Implementing Health Reform: IRS Requests Comments On Cadillac Tax
Originally posted by Timothy Jost on healthaffairs.org.
One of the last remaining features of the Affordable Care Act (ACA) that has yet to be implemented is the so-called “Cadillac tax,” which takes effect in 2018. Section 4980I will impose a 40 percent excise tax on employee benefits the cost of which exceeds certain statutory limits. The Cadillac tax is intended to limit the generosity of employer coverage on the theory that excess coverage encourages excess health care expenditures and thus drives up the total cost of health care. The tax is also, however, one of the major anticipated sources of revenue under the ACA, expected to raise $87 billion over the next 10 years.
On July 30, 2015, the Internal Revenue Service (IRS) released a Revenue Notice, requesting comments (due by October 1, 2015) on various issues that must be resolved to implement the Cadillac tax. The notice supplements an earlier notice requesting comments issued on February 23, 2015.
The earlier notice had addressed issues relating to (1) the definition of applicable coverage subject to the tax, (2) the determination of the cost of applicable coverage, and (3) the application of the dollar limit to the cost of applicable coverage to determine any excess benefit subject to the excise tax. The July 30 notice addresses additional issues, including the identification of the applicable taxpayer liable for the tax, employer aggregation, allocation of responsibility for the tax among applicable taxpayers, payment of the tax, age and gender adjustment, and further issues concerning the cost of applicable coverage.
Section 4980I(a) imposes a 40 percent excise tax on “excess benefits” provided to employees. Excess benefits are defined as the excess of the aggregate cost of applicable coverage for an employee for a month over the applicable dollar limit for that employee for that month. Section 4980I(c)(1) provides that each “coverage provider” must pay the tax on its applicable share of the employee’s excess benefit.
Section 4980I(c)(2) defines the “coverage provider” as (A) the health insurance insurer that provides health insurance coverage under a group health plan, (B) the employer with respect to contributions to health savings accounts (HSAs) or Archer medical savings accounts (MSAs), or (C) “the person that administers plan benefits” with respect to other applicable coverage. Section 4980I(f)(6) provides that the term “person that administers the plan benefits” includes the plan sponsor, as defined by the Employment Retirement Income Security Act, if the plan sponsor administers benefits under the plan. Each coverage provider is responsible for a share of the excise tax proportionate to its share of the total cost of coverage provided to an employee, as determined by the employer.
Defining The “Person That Administers Plan Benefits”
The term “person that administers plan benefits” is not a term that appears elsewhere in the Internal Revenue Code, the Affordable Care Act, or related legislation, so it must be defined for purposes of section 4980I. The IRS proposes two different approaches to identifying this person.
Under the first, the “person that administers plan benefits” would be the person responsible for the day-to-day administration of plan benefits, usually the third party administrator of a self-insured plan. This could cause problems if several third party administrators are responsible for different parts of a benefit plan.
Under the second approach, the “person that administers plan benefits,” would be the person ultimately responsible for administering the plan, including administering issues like eligibility determinations, claims administration, and arrangements with providers. The IRS requests comments on these two alternative approaches.
Related employers are aggregated for purposes of 4980I much as they are for other Internal Revenue Code purposes. The IRS requests comments on how aggregation would affect (1)
identification of the applicable coverage made available by an employer (2) identification of the employees taken into account for the age, gender adjustments, or adjustments for high risk profession employees; (3) identification of the taxpayer that must calculate and report excess benefits, and (4) identification of the employer liable for the tax.
Timing Of Determinations
The notice discusses at some length issues that arise with respect to the timing of determinations of the cost of coverage under self-insured plans and experience-rated insured plans. It is important that tax liability be determined and paid on a timely basis, but self-insured plans may need a time for claims runout at the end of a taxable period to determine the final cost of coverage. Experience-rated plans may receive discounts from the insurer after the end of the taxable period if experience is favorable, and a determination will need to be made whether to attribute this discount retroactively to the taxable period. The IRS requests further comments on these issues.
The notice also discusses at some length tax issues related to the pass through to employers of the excise tax by entities that pay the tax. It is anticipated that this will generally occur. The reimbursement of the cost of the excise tax by the employer to the coverage provider is not itself coverage subject to the excise tax. It is, however, taxable income to the coverage provider.
It is expected that the coverage provider will attempt to recover from the employer the cost of the income tax paid on this reimbursement in addition to the cost of the excise tax. The cost of the income tax is also not considered to be part of the cost of coverage, subject to the excise tax. The IRS requests comments on whether the cost of the income tax reimbursement that can be excluded from the cost of coverage should be determined based on the marginal tax rate of the particular coverage provider or on some average marginal tax rate.
Issues With Account-Based Coverage
Special issues arise with respect to account-based coverage — HSAs, Archer MSAs, flexible spending accounts (FSAs), and health reimbursement arrangements (HRAs). While the excise tax is calculated on a monthly basis, account-based contributions are not necessarily made on a monthly basis. The IRS is considering an approach under which contributions would be allocated pro-rata on a monthly basis.
Under the statute, the cost of applicable coverage under an FSA for any plan year is the greater of an employee’s salary reduction or total reimbursement received under the FSA. If an employer makes non-elective contributions to an employee’s FSA, these are only counted to the extent they are actually spent on medical care. This formula raises the possibility of double counting if amounts contributed through a salary reduction in one year are carried over and spent in a later year.
The IRS is considering, therefore, a safe harbor which would only count funds contributed through a salary reduction agreement in the year it was contributed, not the year it was spent. Comments are requested to this approach, as well as on whether non-elective contributions from an employer to an FSA should be treated the same way, and how contributions to an FSA should be allocated when total employee and employer contributions to a cafeteria plan exceed the statutory limit on contributions to an FSA.
The notice discusses briefly the treatment under the excise tax of the cost of coverage that is taxable to highly compensated employees because the coverage discriminates in their favor. The IRS understands that this excess coverage is subject to the excise tax and intends to revise reporting requirements accordingly.
Increasing Dollar Limits To Account For Age And Gender
Section 4980I(b)(3)(C)(iii) requires that the dollar limit above which the cost of coverage is subject to the excise tax be increased to account for the age and sex of a particular employer’s employees. The increased amount would be equal to the excess of the premium cost of the Blue Cross/Blue Shield standard benefit option under the Federal Employees Health Benefits Plan (FEHBP) if priced for the age and gender characteristics of the employees of an individual’s employer over the premium cost for providing this coverage if priced for the age and gender characteristics of the national workforce. This adjustment recognizes that older employees have higher health care costs than younger employees, and that younger women have higher health care costs than younger men. The fact that the the amounts that individual employers can pay for coverage before the excise tax attaches is adjusted for the age and sex of the employer’s employees has received little attention and is an important safety valve. The threshold can only be adjusted upwards, not downwards.
The notice proposes an approach for determining the age and gender composition of the national workforce and of a particular employer. It then proposes a seven step process that would be used for determining the relative FEHBP premium cost for various age and gender groups and for then determining the age and gender adjustment that should be applied for each employer given the composition of its own workforce.
The IRS is proposing the development of a form for employers to use to notify the IRS and their coverage providers as to the amount of the tax and how much each coverage provider is responsible. The IRS is also considering the method through which the tax would be paid. Finally, the IRS requests comments on the issues raised by this notice and the earlier notice, as well as comments on the relationship between the Cadillac tax and the employer responsibility tax, and stipulates that the notice does not provide guidance on which taxpayers can rely.
