The Affordable Care Act (ACA) added Code Section 4980I to the Internal Revenue Code. Effective for tax years beginning on or after January 1, 2018, an excise tax of 40 percent will be imposed on the cost of employer-sponsored health coverage that exceeds an annual limit. This tax is informally known as the “Cadillac Tax” and will impose a penalty on employers, health insurers and “persons who administer plan benefits” with regard to high-cost health care coverage.
On July 30, 2015, the Internal Revenue Service (IRS) issued guidance on the Cadillac Tax in Notice 2015-52, supplementing Notice 2015-16, which was released on February 23, 2015.
In Notice 2015-52, the IRS addresses the following issues:
- Who must pay the Cadillac Tax
- How employers are aggregated
- How the tax is calculated
- How the tax is paid
Who Must Pay the Cadillac Tax?
The Code defines the “coverage provider” as the taxpayer liable for paying the Cadillac Tax. For purposes of an insured group health plan, the coverage provider is the health insurance issuer. For purposes of a Health Savings Account (HSA) or an Archer medical savings account (MSA), the coverage provider is the employer. For all other types of applicable coverage, the coverage provider is defined as “the person who administers the plan benefits.” The term “person who administers the plan benefits” is not used elsewhere in the Code or the ACA. As a result, the IRS is considering two approaches to defining this term. Notice 2015-52 outlines these approaches.
Under the first approach, the “person who administers the plan benefits” would be the person responsible for performing the day-to-day functions that constitute the administration of plan benefits, such as receiving and processing claims for benefits, responding to inquiries or providing a technology platform for benefits information. The IRS anticipates that this person generally would be a third-party administrator for self-insured benefits.
Under the second approach, the “person who administers the plan benefits” would be the person who has the ultimate authority or responsibility under the plan or arrangement with respect to the administration of the plan benefits. The IRS anticipates that this person would be identified in the applicable plan documents and would not likely be the person who performs the routine administrative functions of the plan. This would likely be the “Plan Administrator” or its delegate for ERISA-covered plans.
How Are Employers Aggregated for Purposes of the Cadillac Tax?
Employers aggregated under the Internal Revenue Code’s controlled group and affiliated service group rules—Code Section 414(b), (c), (m) or (o)—are treated as a single employer for purposes of the Cadillac Tax. In addition, there is a special rule for multi-employer plans. The plan sponsor of a multi-employer plan (as defined in Section 414(f)) is responsible for making the calculations and for providing the notice.
The IRS requests comments on the application of these aggregation rules to the following:
- Identification of the applicable coverage taken into account as made available by an employer
- Identification of the employees taken into account for the age and gender adjustment, and the adjustment for employees in high-risk professions and employees who repair and install electrical or telecommunication lines
- Identification of the taxpayer responsible for calculating and reporting the excess benefit
- Identification of the employer liable for any penalty for failure to properly calculate the Cadillac Tax
Additional Issues in Calculating the Cadillac Tax
The Cadillac Tax imposes a 40 percent penalty on any “excess benefit” provided to an employee for any taxable period. An “excess benefit” is defined as the excess of the aggregate cost of applicable coverage over the annual applicable dollar limit for an employee. The applicable dollar limit for high-cost plans is currently $10,200 for individual coverage and $27,500 for family coverage. These dollar limits will be updated for 2018 when final regulations are issued and thereafter indexed for inflation in future years. The IRS anticipates that the “taxable period” will be the calendar year for all taxpayers; however, the regulations provide that the “taxable period” can be a shorter period as prescribed by the Secretary, and permit the Secretary to prescribe different taxable periods for employers of varying sizes.
In order to determine the amount of tax owed for a taxable period, the employer must determine the extent any applicable coverage exceeded the dollar limit in a given month. The employer then must notify both the IRS and the coverage provider, and the coverage provider then must pay the tax. As a result, employers will need to determine the amount of tax soon after the close of the taxable year so that coverage providers may pay the tax in a reasonably timely manner.
The IRS anticipates a host of timing issues to arise for different fully insured and self-insured plan structures, and requests comments on any such issues.
Calculating the Cost
The cost of the applicable coverage is to be determined using rules “similar to the rules of section 4980B(f)(4)” regarding the determination of the COBRA applicable premium. The IRS has invited comments on potential approaches to determine the cost of applicable coverage. The U.S. Department of the Treasury and the IRS also have asked for comments on any issues raised by the anticipated need to determine the cost of applicable coverage for a taxable period reasonably soon after the end of that taxable period.
Cost of Coverage Transferred to Employer
While the coverage provider will pay the Cadillac Tax for fully insured coverage, the IRS anticipates that the cost of the tax will be passed through to the employer. Additionally, because the Cadillac Tax is not deductible, any reimbursement received by the coverage provider from the employer will be additional taxable income to the coverage provider. As a result, it is likely that a coverage provider will pass along both the Cadillac Tax reimbursement and the additional income tax (the “income tax reimbursement”) to the employer. While the Cadillac Tax reimbursement will be excluded for purposes of determining the cost of applicable coverage, the Code is not clear on whether to recognize the income tax reimbursement. The IRS is still considering whether this reimbursement should be excluded as well. However, Treasury and IRS are concerned that a methodology for excluding an income tax reimbursement may not be administrable, given the potential variability of tax rates and other factors among different coverage providers, as well as potential difficulties in determining and excluding the reimbursement amount. Nonetheless, comments are requested on administrable methods for exclusion of the income tax reimbursement.
Contributions to HSAs, Archer MSAs, FSAs and HRAs
Account-based plans, such as HSAs, Archer MSAs, Flexible Spending Accounts (FSAs) and Health Reimbursement Arrangements (HRAs), pose a unique problem because contributions to such accounts may be difficult to track. 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.
In addition to the above, experience-rated arrangements provide some dilemmas for the IRS. In an experience-rated scenario, the insurer may provide payments to the policyholder after the end of a coverage period. These payments relate to the coverage provided during that coverage period. In other instances, the equivalent of those types of payments may be made through a premium discount or premium holiday for the next coverage period. The IRS is requesting comments on how those payments or discounts may be reflected in the cost of applicable coverage, including comments on any administrative issues that might arise if, for purposes of determining the cost of applicable coverage, the payments or discounts are attributed back to the original period of coverage (for which the taxable year might have ended) rather than accounted for during the period of coverage in which the amounts are paid or the discount applied. In addition, comments are requested on how employers are addressing these payments or discounts currently for purposes of determining their plan’s COBRA applicable premiums.
FSAs with Employer Flex Credits
FSAs also pose a problem because employees may often carry forward salary reduction amounts from one year to the next. To avoid double counting, the IRS is considering providing a safe harbor by which the cost of an employee’s salary reduction would be included in the cost of applicable coverage for that year, regardless of whether any amount was carried to the next year.
Age and Gender Adjustment to the Dollar Limit
As described previously, the dollar limit that determines the onset of the Cadillac Tax for 2018 is $10,200 for self-only coverage and $27,500 for anything other than self-only coverage. However, these limits may be increased based on the age and gender characteristics of a particular workforce. The IRS is considering using the Current Population Survey (Table A-8a), Employed Persons and Employment-Population Ratios by Age and Sex, Seasonally Adjusted (Table A-8a), published annually by the U.S. Department of Labor Bureau of Labor Statistics.
In order to determine the age and gender characteristics of an employer’s population, the IRS is considering requiring an employer to determine the age and gender of each employee as of the first day of the plan year for purposes of determining the population for the entirety of the year.
Notice and Payment of the Tax
In addition to calculating the tax, employers must notify the IRS and each coverage provider of the amount. The IRS is considering the form and deadline of this notice. The IRS is also considering how calculation errors may affect both notice and payment of the tax.
Request for Comments
The IRS invites comments on all of the issues addressed in Notice 2015-52. Comments should be submitted to the IRS no later than October 1, 2015.