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IRS FAQs on ACA Provisions and FSA Carryover


In December, the IRS published Notice 2015-87 providing detailed guidance primarily on the ACA’s impact on several employer-sponsored health care plan design options. Highlights of the guidance are discussed below.

Indexed ACA §4980H Employer Penalties

The IRS notice provides the indexed amounts for employer §4980H penalties for upcoming years. If an applicable large employer does not offer medical coverage to the majority of its full-time employees (70% in 2015; 95% in 2016+), the employer is at risk for a penalty under §4980H(a). An employer would only incur this penalty if it fails to offer medical coverage and at least one full-time employee receives a federal premium tax credit for individual coverage from the Marketplace. For the months that the penalty is incurred, the employer will be assessed the penalty amount times the total number of full-time employees minus a small allowance (80 employees in 2015; 30 employees in 2016+). The original §4980H(a) penalty amount was $2,000 annually ($166.67 per month) per full-time employee. Due to indexing, the §4980H(a) annual penalty amount is $2,080 ($173.33 per month) for 2015 and $2,160 ($180 per month) for 2016.

If an employer offers medical coverage to the majority of its full-time employees, but does not offer affordable and/or minimum value coverage to some full-time employees, the employer is at risk for a penalty under §4980H(b). An employer would incur this penalty each month for each full-time employee who was not offered affordable and/or minimum value coverage and receives a federal premium tax credit for individual coverage from the Marketplace. The original §4980H(b) penalty amount was $3,000 annually ($250 per month) per full-time employee. Due to indexing, the §4980H(b) annual penalty amount is $3,120 ($260 per month) for 2015 and $3,240 ($270 per month) for 2016.

The IRS anticipates that indexed amounts will be posted on the IRS.gov website in future years. Keller will include the indexed amounts in our annual COLA chart.

Indexed ACA Affordability Safe Harbors

In order to avoid both §4980H penalties under the ACA employer mandate, applicable large employers must offer affordable, minimum value medical coverage to full-time employees. The offer of medical coverage is affordable under the ACA if the employee’s required contribution for self-only coverage in the lowest-cost medical plan available is no more than 9.5% of the individual’s household income. Due to indexing, the percentage increased to 9.56% for 2015 and 9.66% for 2016.

Since employers generally do not know their employees’ household incomes, the IRS provided three safe harbor rules for employers to determine whether their offer of coverage satisfies affordability. Instead of the employee’s household income, the employer can base affordability on 1) the employee’s W-2, Box 1 income, 2) the employee’s rate of pay, or 3) federal poverty level. When these safe harbor rules were written, no indexing was included. In Notice 2015-87, the IRS explains that the indexing that applies to the household income threshold was intended to also apply to the employer safe harbors. Therefore, the employer safe harbor threshold increased to 9.56% for 2015 and 9.66% for 2016 of the relevant amounts.

The IRS intends to amend the safe harbor legislation so that in future years the indexed adjustments to the individual affordability percentage will also apply to the employer safe harbor percentage. Keller will include the indexed rates in our annual COLA chart.

Employer Flex Credits and ACA Affordability

An employer’s offer of medical coverage is affordable based on the employee’s required contribution for self-only coverage in the lowest-cost plan available to the employee. The employer can use one of the three safe harbors described above to determine affordability.  IRS Notice 2015-87 explains that the term “required contribution” includes any amount that the employee must pay in order to enroll in coverage, including the employee’s payroll deductions as well as any employer funds that could have been used on non-medical benefits.

In designing benefit packages, some employers have a “flex plan” that provides a fixed dollar amount of employer funds (i.e., flex credits) and allows employees to elect coverage from a variety of benefits. If employer funds are only available to pay for medical care benefits, such as health, dental, or vision insurance, or a health flexible spending account, then the employer funds constitute “health flex contributions” and the IRS allows the funds to count as reducing the employee’s required contribution for self-only coverage in order to determine if the coverage is affordable.

However, if the employer funds are available for purposes other than medical care, such as life insurance, dependent care, 401k contributions, or received as cash, then the funds do not constitute “health flex contributions” and do not reduce the employee’s required contribution when determining affordability. Even if the net result is that the employee pays $0 for self-only medical coverage, the funds do not count as reducing the employee’s required contribution because the employee must choose between either the medical benefits or the non-medical benefits and that choice imposes a cost. For ACA affordability purposes, the employee’s required contribution would therefore be the election amount required for self-only medical coverage before the employer funds are applied.

Example 1:

The employee’s cost for self-only medical coverage is $400 per month. The employer provides $350 of employer funds per month that may only be used for medical and dental insurance. Since the employer funds may only be used for medical care, the funds constitute “health flex contributions” and the employee’s required contribution is reduced to $50. The coverage is considered affordable under the ACA using the federal poverty level safe harbor (and presumably other available employer safe harbors).

Example 2:

The employee’s cost for self-only medical coverage is $400 per month. The employer provides $450 of employer funds per month that may be used to pay for medical and dental insurance, health or dependent care flexible spending accounts, transportation benefits, or 401k. Since the employer funds can be used for non-medical care purposes, the funds are not “health flex contributions”. For purposes of ACA affordability, the employee’s required contribution is the full $400 because the employee must either forgo $400 of non-medical benefits or contribute $400 in payroll deductions in order to enroll in the medical coverage. The coverage might not be considered affordable to all employees under the ACA affordability employer safe harbors.

The IRS recognizes that many plans currently provide employer funds intended to make medical benefits affordable, but those plans might currently allow for funds to be used for non-medical care benefits. For the purposes of employer penalties under ACA §4980H(b), for plan years beginning before January 1, 2017, the IRS will treat these plans as providing flex contributions that reduce the employee’s required contribution. However, this relief does not apply to arrangements where employer funds may be received as cash or that are adopted on or after December 16, 2015.

For plans with employer funds arrangements that qualify for relief, the employer may report the employee’s required contribution as the reduced amount due to the flex contribution on line 15 of Form 1095-C. However, the IRS encourages employers to report the employee’s required contribution without reducing for the flex contribution since it may qualify an employee for a premium tax credit towards Marketplace coverage. If the employer is later notified by the IRS of potential penalty assessments, the employer will have the opportunity to claim relief under Q&A-8 of Notice 2015-87 and avoid the §4980H(b) penalty.

Keller is working with our clients that currently offer flex credits towards non-medical benefits to ensure ACA affordability based on this guidance, for plan years starting January 1, 2017 and after.

SCA or DBRA Fringe Benefits and ACA Affordability

The McNamara-O’Hara Service Contract Act (SCA) and the Davis-Bacon Related Acts (DBRA) require that federal contract employers provide a specified minimum dollar amount of fringe benefits to eligible employees. Under the SCA and DBRA, the term “fringe benefits” includes several medical care benefits as well as many non-medical care benefits. If an employee declines all offered medical care benefits, the employer must still provide the employee with an eligible fringe benefit or pay the employee the fringe benefit amount in cash.

The SCA and DBRA fringe benefit requirement is very similar to the fixed dollar employer funding arrangement discussed above. However, the IRS recognizes that the fringe benefit requirement causes a unique conflict with the ACA affordability rules as discussed above. Therefore, until further guidance is applicable, and at least for plan years starting before January 1, 2017, the IRS will allow that SCA and DBRA fringe benefit arrangements will be treated as reducing the employee’s required contribution for the purposes of compliance with §4980H(b), even if they allow for employees to receive cash in lieu of benefits.

Just as with employer funds above, the employer may report the employee’s required contribution as the reduced amount due to the flex contribution on line 15 of Form 1095-C. However, the IRS again encourages employers to report the employee’s required contribution without reducing for the fringe benefit amount since it may qualify an employee for a premium tax credit towards Marketplace coverage. If the employer is later notified by the IRS of potential penalty assessments, the employer will have the opportunity to claim relief under Q&A-10 of Notice 2015-87 and avoid the §4980H(b) penalty.

Keller will update our clients with SCA and DBRA contracts as additional guidance is issued.

Calculating ACA Hours of Service During a Leave of Absence

When calculating employees’ hours of service to determine who is or is not full-time, the ACA requires employers to count all hours of paid leave as hours of service. In the ACA regulations, §54.4980H-1(a)(24), an hour of service includes any “hour for which an employee is paid, or entitled to payment by the employer for a period of time during which no duties are performed due to vacation, holiday, illness, incapacity (including disability), layoff, jury duty, military duty or leave of absence”. This includes whether the employer pays the employee “directly, or indirectly through, among others, a trust fund or insurer to which the employer contributes or pays premiums”. For most leave categories, the employer pays the employee directly through the payroll system and the hours are easily tracked by the employer. But what about leave for “incapacity (including disability)” when it is paid through an insurance policy?

When an employee has a disability leave of absence, he or she may qualify for income replacement benefits through the employer’s short or long term disability policy. If the policy is insured, and the premiums are paid by the employer, the insurance company’s payment constitutes an indirect payment by the employer. As long as the individual remains an employee, the indirect employer payment must be counted toward the employee’s hours of service. However, if the employee pays the disability insurance premium with after-tax contributions, then the payments are not attributed to the employer and do not count as hours of service.

If you need assistance determining what counts as paid hours of service, please contact your Keller account team.

ACA-Compliant Health Reimbursement Accounts (HRAs)

For an HRA to comply with ACA reforms, it must be “integrated” with an employer’s group medical plan. The integration only applies to individuals who are enrolled in both the HRA and a group medical plan. For instance, if an employee enrolls in self-only medical plan coverage, but the HRA includes coverage for family members, the HRA is only integrated with regard to the employee. The HRA coverage is not integrated with regard to the family members and therefore would fail to comply with the ACA.

The IRS is aware that many HRAs do not currently have the ability to restrict coverage based on enrollment in the related group medical plan(s). For plan years beginning prior to January 1, 2017, if the HRA otherwise meets the requirements for integration, the IRS will not treat it as failing to integrate solely based on covering family members that are not enrolled in an employer’s group medical plan.

Please note that employers are responsible for minimum essential coverage reporting to individuals (Form 1095-B) for HRA coverage that provides reimbursement of medical expenses of individuals who are not enrolled in its group medical plan.

Keller is working with our clients that sponsor HRAs to ensure the plans are properly integrated with an employer group medical plan.

FSA Carryovers and COBRA

Under COBRA, an FSA participant can continue health FSA coverage through the end of the plan year if there is a positive health FSA balance at the time of a qualifying event,[*] such as termination of employment. COBRA premium is calculated at 102% of the applicable cost of coverage for the benefit.

Employers may allow health FSA participants to carry over up to $500 of unused funds at the end of one plan year to be used in the following plan year. If the employer allows a carryover, any carryover funds must be included in determining whether there is a positive balance, cannot be included in determining the amount of COBRA premium, and must be allowed to continue to be carried over into the next following plan year. However, employers may limit their ongoing exposure by adding a condition that funds will only carry over to the next plan year if the employee elects to participate in the FSA during that next plan year.

Positive Balance:

A health FSA has a positive balance if the year-to-date contributions are more than the year-to-date paid claims amount. The year-to-date contributions are the total of the payroll deductions that have occurred, annual employer funds, and carryover funds from the prior year.

For example: During open enrollment for the 2016 calendar year plan, an employee elects to have $2,400 deducted from payroll ($200 per month) for the health FSA. Due to unused funds in the 2015 plan year, $500 carries over into the 2016 plan year. The employer provides $200 of employer funds to all participants’ FSAs in 2016. The employee’s maximum benefit for the plan year is $3,100. The employee terminates employment on March 31, 2016. The employee’s year-to-date contributions would be $1,300 ($600 payroll deductions + $500 carryover + $200 employer funds). If the employee’s paid claims at that time are less than $1,300, the employer must offer COBRA continuation for the FSA.

COBRA Premium:

The maximum COBRA premium allowed is 102% of the monthly cost of coverage. The monthly cost of coverage for a health FSA is the annual employer funds plus the employee’s annual payroll deduction election, divided by the number of months in the plan year. Using the example above, the maximum monthly COBRA premium allowed is $221 ($2,400 election + $200 employer funds, divided by 12, times 102%). The carryover is not included in the calculation. If there is no election other than a carryover from a prior year, the COBRA premium is zero.

Continued Carryover:

COBRA requires that COBRA beneficiaries be provided the same coverage as the coverage provided to similarly-situated active employees. If the plan allows active employees to carry over unused health FSA funds to the next plan year, then similarly-situated COBRA beneficiaries must also be allowed to carry over unused funds under the same terms. Therefore, rather than FSA participation only continuing until the end of the plan year, the carryover participation could continue for the beneficiary’s maximum COBRA coverage period, just like any other COBRA benefit.

However, the plan is not required to allow COBRA beneficiaries to make a new election or have access to employer funds for the next plan year period. Since the COBRA premium calculations do not include carryover funds from a prior plan year, the maximum COBRA premium for the carryover period would be $0.

For example: Using the same details as above, the employee elects COBRA continuation of the health FSA and pays $221 per month through the end of the plan year. The plan allows all participants to carry over funds up to $500. If the COBRA beneficiary has unused funds at the end of the 2016 plan year, up to $500 will carry over to the 2017 plan year. The COBRA beneficiary cannot elect an additional contribution, does not receive the 2017 employer contribution, and does not pay any additional COBRA premium in 2017. Since the qualifying event was the employee’s termination on March 31, 2016, the COBRA coverage ends 18 months later on September 30, 2017. Any funds unused by that date are forfeited.

Conditional Carryover:

The IRS clarified that the availability of carryover funds may be conditioned on the individual’s election to participate in the health FSA during the next plan year. Additionally, the employer may impose a minimum election requirement for participation. If the carryover provision requires a minimum new election, and COBRA beneficiaries are not eligible to make new elections at open enrollment, then COBRA beneficiaries will not be able to carry over funds into the next plan year. The participation requirement would also reduce ongoing FSA administrative fees for active employees who may have a balance of unused FSA funds that otherwise roll from one year to the next.

Please contact your Keller account team for assistance with FSA carryover and COBRA.


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