The first piece of IRS guidance on the Cadillac tax was Notice 2015-16, which was released in February 2015. This Notice is intended to supplement Notice 2015-16 by addressing additional issues under the Cadillac tax, including identifying the entities that may be liable for the tax, how to allocate the tax among aggregated entities (e.g., entities within the same tax controlled group), and how to pay the tax. After considering the comments on both notices, the IRS intends to issue proposed regulations, which will provide further opportunity for comment. The IRS did not provide a timeframe for when proposed regulations might be released. The following summarizes key points from the Notice.
Cadillac Tax Liability
In general, in the case of coverage provided under an insured group health plan, the insurance carrier is responsible for any tax that might apply. With respect to coverage under a health savings account (“HSA”) the employer is responsible for any tax that might apply. For self-insured plans, the entity liable for any tax is “the person that administers the plan benefits.” However, that phrase is not defined in the law, nor is it used elsewhere in the ACA or ERISA. Therefore, the IRS is considering two alternative approaches to determining the identity of the “person that administers the plan benefits.”
The “Claims Administrator” Approach
Under one approach, the entity that is responsible for performing the day-to-day functions that constitute the administration of plan benefits, such as receiving and processing claims for benefits, responding to inquiries, or providing a technology platform for benefits information would be the responsible entity. The IRS anticipates that this entity generally will be a third-party administrator (“TPA”) for self-insured plans, unless the plan is self-administered by the employer or the employer owns the TPA (which is rare). It is anticipated that in most cases, it should be fairly easy to identify the responsible entity under this approach; however, it may be more complicated when the plan uses a separate vendor for pharmacy benefits or mental health benefits, but uses one rate when determining the cost of coverage. The Notice requests comments on this issue and any other concerns this approach would raise.
The “Plan Sponsor” Approach
Under the second approach the IRS is considering, the responsible entity would be the entity that has the ultimate authority or responsibility with respect to the plan administration (including final decisions on administrative matters), regardless of whether that person routinely exercises that authority or responsibility. For this purpose, relevant administrative matters could include eligibility determinations, claims administration, and arrangements with service providers (including the authority to terminate service provider contracts). The IRS anticipates that the entity with such ultimate administrative authority or responsibility would be identifiable based on the terms of the plan and often would not be the entity that performs the day-to-day routine administrative functions under the plan. In other words under this approach the responsible entity would generally be the employer. The IRS requests comments whether this approach would allow easy identification of the responsible entity or whether this approach might raise other issues.
The Cadillac tax provides that all employers treated as a single employer for federal tax purposes are treated as a single employer. This is the same standard that applies when determining if an employer is a member of an “aggregated ALE group” for purposes of the ACA’s employer reporting requirements. The Notice requests comments on the application of the employer aggregation rules for identification of (1) coverage “as made available by an employer;” (2) the employees taken into account for the age and gender adjustment, and the adjustment for employees in high risk professions; (3) the entity responsible for calculating and reporting the tax; and (4) the employer liable for any penalty for failure to properly calculate the tax.
Cost of Applicable Coverage
The Cadillac tax is expected to apply on a calendar year basis, regardless of plan year. To calculate the amount of any tax due for the year, an employer must determine the extent to which the cost of coverage provided to an employee during any month exceeds the dollar limit. The employer then must notify both IRS and the coverage provider of the amount of the excess benefit, and the tax must be paid by the coverage provider (the insurance carrier, TPA or employer). The IRS anticipates that the employer notification will occur sufficiently soon after the end of the year to enable coverage providers to pay any applicable tax in a reasonably timely manner.
The Cadillac tax statute provides that the cost of coverage is to be determined using rules “similar to the rules” used for determining the COBRA premiums. The Notice requests further comments on any issues raised by the anticipated need to determine the cost of coverage reasonably soon after the end of the year.
The IRS anticipates that the potential timing issues are likely to be different for insured plans and self-insured plans, and will also be different for HSAs, health flexible spending arrangements (FSAs), and health reimbursement arrangements (HRAs). For example, with respect to a health FSA or HRA that operates on a calendar year basis, the cost may be determinable only after the end of the calendar year and a subsequent run-out period during which employees may submit claims for reimbursement. In that case, an employer will need additional time to compute the cost of coverage before it can calculate any excess benefit for each employee and allocate it among coverage providers. The IRS also requests comments on how payments related to experience-rated contracts may impact the timing of an employer’s calculation and allocation of any excess benefit.
Pass-Through of Tax to an Employer
The IRS recognizes that in some cases, a coverage provider such as an insurance carrier or TPA may seek to pass the amount of any Cadillac tax through to the employer. If the coverage provider is reimbursed for the tax, the reimbursement will be additional taxable income to the coverage provider. This is known as the “Cadillac tax reimbursement.”
It is also anticipated that the amount passed through may include an amount to account for the additional income tax the coverage provider will incur. This is known as the “income tax reimbursement.”
The IRS anticipates that the amount of any Cadillac tax reimbursement should be excluded from the cost of applicable coverage (i.e., it should not be counted when determining if the cost of coverage exceeds the threshold). It is expected that future regulations will reflect this interpretation. The IRS requests comments on whether some or all of the income tax reimbursement could be excluded from the cost of applicable coverage, and how such an exclusion might be administered, given the potential variability of tax rates and other factors among different coverage providers.
The IRS also anticipates that coverage providers would be permitted to exclude the amount of any Cadillac tax reimbursement or income tax reimbursement only if it is separately billed and identified as attributable to the cost of the Cadillac tax. Separately billed amounts in excess of the Cadillac tax reimbursement or the income tax reimbursement could not be excluded from the cost of coverage.
Income Tax Reimbursement Formula
If the IRS concludes that an income tax reimbursement can be excluded from the cost of coverage, it is anticipated that the amount of the income tax reimbursement would be determined using a formula commonly used to calculate “tax gross-ups.” Under the formula, the amount of the income tax reimbursement that would be excludable from the cost of coverage would be equal to the amount of the tax divided by (1 – [coverage provider’s marginal tax rate]) minus the amount of the tax. For example, if the amount of the Cadillac tax due is $1,000 and the coverage provider’s marginal tax rate is 20%, the gross up would be $1,000 / (1 – 0.2) – $1,000, or $250.
If it is determined that an income tax reimbursement can be excluded from the cost of coverage, the IRS is considering two possible approaches for applying the formula described above. The first approach would use the coverage provider’s actual marginal tax rate in the formula. This approach could provide greater flexibility to taxpayers, but also could create administrative difficulties, as a coverage provider’s marginal tax rate may change from year to year (including potential retroactive changes due to amended returns, audits, or other circumstances), and may be determined based on its fiscal year rather than the calendar year basis which applies to the Cadillac tax.
The second approach involves applying a standard marginal tax rate based on typical marginal tax rates applicable to different types of health insurance issuers.
Allocation of Contributions to HSAs, FSAs, HRAs
Under the ACA, coverage subject to the Cadillac tax includes coverage under certain HSAs, FSAs, or HRAs. The IRS is considering an approach under which contributions to 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 an amount to an HSA for an employee for a plan year, That contribution would be allocated ratably to each calendar month of the plan year, regardless of when the employer actually contributes the amount to the HSA. Similarly, if an employee elects to contribute to an FSA for a plan year, the employee’s total contributions would be allocated ratably to each calendar month of the plan year, even though the entire amount contributed for the plan year would be available to reimburse qualified medical expenses on the first day of the plan year. Comments are requested on this approach as well as alternative approaches.
Cost of Applicable Coverage under FSAs with Employer Flex Credits
In general, the cost of coverage of a health FSA for any plan year would be the greater of the amount of an employee’s salary reduction or the total reimbursements under the FSA. Under this general rule, in determining the portion of the cost of coverage attributable to non-elective flex credits (employer FSA contributions), the cost of the non-elective flex credit would be the amount that is actually reimbursed in excess of the employee’s salary reduction election for that plan year. For example, if an employee elects to contribute $1,000 to a health FSA for the plan year and the employer makes a non-elective flex credit of $500 available to the employee, but the employee only has $1,200 in reimbursable medical expenses that year, the cost of coverage for the FSA for the plan year would be $1,200 (comprised of the $1,000 salary reduction plus the additional $200 in reimbursements attributable to the non-elective flex credit provided by the employer) rather than the full $1,500 elected or available under the FSA for the plan year.
With regard to FSA carryovers, the IRS is considering providing a safe harbor under which unused amounts that are carried forward would be taken into account when initially funded by salary reduction but would be disregarded when used to reimburse expenses in a later year. For example, if an employee elected to reduce his salary by $1,200 to contribute to an FSA in a given year, the FSA’s cost of coverage in that year would be $1,200 regardless of the actual amount of reimbursements. Accordingly, if that same employee carried over $500 of unused funds that were used to reimburse expenses in the second year, and elected no new salary reduction for the second year, the FSA’s cost of applicable coverage in the second year would be $0. It is anticipated that this safe harbor approach would be limited to cases in which the employer is not making non-elective flex credits available for use in the FSA.
The IRS is also considering a variation to the safe harbor to address situations in which non-elective flex credits are available under a cafeteria plan that includes an FSA. Under the variation, an FSA could be treated as funded solely by salary reduction if the amount elected by the employee for the FSA was less than or equal to the maximum permissible employee contribution to an FSA. For example, if an employee with a $1,000 non-elective flex credit available reduces salary by an additional $5,000 under a cafeteria plan and allocates $2,550 to the FSA, the FSA would be treated as funded solely by salary reduction. As a result, the cost of coverage would be $2,550. Comments are requested on the allocation of FSA amounts between non-elective flex credits and salary reduction when the total election for the FSA exceeds the maximum salary reduction amount permitted by law (e.g., $2,550 for plan years beginning in 2015).
Inclusion of Self-Insured Coverage Includible in Income
The Cadillac tax includes coverage under any group health plan made available to the employee by an employer that is excludable from the employee’s gross income. In general, employer-provided coverage under a health plan is excludable from an employee’s gross income. In addition, the reimbursements for medical expenses received by the employee are also excluded unless the reimbursements are paid to a highly-compensated individual (“HCI”) under a self-insured plan that discriminates in favor of HCIs.
Under the ACA, certain employers must report the aggregate cost of employer-provided coverage on the Form W-2 (generally those who issued 250 or more W-2s in the prior year). Current IRS guidance (Notice 2012-9) permits employers to reduce the amount reported on the Form W-2 by any excess reimbursement included in gross income due to the rules applicable to self-insured plans.
Although excess reimbursements currently can be excluded from the cost reported on the Form W-2, the IRS intends to modify Notice 2012-9 (its guidance on the ACA’s W-2 reporting requirement) to make excess reimbursements subject to the W-2 informational reporting and that the forms and instructions will be modified to reflect this change. Notice 2012-9 should be followed until modification is issued.
The effect of this provision is that although an HCI is taxed on the value of the discriminatory coverage, that value of that coverage is includible for Cadillac tax purposes.
Age and Gender Adjustment to the Dollar Limit
The Cadillac tax contains two baseline per-employee dollar limits for 2018 ($10,200 for self-only coverage and $27,500 for other than self-only coverage) but the law also provides that various adjustments will apply to these amounts, including an increase based on the age and gender characteristics of all employees of an employer, determined separately for self-only coverage and other than self-only coverage. The IRS intends to publish adjustment tables to facilitate and simplify the calculation of the age and gender adjustment.
Notice and Payment
The employer must notify both IRS and the coverage provider of the amount of the excess benefit, and the tax must be paid by the coverage provider (the insurance carrier, TPA or employer). The law provides that each coverage provider is liable for the excise tax on its applicable share of the excess benefit, but does not specify the time and manner in which the excise tax is paid. The IRS is considering using Form 720 as the method for payment of the tax
Employer Action Steps
As with the first Notice, this latest guidance does not provide a great deal of concrete guidance. However, it offers further insight into the IRS’s intended approach to implementation. It also presents an opportunity for practitioners to provide comments to the IRS for consideration. Public comments on these issues are due by October 1, 2015.