Payments under an Opt-Out Arrangement are included in the Health Coverage Affordability Calculation unless the arrangement is an "Eligible Opt-Out Arrangement"

The IRS released proposed regulations in July to clarify how payments an employee could elect under an opt-out provision in an employer’s group health plan must be taken into account in determining whether the cost of coverage is affordable under the Affordable Care Act (ACA) rules. Whether an employer provides affordable coverage to its employees affects whether the employer can be assessed a penalty under ACA's employer mandate and whether an individual is exempt from the individual mandate penalty. How "affordable coverage" is calculated is a crucial question under the ACA. The Presidential election may result in repeal or substantial modification of the ACA. Since we don’t know how fast that will occur, employers may still want to be sure opt-out arrangements are structured to avoid ACA penalties.

The newly proposed regulations explain when payments available under an "opt-out arrangement" are treated as a cost to employees in determining if health coverage is affordable. An "opt-out arrangement" is an arrangement where the employer pays cash to employees who decline coverage under the employer's group health plan.

In Notice 2015-87, the IRS took the position that the availability of opt-out payments is treated as a cost to the employee, in addition to the premium the employee must pay, in determining the total cost of coverage to the employee and whether that cost is affordable calculation. Because the affordable cost level is low, counting the opt-out payments often causes the premiums to exceed the affordability limit. However, the IRS also suggested that "conditional" opt-out arrangements are not counted, and said that further guidance would be forthcoming. The proposed regulations contain the promised guidance.

Under the proposed regulations, the availability of a payment to employees under an "eligible opt-out arrangement" will not be counted in the affordability calculation for that employer's health coverage. An eligible opt-out arrangement requires the employee who declines employer-provided health coverage to provide evidence that the employee and his or her dependents have other group coverage.

Opt-Out Arrangements and Affordability of Employer Health Coverage

In Notice 2015-87 (the "Notice") issued in December 2015, the IRS said that availability of an opt-out payment to an employee who waives employer group health coverage will generally be considered an additional cost to the employee of electing the employer’s group health coverage. The IRS reasoned that if an employee can get extra pay for declining health coverage, then the employee is also foregoing that extra pay if he or she accepts health coverage. Thus, the IRS said that the amount of the extra pay provided if an employee opts out of health coverage should be included in the cost of health coverage for purposes of determining affordability. However, the IRS also said that additional guidance would be forthcoming on opt-out arrangements – in particular, the treatment of an opt-out arrangement that includes conditions in addition to declining coverage (such as proof that the employee has other coverage available).

The proposed regulations fulfill the IRS's promise of additional guidance on opt-out arrangements and affordability of an employer's health coverage. An eligible opt-out arrangement is an arrangement that makes the opt out payment only to employees who (i) decline employer-sponsored major medical coverage, and (ii) provide "reasonable evidence" that they and their “expected tax family” have or will have minimum essential coverage other than individual or exchange coverage during the plan year or other period covered by the opt-out arrangement. Generally, an employee will need to have other group health coverage under another employer’s plan.

"Reasonable evidence" can be the employee's own certification that the employee's "tax family" does have and will have minimum essential coverage under the ACA. The certification can be provided during annual open enrollment and must be provided at least once per plan year. Notwithstanding the employee's certification, if the employer knows or has reason to know that the employee does not in fact have the required coverage, the employer should not make an opt-out payment to that employee.

The employee's "tax family" consists of the employee and all individuals the employee is reasonably expected to claim as a personal exemption on his or her individual tax return. One thing to note - this term can include individuals that are not eligible under the employer plan (e.g., dependents who are age 26 or older).

When the requirements of an eligible opt-out arrangement are met, the opt-out payment is not considered for affordability purposes for the entire period of coverage to which the payment applies, even if the other coverage subsequently terminates for the employee or a member of the employee’s expected tax family. This is the case even if the opt-out payment is adjusted or terminated when the other coverage is lost, and regardless of whether the employee must notify the employer of the loss of the other coverage.