This blog post was authored by Stephanie J. Lowe
Beginning in 2018, the Internal Revenue Service (“IRS”) will subject plan sponsors to an excise tax if they provide overly generous levels of health benefits to employees above a certain threshold. The IRS recently released Notice 2015-16 to introduce the future excise tax on high cost employer-sponsored health coverage, also known as the Cadillac Tax. The Cadillac Tax will impose a 40% excise tax on any excess benefit an employer provides to an employee through its applicable employer-sponsored health coverage. The IRS will tax plans where the aggregate cost of the applicable employer-sponsored health coverage exceeds a statutory dollar limit ($10,200 for self-only coverage and $27,500 for self and spouse or dependent coverage), subject to various adjustments.
Employers will be responsible for calculating whether the health plans employees enroll in provide an excess benefit. The calculations are based on the health coverage the employee actually enrolls in, not just what is offered to the employee. ALL employer plans, not just large employers, are potentially subject to the Cadillac Tax.
Since the Department of Treasury (“Treasury”) and IRS are still working on developing final regulations for the Cadillac Tax, the Treasury and the IRS have invited comments on issues related to the Cadillac Tax. Here is what employers need to know about the upcoming Cadillac Tax:
What law governs the Cadillac Tax?
The Cadillac Tax was added as part of the Affordable Care Act by Section 49801 of the Internal Revenue Code (Code). IRS Code section 4980I(a) imposes a 40% excise tax on any “excess benefit” provided to an employee, and section 4980I(b) provides that an excess benefit is the excess, if any, of the aggregate cost of the applicable coverage of the employee for the month over the applicable dollar limit for the employee for the month.
When does the Cadillac Tax go into effect?
The IRS will begin to enforce the Cadillac Tax for taxable years beginning after December 31, 2017. This means that the Cadillac Tax will first apply in 2018.
What is “applicable employer-sponsored coverage”?
The Cadillac Tax applies to applicable employer-sponsored coverage. Applicable employer-sponsored coverage (“applicable coverage”) is coverage under any group health plan that an employer makes available to an employee and that is excludable from the employee’s gross income or would be excludable if it were employer-provided coverage. A “group health plan” means a plan (including a self-insured plan) that provides health care to employees, former employees, the employer, other people associated or formerly associated with the employer in a business relationship, or their families.
The types of coverage included in applicable coverage are:
- Health Flexible Spending Accounts (FSAs);
- Archer Medical Savings Accounts (MSAs);
- Heath Savings Accounts (HSAs) (including employer contributions and employee pre-tax salary reduction contributions);
- Governmental plans, which is defined as coverage under any group health plan established and maintained primarily for its civilian employees of the federal government, state government, political subdivision, or an agency of the government;
- Coverage for on-site medical clinics, but excludes on-site medical clinics that only provide de minimis medical care;
- Retiree coverage;
- Multiemployer plans;
- Certain excepted benefits offered as independent, non-coordinated benefits (including coverage only for a specified disease or illness and hospital indemnity or other fixed indemnity insurance) if the payment for the coverage is excluded from gross income or a deduction is allowed; and
- Coverage provided through an on-site medical clinic (more guidance needed).
Note: The IRS anticipates that future guidance will provide that an HRA is applicable coverage.
Types of coverage excluded from applicable coverage are:
- Coverage for accident or disability income insurance only;
- Coverage issued as a supplement to liability insurance;
- Liability insurance (including general and automobile liability insurance);
- Workers’ Compensation insurance;
- Automobile medical payment insurance;
- Credit-only insurance;
- Other insurance under which medical care is secondary to other insurance benefits;
- Long-term care coverage;
- Stand-alone dental or vision coverage;
- Certain excepted benefits offered as independent, non-coordinated benefits (including coverage only for a specified disease or illness and hospital indemnity or other fixed indemnity insurance) if the payment for the coverage is not excluded from gross income, which includes coverage only for a specified disease or illness and hospital indemnity.
What is the applicable dollar limit?
The Cadillac tax will apply to plans where the aggregate cost of the applicable coverage the employee enrolls in exceeds a statutory dollar limit. There are two annual applicable dollar limits under the Cadillac Tax—one for an employee with self-only coverage and one for an employee with other-than-self-only coverage, which is minimum essential coverage provided to the employee and at least one other beneficiary such as a spouse or dependent or a multiemployer plan. The applicable dollar limits will be redefined each year. For 2018, the applicable dollar limit will be $10,200 per employee for self-only coverage and $27,500 per employee for other-than-self-only coverage. In addition to the limits set each year, various adjustments may increase the applicable dollar limits in certain circumstances. For example, a cost-of-living adjustment will be applied each year to determine the applicable dollar limit. Other adjustments include an age and gender adjustment, a qualified retiree adjustment, and a high-risk profession adjustment.
What is an “excess benefit”?
An excess benefit is the cost of applicable coverage that goes over the applicable dollar limit. Employers who provide an excess benefit to employees will be subject to a 40% excise tax on the amount of the excess benefit. This is determined on a monthly basis. Section 4980I(b) defines an “excess benefit” as the excess of (A) the aggregate cost of the applicable coverage of the employee for the month, divided by (B) the applicable dollar limit for the employee for that month (1/12 of the annual statutory dollar limit).
What determines the cost of applicable coverage?
The excise tax is based on the cost of the applicable coverage the employee is actually enrolled in, not just the coverage offered to the employee. The employer will determine the cost of applicable coverage for the Cadillac Tax according to rules similar to the rules an employer uses to determine the COBRA applicable premium. Similar to the COBRA rules, the Treasury anticipates the cost of applicable coverage for an employee will be based on the average costs of applicable coverage for an employee and all similarly situated employees, rather than based on the characteristics of each individual. Notice 2015-16 goes into further detail about how the Treasury proposes to divide employees into similarly situated groups.
A. Self-Insured Plans
For self-insured plans, there are two methods for self-insured plans to compute the COBRA applicable premium that the Treasury explores as a method to determine the cost of applicable coverage: (1) the actuarial basis method and (2) the past cost method. The actuarial basis method involves an actuarial estimate of the cost of providing coverage for a self-insured plan. The past cost method determines the cost of applicable coverage based on the cost to the plan for similarly situated beneficiaries for the same 12-month determination period. The Treasury is still considering timelines for when the 12-month determination period can take place. The costs taken into account under the past cost method include claims, premiums for stop-loss or reinsurance policies, administrative expenses, and the employer’s reasonable overhead expenses.
B. Health Reimbursement Accounts (HRAs)
The Treasury and IRS expect that the future regulations will provide that an HRA is applicable coverage under the Cadillac Tax. They are still considering various methods for determining the cost of applicable coverage under an HRA. One approach is to base the cost of applicable coverage on the new amounts made available to a participant each year. This approach might provide employers with greater certainty about the cost of applicable coverage under an HRA from year-to-year. Another approach is to add all claims and administrative expenses of an HRA for a particular period and divide that sum by the number of employees covered for that period. The Treasury requests comments on the types of methods for calculating the cost of applicable coverage for an HRA in order narrow down the choices to one method.
How will the Cadillac Tax affect employers with CalPERS plans?
While it is too early to definitively determine whether or which CalPERS plans will provide an excess benefit over the statutory dollar amount, CalPERS plans will likely be subject to the Cadillac Tax if they do not change by 2018. One preliminary estimate conducted by CalPERS showed that one of the out-of-state plans and one of the PPO plans may be impacted. CalPERS states that it has been working aggressively to keep its rates down.
Where can I send comments about the Cadillac Tax?
The Treasury and the IRS invite employers to comment on issues related to the Cadillac Tax. These comments will be considered in the development of the proposed regulations that will be issued in the future and subject to public notice and comment.
Individuals may mail comments to CC:PA:LPD:PR (Notice 2015-16), Room 5203, Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, Washington D.C. 20044 between now and May 15, 2015. Comments may also be e-mailed to Notice.firstname.lastname@example.org with “Notice 2015-16” in the subject line by May 15, 2015. The Treasury and IRS plan to issue a second notice inviting more comments on additional Cadillac Tax issues that were not addressed in Notice 2015-16.
More information can be found in the IRS Notice 2015-16.