IRS Issues Second Notice on “Cadillac Tax”August 31, 2015
On July 30, the IRS issued Notice 2015-52, the second notice on potential regulatory approaches to implementing the Affordable Care Act’s (ACA) 40% excise tax on high cost plans, also known as the “Cadillac Tax”. The first notice, Notice 2015-16, was issued in February 2015.
Starting in 2018, the excise tax will be owed on the cost of group health coverage that exceeds statutory limits. The initial baseline limits for 2018 are $10,200 for self-only coverage and $27,500 for all other coverage. For more background, see IRS Notice 2015-16 Guidance on “Cadillac Tax”.
The comment period on the first notice closed in May. While still considering comments submitted in response to that notice, the IRS invites comments on the issues discussed in Notice 2015-52, as well as any other issues regarding the excise tax. This includes the opportunity to submit additional comments on the issues presented in Notice 2015-16. The new comment period will close October 1, 2015.
As the 2018 effective date gets closer, there has been increased public opposition to this administratively complex excise tax. Bills to repeal the tax were presented in Congress earlier this year by both Democrat and Republican Representatives, and last year by a Republican Senator. The push to repeal has garnered the support of many employers, unions, trade organizations, insurers and agents, and local governments. Earlier this year, several of these entities formed a coalition, Alliance to Fight the 40, specifically to seek repeal of the 40% excise tax.
In the meantime, the IRS has forged ahead with the process of drafting the regulations. This notice, as with the earlier notice, presents some of the issues that need to be resolved and an IRS request for feedback.
What issues are discussed in Notice 2015-52?
- Entities responsible for paying the excise tax
- Notice and payment
- Employer aggregation issues
- Cost of applicable coverage
- Age and gender adjustments
Who is liable for paying the excise tax?
The Internal Revenue Code (Code) says that each “coverage provider” is responsible for paying the share of the tax that relates to the coverage it provides. Coverage provider is then defined as either a) the health insurance issuer for fully insured benefits, b) the employer for HSA and MSA contributions, or c) “the person that administers the plan benefits” for any other coverage. Notice 2015-52 presents two potential approaches to defining “the person that administers the plan benefits”:
- The entity responsible for daily administrative functions of the plan, e.g. claims review, answering inquiries, or maintaining technology services. For self-insured plans, this might be a third-party administrator (TPA), the employer, or the plan sponsor of a multi-employer plan. The IRS noted the potential for problems in situations where responsibility is split for administering different aspects of a plan.
- The entity with ultimate authority or responsibility to the plan, including final decisions on administrative matters, such as eligibility terms, claims administration, and managing service providers. This entity would likely be named in the plan documents. The IRS is asking whether this approach is likely to point to one easily identified entity or multiple parties, as in the first approach.
How will coverage providers know how much they owe?
Each coverage provider is responsible for paying the tax only on the portion of excess benefit attributable to the benefit it provides. However, coverage providers generally do not have knowledge of the cost of coverage from other providers. Therefore, the employer is tasked with the responsibility to calculate the total cost of coverage and whether there is excess benefit, determine what portion of the excess is attributable to each provider, and notify the coverage providers.
An employee, in 2018, has self-only medical insurance with an annual premium of $10,000, and no other applicable coverage:
- The employer calculates that the total cost of coverage is $10,000, which is lower than the $10,200 baseline for self-only coverage.
- The employer notifies the insurance coverage provider, the insurance carrier, that there is no excess benefit.
An employee, in 2018, has self-only medical insurance with an annual premium of $10,000. The employee’s only other applicable coverage is an FSA funded with a $2,200 election. The FSA has no employer funding or carryover benefit.
- The employer calculates that the total cost of coverage is $12,200, which is $2,000 more than the $10,200 baseline for self-only coverage (assume no age or gender adjustments apply).
- The employer calculates that the $10,000 insurance premium is 82% of the total cost of coverage and the $2,200 FSA is 18% of the total cost of coverage. $10,000 premium / $12,200 total cost of coverage = 82% $2,200 FSA / $12,200 total cost of coverage = 18%
- The employer notifies the insurance coverage provider, the insurance carrier, that they are responsible for paying the excise tax on $1,640 (82% of the $2,000 excess).
- The employer notifies the FSA coverage provider, likely the employer or a third-party administrator, that they are responsible for paying the excise tax on $360 (18% of the $2,000 excess).
What happens if the Coverage Provider charges the employer for the cost of the excise tax?
Assuming that the coverage provider is not the employer, the IRS expects the coverage provider will require reimbursement from the employer for the cost of the excise tax. The excise tax reimbursement would be additional income to the coverage provider and therefore would lead to additional income taxes at the coverage provider’s marginal tax rate. Therefore, the IRS anticipates that some coverage providers will also require reimbursement of the additional income tax. The Code provides that amounts attributable to the excise tax are excludable from the cost of coverage. That exclusion would seem to apply to the excise tax, excise tax reimbursement, and income tax reimbursement. However, the IRS is looking for comment on the feasibility of calculating the amount to exclude if reimbursement amounts are not billed separately from the insurance premium.
How will employer aggregation rules affect administration of the excise tax?
Affiliated employers that are treated as a single employer under § 414 (b), (c), (m), or (o) are also treated as a single employer by the excise tax. Comments are invited on how that aggregation may cause difficulties in: 1) identifying the employers’ applicable coverage, 2) determining adjustments for age, gender, and certain high risk professionals, 3) establishing which taxpayer is responsible for calculation and notification of the excess benefit amount, and 4) establishing which taxpayer is liable for penalties. There was no indication of how the regulations might address these concerns; only a request for comments.
When will the Cost of Applicable Coverage need to be determined?
The IRS indicated a preference for requiring the cost of applicable coverage to be determined within a short time after the end of each calendar year. Here are a few of the reasons why this timing might be problematic:
- If the cost of applicable self-insured coverage is partially derived from the claims experience, it will be impossible to calculate the cost until after the end of the plan year run-out period.
- If the cost of coverage in a non-calendar year FSA is partially derived from the total contributions, it will be impossible to calculate the cost until after the last contribution for the plan year due to the possibility of a change in status election change.
- For experience-rated insurance coverage, premium payments or discounts may correlate to the cost during the taxable period, but those amounts would not be known until after the coverage period ends. Often, the discount or payment will be applied to the next coverage period.
How will the Cost of Applicable Coverage be determined for HSAs, Archer MSAs, and Health FSAs?
In Notice 2015-16, the IRS explained that the cost of these benefits will include both employer and employee pre-tax contributions. In Notice 2015-52, the IRS noted that the cost must be determined on a monthly basis, regardless of when the contributions were made. The suggested approach is to divide the total plan year contributions equally by the number of calendar months in the plan year.
For HSAs, MSAs, and calendar year FSAs, the total cost will be known once the final payroll deduction is withheld for the calendar year.
For non-calendar year FSAs, this approach would require waiting until the end of the FSA plan year in case there is a change in status election change. One possible solution, to enable earlier cost determination, would be to provide a safe harbor for non-calendar plan years. The safe harbor could calculate the monthly cost for each month based only on pro-rata portion of the election effective at the start of that month.
How will flex credits and carryover affect the cost calculation of Health FSAs?
The Code states that the cost of FSA coverage shall equal the amount of employee contributions plus any reimbursements paid over that amount. Employer credits and carryover amounts from the previous year could lead to reimbursement amounts that are more than the employee’s contributions for that plan year. However, the amount of any carryover would have been included in the cost of coverage for the year it was contributed. The IRS proposed a safe harbor for plans that allow carryover, but the safe harbor would only apply to plans that do not have employer credits.
How will the Applicable Dollar Limit be adjusted for age and gender?
The proposed approach to this is quite complex, involves rate tables with adjustment factors in 5 year age bands for each gender, and calculates the potential adjustment for self-only coverage separately from coverage for two or more individuals. Employers would need to determine what fraction of their employees fit in each category and what adjustment to make to that portion of the premium. Once all adjustments are made, the adjusted premiums would be added together to represent the employer’s premium cost. The employer’s premium cost compared to the national premium cost would determine if the employer’s applicable dollar limits should be increased. The notice explains each proposed step of this process and the proposed source of data and also requests comment on each part.
What should employers be doing now?
As a reminder, all employer-sponsored health plans are affected by the requirement to calculate the tax, and many tax-advantaged benefit programs may have to be reduced in 2018 to avoid the new excise tax, should this ACA provision remain in effect. The notices outline many of the implementation challenges for the IRS and the potential administrative burdens in store for employers and coverage providers.
However, the IRS stated that taxpayers may not rely on any guidance or draw any inferences from provisions of either notice. The IRS will use submitted comments to guide formulation of proposed regulations, which they expect to issue next. Until the proposed regulations are issued, there will remain many unanswered questions regarding the calculation of the monthly cost of coverage and whether employers will be able to utilize age and gender adjustments.
Keller urges employers to submit policy and procedural comments to firstname.lastname@example.org. Comments must be submitted no later than October 1, 2015 and include “Notice 2015-52“ in the subject line. We will continue to monitor IRS news and keep you updated.