the previous guidance — along with related forms and instructions — will be modified to make excess reimbursements subject to reporting. (Employers should continue to follow the previous guidance until it’s formally changed.) Similarly, the IRS states that excess reimbursements should be included in the cost of applicable coverage for purposes of the Cadillac tax.
2 approaches to liability
For coverage other than insured plans or HSAs (for example, self-insured plans and Health FSAs), the coverage provider liable for the excise tax is “the person that administers the plan benefits.” Because this term isn’t defined in the statute, the Notice suggests two alternative approaches for determining who’s liable:
- Identify the day-to-day administrator. The person (or entity) responsible for performing the day-to-day functions of plan administration (such as processing claims, responding to inquiries or providing a technology platform for benefits administration) may be held liable. In most cases, this would be a third-party administrator.
- Recognize the decision maker. Alternatively, the person (or entity) that has ultimate decision-making authority over matters of plan administration (such as eligibility determinations, claims administration and arrangements with service providers) may be held liable. In most cases, this would be the employer.
The IRS has requested comments on the feasibility of each approach.
Although the Cadillac tax itself is conceptually simple, Notice 2015-52 and its predecessor Notice 2015-16 reflect the complexity of its implementation. After considering public comments on both notices, the IRS intends to issue proposed regulations. Thus, interested parties should study both notices carefully and consider submitting comments by October 1.
Cadillac tax thresholds
As a reminder, the cutoff point for the value of benefits subject to the Cadillac tax (see main article) is $10,200 for individual coverage, and $27,500 for “other than self-only,” as the law describes it. Survey data for 2014 from the Kaiser Foundation put the value of the average annual premiums for employer-sponsored health insurance at $6,025 for single coverage and $16,834 for family coverage.
It’s not hard to see how plans with above-average values today, assuming typical annual cost increase rates, will be in trouble by 2018, or shortly thereafter. The Cadillac thresholds will be inflation-adjusted after 2018, but by no more than one point above the consumer price index — in other words, much less than the 5.6% annual increase in health benefits costs projected by the Congressional Budget Office.
To learn more about the Cadillac Tax implementation and the mandated completion of the 1094 and 1095 series of compliance returns, sign up for our C-Suite Educational Series on October 7.
Do you have any other questions regarding Cadillac Tax implementation?