On July 8, 2016, the Internal Revenue Service (IRS) released proposed regulations implementing some of the rules previously announced in IRS Notice 2015-87. The proposed regulations will apply for taxable years beginning after December 31, 2016.

Among other topics, Notice 2015-87 introduced a rule that employers offering opt-out payments (also known as "cash-in-lieu") must add the cash amounts to each employee's premium contribution when calculating coverage affordability for the Affordable Care Act's ("ACA") employer mandate.

Notice 2015-87 distinguished between "unconditional" and "conditional" opt-out arrangements. Unconditional opt-out arrangements are those in which the opt-out payments are conditioned solely on an employee declining the employer-sponsored coverage (i.e. an employee declines coverage and gets cash). Conditional opt-out arrangements are those in which the opt-out payments are conditioned on an employee declining coverage and satisfying some other meaningful requirement related to the provision of health care, such as a requirement to provide proof of coverage by a spouse's employer (i.e. an employee declines coverage, but to get the cash he/she must provide proof of alternative group health coverage).

The proposed regulations clarify that employer contributions to a Section 125 Plan that may be used by an employee to purchase minimum essential coverage are not opt-out payments subject to these rules. However, an employer offering cash-in-lieu under a Section 125 Plan still may face affordability issues under the employer mandate. For more information on this, see our prior article at: http://www.lcwlegal.com/IRS-Releases-Further-Guidance-on-Application-of-the.

The most notable employer impact created by these proposed regulations is a new requirement that an employer who offers cash-in-lieu must maintain an "eligible opt-out arrangement" to avoid increasing an employee's premium contribution by the cash amount when it calculates affordability for the employer mandate. The requirements for an "eligible opt-out arrangement" are more stringent than the conditional opt-out arrangement contemplated by IRS Notice 2015-87. As a result, employers who offer cash-in-lieu outside of a Section 125 Plan, will be forced to comply with these new requirements relating to "eligible opt-out arrangements" in order to avoid the potential ACA penalties for offering unaffordable coverage to full-time employees.

Determining Affordability with an Unconditional Opt-Out Arrangement

For employers offering unconditional opt-out payments, the proposed regulations adopt the rule that an employee's required premium contribution includes the amount the employee could receive if he or she had declined coverage. In other words, the cash an employee could receive for declining coverage will be added to the employee's premium toward the lowest cost plan when the employer runs the affordability calculation. The proposed regulations analogized the scenario to a salary reduction and reasoned that, in both situations, an employee must forego a specified amount of cash compensation to enroll in coverage. Therefore, the opt-out payment effectively increases the employee's required contribution.

For example, XYZ offers employees the lowest cost health plan at a total premium of $400 per month. Employees must contribute $80 toward the premium if they enroll in coverage. However, employees who opt-out of coverage get $350 per month. The IRS will consider this to be an unconditional opt-out arrangement because the employee automatically gets cash for opting out without having to satisfy any additional condition. When XYZ calculates affordability, the employee contribution toward the lowest cost health plan will be $430 ($350 + $80), thereby making the coverage unaffordable. XYZ will have exposure to potential penalties for offering unaffordable coverage under the ACA's employer mandate.

Determining Affordability with an Eligible Opt-Out Arrangement

Notice 2015-87 stated that employers with a conditional opt-out arrangement were not required to add the cash opt-out amount to the employee's premium contribution when calculating affordability. According to this Notice, it appeared that an employer who required employees to provide proof of alternative group health coverage in order to receive cash-in-lieu would not have to add the cash amounts to the affordability determination.

However, the new proposed regulations state that only an arrangement that qualifies as an "eligible opt-out arrangement" will escape the requirement that the cash be added to the employee's premium contribution. An "eligible opt-out arrangement" means an arrangement that requires the following:

  1. The employee must provide proof of minimum essential coverage ("MEC") through another source (other than coverage in the individual market, whether or not obtained through Covered California). This requirement includes government sponsored programs such as most Medicaid coverage, Medicare part A, CHIP, and most TRICARE coverage;
  2. The proof of coverage must show that the employee and all individuals in the employees expected tax family have (or will have) the required minimum essential coverage. An employees expected tax family includes all individuals for whom the employee reasonably expects to claim a personal exemption deduction for the taxable year(s) that cover the employer's plan year to which the opt-out arrangement applies;
  3. The employee must provide reasonable evidence of the MEC for the applicable period. Reasonable evidence may include an attestation by the employee;
  4. The arrangement must provide that the evidence/attestation be provided every plan year;
  5. The evidence/attestation must be provided no earlier than a reasonable time before coverage starts (e.g. open enrollment). The arrangement can also require the evidence/attestation to be provided after the plan year starts; and
  6. The arrangement must provide the opt-out payment cannot be made (and the employer must not in fact make payment) if the employer knows that the employee or family member doesn't have the alternative coverage.

If these conditions are met, the opt-out arrangement is an "eligible opt-out arrangement," meaning that the amount of the opt-out payment is excluded from the employee's required premium contribution for the affordability calculation. Employers who wish to maintain cash-in-lieu arrangements outside of a Section 125 Plan should start revising the terms of the arrangement to meet the "eligible opt-out arrangement" definition.

Eligible Opt-Out Arrangement Rules Continue to Apply if Alternative Coverage Terminates before End of Plan Year

In some cases, an employee's or a member of the employee's expected tax family's alternative coverage may terminate before the end of the employer's plan year. The proposed regulations provide that, in such cases, an employer may continue to exclude the amount of the opt-out payment from the affordability determination for the remainder of the plan year as long as the reasonable evidence rule is satisfied.

Opt-Out Payments under Collective Bargaining Agreements Get Some Relief

The proposed regulations adopt the general transition relief provided in Notice 2015-87. All employers are not required to increase the amount of the employee's contribution by the opt-out amount until the January 1, 2017 plan year, as long as the employer maintained the arrangement prior to December 16, 2015.

Employers with collective bargaining agreements (CBA) now have additional relief. Employers are not required to increase the amount of an employee's required premium contribution by opt-out payments that do not qualify under an eligible opt-out arrangement, until the later of: (1) the beginning of the first plan year that begins following the expiration of the CBA in effect before December 16, 2015 (disregarding any extensions on or after December 16, 2015), or (2) the applicability date of the regulations. The proposed regulations clarified that there will not be a permanent exception for opt-out arrangements provided under CBAs.

Individual Mandate & Exchange Rules

The proposed regulations also contain information regarding the Individual Mandate and exchange coverage. Some of the ways in which the proposed regulations will impact individuals are as follows:

  • Until the IRS issues final regulations, individuals may treat their employer's opt-out payments under any opt-out arrangement as increasing their required premium contribution for purposes of the individual mandate and to determine subsidy eligibility.
  • When an individual declines to enroll in employer-sponsored coverage for a plan year and his/her employer fails to offer the opportunity to enroll in future plan years, the exchange will treat him/her as ineligible for employer-sponsored coverage during those future plan years. The individual could receive a subsidy and trigger employer penalties.

Employers who offer cash-in-lieu should also be aware that cash payments made to employees in lieu of health benefits must be included in the regular rate for overtime purposes under the FLSA. For more information, see http://www.lcwlegal.com/files/144107_June%202016%20-%20Flores.pdf.

We previously detailed IRS Notice 2015-87 in the Client Update. The article can be found here http://www.lcwlegal.com/IRS-Releases-Further-Guidance-on-Application-of-the.

The complete text of the proposed regulations can be accessed here https://www.federalregister.gov/articles/2016/07/08/2016-15940/premium-tax-credit.