Under a common strategy for controlling group health care plan costs, employers sometimes adopt arrangements under which an employee is offered cash as an incentive to waive coverage. These arrangements are colloquially referred to as “opt-out plans” or “opt-out arrangements.” Amounts offered under opt-out arrangements—we will call them “opt-out credits”—are in some instances paid as unrestricted, taxable cash. Other opt-out arrangements might impose a requirement that, to qualify for the opt-out credit, the employee must have other group health plan coverage. And still others might offer only a choice between group health plan participation and an opt-out credit that consists of a contribution to the employee’s health flexible spending account. This post examines how opt-out credits affect an applicable large employer’s determination of affordability for purposes of complying with the Affordable Care Act’s (ACA) employer shared responsibility rules, and it explains how opt-out credits are reported.

Background

Whether coverage is “affordable” plays a role in the ACA regulatory scheme in three instances:

  • The individual mandate

Under the ACA’s individual mandate, U.S. citizens and green card holders must have “minimum essential coverage” or pay a tax penalty. “Minimum essential coverage” includes coverage under certain government-sponsored programs (e.g., Medicare and Medicaid), eligible employer-sponsored plans, individual market coverage, grandfathered group health plans, and other coverage, as recognized by regulation. An individual may be exempt from the penalty for failing to maintain minimum essential coverage, however, if available health care coverage is unaffordable based on the individual’s income. Specifically, the exemption applies in any month in which an individual’s contribution for health care coverage for the month exceeds 8% of his or her household income.

  • Eligibility for premium tax subsidies and cost sharing reductions

Certain low- and moderate-income taxpayers are entitled to claim a premium assistance tax credit and cost sharing reductions to assist them to obtain health insurance through a qualified health plan offered in a public insurance exchange or marketplace. The premium assistance tax credit is available for individuals who: (i) have a household income for the taxable year between 100% and 400% of the federal poverty line (FPL) for the individual’s family size; (ii) may not be claimed as a dependent by another taxpayer; and (iii) if married, file a joint return. Where an individual is offered coverage by his or her employer, premium tax credits and cost sharing reductions are denied if the offered coverage is both affordable and provides minimum value. Where this occurs, the employee is said to be “firewalled,” i.e., though otherwise eligible for a premium tax credit, he or she is nevertheless rendered ineligible.

  • Employer shared responsibility

Under the ACA employer shared responsibility rules, applicable large employers (generally employers with 50 or more full-time and full-time equivalent employees) must make an offer of coverage to substantially all of their full-time employees or face the possibility of having to make assessable payments to the government (i.e., non-deductible excise tax penalties). Applicable large employers that make the requisite offer of coverage are able to avoid any exposure for assessable payments, however, if the offer of coverage is both affordable and provides minimum value. (“Minimum value” coverage is generally synonymous with major medical coverage.) Coverage is affordable if an employee’s share of the premium for employer-provided coverage would cost the employee 9.5% or less of his or her annual household income. Because employers generally will not know their employees’ household incomes, employers can take advantage of one or more of the three affordability safe harbors. If an employer meets the requirements of any of these safe harbors, the offer of coverage will be deemed affordable for purposes of the employer shared responsibility provisions regardless of whether it was affordable to the employee for purposes of the premium tax credit. The three affordability safe harbors are the Form W-2 wages safe harbor, the rate of pay safe harbor, and the FPL safe harbor. These safe harbors are all optional.

Opt-out Credits and Affordability

On November 26, 2014 the Treasury Department and the IRS issued final regulations implementing the individual mandate. Among other things, these regulations provide rules for determining affordability where an employer offers opt-out flex credits. It provides:

(E) Employer contributions to cafeteria plans. Amounts made available for the current plan year under a cafeteria plan, within the meaning of section 125, are taken into account in determining an employee’s or a related individual’s required contribution if: (1) The employee may not opt to receive the amount as a taxable benefit; (2) The employee may use the amount to pay for minimum essential coverage; and (3) The employee may use the amount exclusively to pay for medical care, within the meaning of section 213. [Treas. Reg. § 1.5000A-3(e)(3)(ii)(E)]

Under this regulation, an opt-out credit may be taken into account for determining affordability for purposes of the ACA individual mandate only if the employee does not have the option to elect cash, and the credit may be used to purchase minimum essential coverage. Based on comments in the preamble to these final regulations (79 Fed. Reg. p. 70,466, 3rd column), the regulators anticipate that a similar rule will be adopted for employer shared responsibility purposes. Moreover, in their informal comments at industry and bar association meetings, Treasury and IRS representatives (expressing their own views and not that of the agency they represent) have consistently made it clear that the approach taken in the final individual responsibility regulations applies with equal force in the employer context.

The approach adopted by the final individual mandate regulations adds to the employee’s cost of coverage the opt-out amount that the employee would have to forgo in order to obtain the coverage. Applying this rule in the context of the employer shared responsibility rules makes coverage offered alongside an opt-out arrangement far less affordable. This has a substantive impact on the employer’s exposure, and it also impacts reporting on Form 1095-C.

Reporting the opt-out payment

To grasp the consequences of the rule described above, consider the following two examples:

Example 1: Employer provides a $1,500 opt-out payment that may only go the health FSA if the employee waives coverage.

NOTE: This benefit might be attractive to an employee who has other coverage under the plan of a spouse. Care must be taken, however, to ensure that the health FSA is structured as an excepted benefit. Failure to do so will trigger ACA violations relating to annual and lifetime limits and first-dollar preventive services. (For an explanation of these issues, please see our previouspost on the subject.)

Example 2: Employer provides a $1,500 opt-out payment that is paid in cash if the employee waives coverage.

Assume that in both cases, the employee premium for the employer’s group health plan is $50 per month or $600 per year. Both offers are affordable under the FPL safe harbor. (Under the FPL safe harbor, if the cost of coverage is $92.38 per month or less, coverage is deemed affordable.)

NOTE: If the opt-out arrangement reimburses an employee upon proof of other coverage, the arrangement would be an employer payment plan even if the employer includes the amount in taxable income. The other coverage in this instance would have to be limited to other group health plan coverage. (For an explanation of these issues, please see our previous post on the subject.)

In Example 1, the employee cost of health coverage is $50.00 per month. Thus, the employer will enter $50 on Form 1095-C, line 15 and enter Code 2G (“4980H affordability federal poverty line safe harbor”) on line 16. That a code is entered on line 16 indicates that the employee is firewalled and that the employer will not incur a penalty under Code § 4980H(b).

In Example 2, the employee cost of health coverage is $175.00 per month. This amount consists of the $50 employee cost plus $125 per month lost opportunity cost (i.e., the $1,500 annual opt-out credit divided by 12). Since the employer is using the FPL safe harbor, which assumes that each employee earns the FPL amount, line 16 would be left blank, thereby signaling that a penalty may be due.

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Special thanks to Frank Palmieri, Esq. Palmieri & Eisenberg, for providing the examples used in this post.