The Patient Protection and Affordable Care Act (PPACA), P.L. 111-148, added a new 40% nondeductible excise tax on high-cost health coverage, commonly referred to as the “Cadillac tax.” Effective for tax years beginning after Dec. 31, 2017, this provision, Sec. 4980I, imposes the excise tax on the amount by which the monthly cost of an employee’s “applicable employer-sponsored coverage” exceeds statutory dollar limits.
While the tax is conceptually straightforward, its implementation will likely prove complex. The IRS has not yet issued regulations, but it has issued two notices, Notices 2015-16 and 2015-52, seeking comments for proposed regulations, which also contain proposed rules. Notice 2015-16 primarily addresses the definition of applicable employer-sponsored coverage, determining the cost of this coverage, and applying the statutory dollar limit on the cost of applicable coverage. Notice 2015-52 addresses how to identify the taxpayers liable for the excise tax, what the employer aggregation rules for the tax are, how to allocate the tax among taxpayers, and how to pay the tax.
Coverage subject to the tax
The tax applies to applicable employer-sponsored coverage (or “applicable coverage”). Generally, applicable coverage is coverage under an employer group health plan that either is excludable from gross income under Sec. 106 or would be excludable if it were employer-provided coverage. A “group health plan” is broadly defined under Sec. 5000(b)(1) as a plan that provides “health care (directly or otherwise) to the employees, former employees, the employer, others associated or formerly associated with the employer in a business relationship, or their families.”
The most common applicable coverage is a major medical plan, but applicable coverage is much broader than that. Sec. 4980I(d)(2) provides specific guidance on determining the cost of certain types of coverage. Many employers sponsor a health care flexible spending arrangement (health FSA), which constitutes applicable coverage.
Employers may also provide a health savings account (HSA) or Archer medical spending account (Archer MSA). An HSA or an Archer MSA will generally constitute applicable coverage. In Notice 2015-16, the IRS states that the proposed regulations will provide that employer contributions to HSAs and Archer MSAs, including salary reduction contributions to HSAs, are included in applicable coverage; however, employee after-tax contributions to HSAs and Archer MSAs are expected to be excluded. Health reimbursement arrangements (HRAs) meet the general definition of applicable coverage and, as such, are not excluded.
The employer will have to determine how to allocate the cost of the applicable coverage. 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. This allocation rule would apply to HSAs, Archer MSAs, FSAs, and HRAs. 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.
For health FSAs, Sec. 4980I(d)(2)(B) provides that the cost of applicable coverage is equal to the sum of (1) the amount of any contributions made under a salary reduction election, and (2) the cost of applicable coverage under the generally applicable rules for determining the cost of applicable coverage for any reimbursement under the arrangement in excess of the contributions made under the salary reduction agreement. To address issues relating to carryovers for health FSAs, Notice 2015-52 notes the possibility of a safe harbor. Under the safe harbor, the cost of applicable coverage for the plan year would be the amount of an employee’s salary reduction without regard to carryover amounts. The proposed guidance includes other variations on the safe harbor.
Exceptions to coverage
Sec. 4980I does exclude certain types of coverage from the tax. One exception is for long-term care; another is for any coverage described in Sec. 9832(c)(1), except on-site medical clinics (Sec. 4980I(d)(1)(B)(i)). Sec. 9832(c)(1) refers to coverage that is only for accident, or disability income, insurance; coverage issued as a supplement to liability insurance; liability insurance, including general liability and automobile liability insurance; workers’ compensation or similar insurance; automobile medical payment insurance; credit-only insurance; and other similar insurance coverage specified in regulations under which benefits for medical care are secondary or incidental to other insurance benefits. These are all excluded from the excise tax.
Although on-site medical clinics are not specifically excluded, the IRS indicated in Notice 2015-16 that it intends to exclude those types of clinics if they offer de minimis benefits.
The second exception excludes any coverage under a separate policy, certificate, or insurance contract that provides benefits to treat the mouth (and any organ or structure in it) or the eye, commonly referred to as “limited scope” dental or vision coverage. According to Notice 2015-16, it should not matter whether the limited-scope coverage is provided on an insured or self-insured basis.
The third exception excludes coverage described in Sec. 9832(c)(3), which refers to coverage only for a specified disease or illness and hospital indemnity or other fixed-indemnity insurance if payment is not excludable from the employee’s gross income or, in the case of self-employed individuals, a deduction under Sec. 162(l) for 50% of the medical coverage cost is not allowable. The IRS is also considering whether to exclude employee-assistance programs (EAPs) as an excepted benefit.
Coverage for the self-employed
Coverage for self-employed individuals treated as “employees” under Sec. 401(c)(1) is subject to a special rule, which appears to replace the general rule and exceptions noted above. Coverage under any group health plan that provides “health insurance coverage” to a self-employed individual will be treated as applicable coverage subject to the excise tax if a deduction is allowable under Sec. 162(l) (permitting a deduction for 50% of the cost of the self-employed person’s health insurance) for “all or any portion” of the cost of that coverage.
“Health insurance coverage” means benefits consisting of medical care (provided directly, through insurance or reimbursement, or otherwise) under any hospital or medical service policy or certificate, hospital or medical service plan contract, or health maintenance organization contract offered by a health insurance issuer. The IRS may nevertheless provide in the regulations that the excepted benefits described in Sec. 9832(c)(1) are excluded from the special definition for self-employed individuals.
Persons liable for the tax
Under Sec. 4980I(c)(1), the “coverage provider” is liable for the tax. For an insured plan, this is the health insurance issuer. For an HSA or an Archer MSA, it is the employer.
For all other coverage, the coverage provider is “the person that administers the plan benefits,” which is not defined anywhere in the Code. The IRS is considering two approaches to this definition. Under either, the “person” that administers the plan benefits will generally be an entity—not an individual.
One approach defines the person that administers the plan benefits as the person responsible for performing the day-to-day functions to administer plan benefits. This person generally would be a third-party administrator unless the employer performs these functions internally.
Under the second approach, this person would be the person that has the ultimate authority or responsibility under the plan or arrangement to administer the plan benefits (including final decisions on administrative matters), regardless of whether that person routinely exercises that authority or responsibility. This approach would look at the terms of the plan documents.
The first approach would likely shift the liability to the third-party administrator; the second would leave the liability with the employer. In most plans, the employer is also the “plan administrator” under the Employee Retirement Income Security Act even if the plan has a third-party administrator.
As a related matter, Sec. 4980I(f)(9) provides generally that all employers treated as a single employer under Sec. 414(b), (c), (m), or (o) are treated as a single employer—the usual “controlled group” rules. However, applying these rules raises some questions. As such, the IRS has requested comments on identifying the applicable coverage taken into account, the employees taken into account for adjustment purposes, the taxpayer responsible for calculating and reporting the excess benefit, and the employer liable for any penalty for the failure to properly calculate the Sec. 4980I excise tax.
Amount of the tax and cost of coverage
Although certain subsections of the statute refer to the coverage “made available” to the employee, the IRS has indicated that applicable coverage is the coverage in which the employee is enrolled rather than coverage that is merely offered. The excise tax attributable to an employee’s applicable coverage is 40% of the employee’s “excess benefit,” which is the sum of the employee’s monthly excess amounts for the tax period, usually a calendar year.
An employee’s “excess amount” for a month is the amount, if any, by which the aggregate cost of the employee’s applicable employer-sponsored coverage for the month exceeds one-twelfth of the annual limitation for the calendar year including that month.
The aggregate cost of an employee’s applicable coverage is the sum of the costs for each coverage. Generally, the costs are determined under rules similar to COBRA, which defines the “applicable premium” as the plan’s cost for similarly situated beneficiaries for whom a qualifying event has not occurred (without regard to whether that cost is paid by the employer or the employee). The cost of coverage does not include the cost of any excise tax that may be due.
For the excise tax, separate cost amounts must be calculated for self-only and “other than self-only” coverage even if the plan calculates only one premium for COBRA purposes. Because the excess benefit that determines the excise tax is the sum of monthly excess amounts, it is important to know the monthly cost of each applicable employer-sponsored coverage. Notice 2015-16 provides an extensive analysis of the potential approaches to determining the cost of coverage, and the regulations should provide definitive guidance.
A related issue to consider is the “tax period.” To calculate the amount of any excise tax that a coverage provider may owe, the employer must determine the extent, if any, to which the cost of applicable coverage provided to an employee during any month of the tax period exceeds the dollar limit. Notice 2015-52 recognizes that there are likely to be different periods for insured plans and self-insured plans, as well as HSAs, Archer MSAs, health FSAs, and HRAs. In certain cases, the information may be available after the calendar year for a calendar-year plan. However, in other cases, the information may not be as easy to determine if the plan year is not a calendar year. There is also a related issue as to how experience-rated contracts and premium discounts are considered, which will be addressed in the regulations.
If the insurer or a third-party is liable for the tax, that party will likely pass the cost along to the employer. Because Sec. 4980I(f)(10) provides that the excise tax is not deductible, the coverage provider will have its taxable income increase (that is not offset by a deduction) by reason of the receipt of an excise tax reimbursement. As a result, it is anticipated that the amount the coverage provider passes through to the employer may include not only the excise tax reimbursement, but also an amount to account for the additional income tax the coverage provider will incur (the income tax reimbursement). Under Notice 2015-52, the IRS is considering whether some or all of the income tax reimbursement could be excluded from the cost of applicable coverage.
The annual limitation
The annual limitation on a particular employee’s coverage is based on statutory dollar amounts, subject to certain adjustments. Initially, the dollar amounts are $10,200 for self-only coverage and $27,500 for coverage other than self-only. Certain higher limits apply for “qualified retirees” and participants in “high-risk professions.”
The initial dollar amounts are subject to several adjustments: a health cost adjustment percentage; a cost-of-living adjustment; the qualified retirees or high-risk professions adjustment; and the age and gender adjustment. The IRS presumably will provide updates on the amounts and supply tables or formulas for calculating the adjustments.
Calculating and paying the tax
The employer must calculate and report the excess benefit for each coverage provider to both the coverage provider and the IRS. Each coverage provider must then pay the excise tax on its applicable share of the excess benefit for an employee for any tax period. Each coverage provider is liable for the excise tax on its applicable share of the excess benefit for an employee for any tax period, but the statute does not specify the time and manner in which the excise tax is paid.
The IRS is considering designating Form 720, Quarterly Federal Excise Tax Return, to use to pay the tax annually even though Form 720 generally is filed quarterly. Under this approach, the IRS would designate a particular quarter of the calendar year to use Form 720 to pay the excise tax.
If the employer fails to accurately calculate the excess benefit attributable to each coverage provider, and as a result the coverage provider pays too little excise tax, the coverage provider will not pay any penalty, but must pay the amount of the additional excise tax. The employer who miscalculated the tax will have to pay a tax penalty (in addition to any excise tax it may need to pay as a coverage provider itself) of 100% of the additional excise tax that must be paid by coverage providers due to the miscalculation.
In addition to the penalty, the employer must pay interest on the underpayment at the Sec. 6621 underpayment rate beginning on the due date for the unpaid amount and ending on the date the penalty is paid. The penalty will not apply if the employer or plan sponsor neither knew nor, exercising reasonable diligence, would have known that it had failed to properly calculate the excess benefit. The penalty may also not apply if the failure is due to reasonable cause and not to willful neglect.
Employers with higher-cost coverage need to plan ahead to determine whether the excise tax applies to their coverage starting in 2018. They must consider not only their major medical plan, but also other arrangements, such as health FSAs, HSAs, Archer MSAs, and HRAs. Some employers have taken steps to reduce coverage amounts with an eye toward the annual limitations that will apply in 2018. A gradual approach may be easier to implement and communicate to employees.
Despite some helpful guidance in the IRS notices, many issues remain to be resolved through the proposed regulations. Stay tuned.
B. David Joffe, J.D., is a partner and chairperson of the Employee Benefits and Executive Compensation Group of Bradley Arant Boult Cummings LLP in Nashville, Tenn.