Monthly Health Care Reform Update IRS RELEASES INITIAL GUIDANCE ON THE CADILLAC TAX

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1 - Mnthly Health Care Refrm Update IRS RELEASES INITIAL GUIDANCE ON THE CADILLAC TAX This update is part f a Brwn & Brwn series summarizing new guidance issued in cnnectin with the Patient Prtectin and Affrdable Care Act (als knwn as Health Care Refrm). We are jining frces with ur business partner, the law firm f Miller Jhnsn, t prvide these updates t yu. Fr this editin, we are examining new IRS guidance n the excise tax n high cst emplyer-spnsred health cverage (i.e., the Cadillac tax ), which will becme effective in The Cadillac tax is a 40% nndeductible excise tax n the aggregate cst f applicable emplyer-spnsred cverage (referred t here as applicable cverage ) that exceeds certain dllar limits. Ntice The IRS recently released Ntice , its first guidance n the Cadillac tax. The Ntice is intended t initiate and infrm the prcess f develping regulatry guidance n the Cadillac tax and, as such, des nt ffer guidance n which taxpayers may rely. Hwever, it des discuss sme f the majr issues surrunding the implementatin f the Cadillac tax and ffers ptential appraches fr reslving thse issues. It als seeks cmments frm interested parties n these issues as well as n related issues under COBRA. The Ntice fcuses n three key tpics relating t the Cadillac tax: What types f cverage cnstitute applicable cverage subject t the Cadillac tax. Hw t determine the cst f applicable cverage. Hw t apply the annual statutry dllar limits t the cst f applicable cverage. What Cnstitutes Applicable Cverage Subject t the Cadillac Tax? The statute cntains a general definitin f applicable cverage that includes any cverage under a grup health plan made available t an emplyee by an emplyer (including gvernmental emplyers) if the cverage wuld be excludible frm the emplyee s incme if paid by the emplyer. The statute als specifically indicates that certain types f cverage will cnstitute applicable cverage, including Medical Flexible Spending Accunts ( FSAs ), Health Savings

2 Accunts ( HSAs ), gvernmental plans, retiree cverage, multiemplyer plans and n-site medical clinics. Hwever, the statute expressly exempts certain types f emplyer-spnsred cverage frm the Cadillac tax, including the fllwing: Dental r visin insurance that is issued under a plicy, certificate r cntract f insurance that is separate frm the grup health plan; Lng-term care insurance; Cverage nly fr accident, r disability incme insurance, r sme cmbinatin f the tw; Liability insurance; Cverage issued as a supplement t liability insurance; Wrkers cmpensatin r similar insurance; Cverage fr a specified disease r illness and hspital indemnity r ther fixed indemnity insurance that is nt excludible frm incme. The Ntice identifies several pen questins relating t the statute s definitin f applicable cverage and addresses them as fllws: Health Reimbursement Arrangements and Executive Physical Prgrams: Althugh they are nt specifically identified as applicable cverage under the statute, future guidance will likely prvide that Health Reimbursement Arrangements ( HRAs ) and executive physical prgrams are als included in the definitin f applicable cverage, since these frms f cverage meet the general definitin f applicable cverage under the statute and are nt specifically excluded. On-site Medical Clinics: The IRS is cnsidering excluding sme n-site medical clinics frm the definitin f applicable cverage, namely, thse that prvide nly de minimis medical care (such as first aid) t emplyees and thse that prvide certain services in additin t (r in lieu f) first aid, such as immunizatins, allergy injectins, prvisin f aspirin and treatment f injuries caused by accidents at wrk. On the ther hand, n-site medical clinics prviding primary care will be included in applicable cverage. The IRS als seeks cmments n hw t determine the cst f cverage prvided by an n-site medical clinic that is cnsidered applicable cverage. Self-insured Dental and Visin Cverage: The IRS ntes that many cmmentatrs have interpreted the statute t mean that nly fully insured standalne dental and visin benefits are specifically excluded frm the Cadillac tax.

3 The Ntice states that the IRS is cnsidering using its regulatry authrity t als exclude self-insured dental and visin cverage, prvided that such cverage qualifies as an excepted benefit under previusly issued regulatins that apply fr ther Health Care Refrm purpses. Emplyee Assistance Prgrams: The IRS is als cnsidering excluding Emplyee Assistance Prgrams that qualify as an excepted benefit. Hw is the Cst f Applicable Cverage Determined? The Cadillac tax is 40% f an emplyee s excess benefit fr each calendar mnth. The excess benefit is the amunt that the aggregate cst f each type f applicable cverage in which the emplyee is enrlled exceeds 1 / 12 th f the annual dllar limit. As a result, t calculate any ptential liability under the Cadillac tax, the taxpayer needs t knw the aggregate cst f all applicable cverage. The Ntice indicates that the cst f cverage under a grup health plan will likely be determined using the same principles that apply fr purpses f calculating the applicable premium under COBRA. The applicable premium under COBRA is based n the cst f cverage fr similarly situated nn-cobra beneficiaries. The IRS acknwledges, hwever, that the current COBRA regulatins lack definitive guidance n a number f issues relevant t the calculatin f the applicable premium, such as: Hw a grup f similarly situated nn-cobra beneficiaries is determined. The IRS anticipates that a similar standard will apply fr the Cadillac tax, meaning that the cst f each type f applicable cverage fr a given emplyee will be based n the average cst f that type f cverage fr that emplyee and all similarly situated emplyees. Under the apprach envisined by the IRS fr this purpse, each grup f similarly situated emplyees wuld be determined by starting with all emplyees cvered by a particular benefits package (i.e., a PPO ptin vs. a HMO ptin), then subdividing that grup based n mandatry disaggregatin rules (i.e., self-nly vs. ther than self-nly cverage), and allwing further subdivisin f the grup based n permissive disaggregatin rules (i.e., bna fide emplyment-related criteria, bna fide gegraphic distinctins, r ther factrs). The methds that self-funded plans may use t calculate COBRA premiums. Self-funded plans currently can chse between tw methds t determine the COBRA applicable premium: the actuarial basis methd and the past cst methd. The IRS anticipates that these methds will apply fr purpses f determining the cst f cverage fr self-insured plans under the Cadillac tax and discusses ptential standards that may apply under each methd.

4 The IRS als seeks cmments n whether an emplyer shuld be able t switch between methds. Fr example, the IRS is cnsidering a rule that wuld generally require use f ne methd fr a perid f at least five years, unless there is a significant change in the benefits r emplyees cvered by the plan. Hw COBRA premiums are calculated fr HRAs. Based n current guidance, we knw that COBRA premiums under an HRA may nt be based n a qualified beneficiary s reimbursement amunts available under the HRA, but therwise there is limited guidance under COBRA fr determining the cst f HRA cverage. As a result, the IRS is cnsidering varius methds that future guidance might permit fr use in determining the cst f HRA cverage, such as: Determining the cst based n amunts made newly available t a participant each year (thugh the IRS is cncerned that this apprach might vervalue the HRA). Aggregating the csts (claims and administrative expenses) fr the year fr all self-nly HRAs and fr all ther than self-nly HRAs, and dividing by the number f emplyees cvered fr the year at each cverage level. Permitting r requiring emplyers t use the actuarial basis methd t calculate the cst f HRA cverage. While the IRS is primarily cnsidering these appraches fr purpses f determining the cst f cverage under the Cadillac tax, the Ntice indicates that the IRS may apply the same appraches fr purpses f determining the applicable COBRA premium as well. In additin, the Ntice cnfirms specific rules set frth under the statute fr determining the cst f applicable cverage, such as: Separate csts must be calculated fr self-nly cverage and ther than selfnly cverage (i.e., emplyee-plus-ne and family cverage). The cst f applicable cverage is based n the cverage in which the emplyee is actually enrlled (rather than n the cverage ffered t the emplyee, but in which the emplyee des nt enrll). The cst f cverage under a Medical FSA will be the sum f emplyee pre-tax cntributins t the Medical FSA, plus any reimbursement in excess f the emplyee s pre-tax cntributins (i.e., due t emplyer cntributins t the Medical FSA). The cst f cverage under an HSA is the sum f emplyee pre-tax cntributins and emplyer cntributins t the HSA. The Ntice cnfirms, hwever, that

5 after-tax cntributins made utside a Sectin 125 Cafeteria plan are nt included fr purpses f determining the cst f cverage under an HSA. The plan may treat pre-age 65 retirees and pst-age 65 retirees as similarly situated beneficiaries in determining the cst f retiree cverage. Hw are the Annual Dllar Limits Applied t the Cst f Applicable Cverage? In 2018, the first year that the Cadillac tax is impsed, the annual dllar limit fr self-nly cverage is $10,200 and fr ther than self-nly cverage is $27,500. In general, the prrated dllar limit that applies t an emplyee fr any mnth is determined based n whether the emplyee is enrlled in self-nly r ther than self-nly cverage as f the beginning f the mnth. The Ntice indicates that the IRS is cnsidering hw t apply the dllar limits when an emplyee simultaneusly has ne type f cverage that is self-nly cverage and anther type f cverage that is ther than self-nly cverage. Under ne prpsed apprach, the applicable dllar limit wuld depend n whether the emplyee s primary cverage/majr medical cverage is self-nly r ther than self-nly cverage. An alternative apprach wuld be t apply a cmpsite dllar limit based n the cst f each type f cverage. The annual dllar limits will be subject t varius adjustments that will be addressed in future regulatins, including the fllwing: Health Cst Adjustment: A ne-time adjustment designed t increase the baseline annual dllar limit amunts in the event that the actual grwth in the cst f U.S. health care between 2010 (i.e., the year that Health Care Refrm was enacted) and 2018 (i.e., the year the Cadillac tax is effective) exceeds the prjected grwth fr that perid. Cst-f-Living Adjustment: An annual adjustment beginning in 2019 t reflect changes in the cst-f-living. Age and Gender Adjustment: An annual adjustment based n the age and gender characteristics f the emplyer s wrkfrce and hw they differ frm thse f the natinal wrkfrce. High-Risk Prfessin Adjustment: An annual adjustment fr participants in a plan spnsred by an emplyer in which the majrity f the emplyees enrlled in the plan are engaged in a high-risk prfessin, r emplyed t repair r install electrical r telecmmunicatins lines. High risk prfessins include plice fficers; firefighters; emergency medical technicians, paramedics, and firstrespnders; lngshremen; and emplyees engaged in the cnstructin, mining, agriculture (but nt fd prcessing), frestry, and fishing industries. Qualified Retiree Adjustment: An annual adjustment fr participants wh are qualified retirees. A qualified retiree is a retiree wh is receiving cverage by

6 reasn f being a retiree, is at least age 55 and is nt eligible fr enrllment in Medicare. Issues Nt Addressed in Ntice The IRS expects t release anther ntice that will address and invite cmments n ther issues relating t the Cadillac tax that are nt addressed in Ntice , including prcedural issues relating t assessment f the tax. We are still awaiting guidance as t the apprpriate entities respnsible fr paying the tax. The statute indicates that the insurer is respnsible fr paying the Cadillac tax fr fully insured arrangements while the emplyer is respnsible fr paying the Cadillac tax fr HSAs. Hwever, fr all ther self-funded cverages that are subject t the Cadillac tax, the persn that administers the plan benefits is respnsible fr paying the Cadillac tax. It is nt clear whether this phrase means the plan spnsr (wh is generally the plan administratr under a single emplyer plan) r if it ptentially means the third-party administratr. Regardless f which entity is respnsible fr paying the Cadillac tax, the statute is clear that the emplyer is respnsible fr calculating the amunt f the Cadillac tax. Because different entities are required t pay the Cadillac tax fr different types f cverage, but the Cadillac tax is calculated by using the aggregate cst f the applicable cverage, the Cadillac tax may need t be allcated pr rata t the different entities respnsible fr paying the Cadillac tax. We anticipate that future guidance will address hw this allcatin prcess might wrk. Next Steps Emplyers, insurers and third-party administratrs have lng been awaiting guidance n the Cadillac tax and Ntice indicates that the IRS has finally started t tackle the cmplex issues surrunding the implementatin f the tax. Althugh the Ntice des nt ffer definitive answers n thse issues, it des prvide significant insight int the IRS s thught prcess and gives interested parties an pprtunity t prvide input n a number f critical tpics. Because the Cadillac tax may ptentially subject emplyers t a significant liability, emplyers particularly thse negtiating cllective bargaining agreements that extend int 2018 shuld begin t cnsider the implicatins f the Cadillac tax nw. MJ_DMS v