On April 17, the Internal Revenue Service (“IRS”) published regulations detailing how employers and insurers will calculate a new tax imposed under the Patient Protection and Affordable Care Act (now called the “ACA” by regulators). The new tax will directly apply to employers offering self-funded major medical plans and certain other self-funded plans (such as a health reimbursement arrangement (“HRA”)). In addition, the new tax will apply to insurance issuers with respect to fully insured health policies, including a health maintenance organization (“HMO”) contract. The tax is rather modest, starting at $1 per covered life per year.

Use of Tax Revenue. The ACA contains provisions intended to improve the quality of health care. One such provision establishes a private, nonprofit corporation called the Patient-Centered Outcomes Research Institute (the “Institute”). The Institute will help evaluate the quality and effectiveness of various medicines and treatments. This new tax (the “Research Tax”) will help fund the Institute.

Plans Subject to Tax. The Research Tax generally will apply to major medical benefits. Many other benefits — such as a dental plan, vision plan and health flexible spending arrangement (“Health FSA”) — will often be an “excepted benefit” and not subject to the tax. The following chart discusses how the Research Tax applies to various benefits that may be offered by an employer. See below for an important “non-duplication” rule, which can reduce the tax owed by an employer.

Click here to see the table.

Non-Duplication Rule. An employer may offer two or more self-funded health plans. If both the plans have the same plan year, an employer may treat them as a single health plan for purposes of calculating the Research Tax. If so, the same “life” (i.e., enrollee) covered under each arrangement would count as only one “covered life,” not two covered lives.

Example of Non-Duplication Rule. Suppose an employer offers major medical benefits and a separate prescription drug benefit. Both benefits are self-funded and have the same plan year. The medical plan covers 1,000 individuals while the prescription drug plan covers 800 individuals. Of the prescription drug plan enrollees, 700 are also covered by the major medical plan, while 100 are covered only by the prescription drug plan. For simplicity, assume that no employees terminate coverage during the year and that no new employees begin participating during the year.

If both plans were considered separately, the employer generally would owe $1,800 ($1,000 for the major medical plan and $800 for the prescription drug plan). Under the non-duplication rule, the employer would consider the number of unique lives covered under both plans. Here, there are 1,100 unique lives (the 1,000 from the medical plan and the 100 who are covered under the prescription drug plan, but not the medical plan). Thus, the employer generally would owe $1,100 (not $1,800), which is $1 per unique covered life.

Who is Responsible for Fee. The insurance issuer is responsible for the Research Tax with respect to a fully insured health plan. The “plan sponsor” of a self-funded plan is responsible for the Research Tax with respect to a self-funded plan. The “plan sponsor” is generally the employer that established or maintains the plan. The regulations provide other rules for other types of plans. For example, the board of trustees is the plan sponsor of a multiemployer plan, and the committee is the plan sponsor of a multiple employer welfare arrangement.

Calculating “Covered Lives.” The proposed regulations contain detailed guidance on how an employer with a self-funded plan calculates the average number of covered lives under the plan. The determination is made once per year, after the end of the plan year. The regulations provide three possible methods: (1) the actual count method; (2) the snapshot date method; and (3) the Form 5500 method. Insurance issuers use similar methods for fully insured health plans. Special counting rules apply for HRAs and Health FSAs which are not excepted benefits.

During a special transition period relating to this year, a plan sponsor can use any “reasonable method” to determine covered lives. However, since the term “reasonable method” is not defined, we expect that plan sponsors will likely use one of the three prescribed (and better defined) methods.

All the methods approximate the “average” number of lives covered in the year. For example, the Form 5500 method typically requires a plan sponsor to add the total participants covered at the beginning and end of the plan year, as reported on the plan sponsor's Form 5500. The result is the average number of lives covered (although a different calculation applies if the only coverage offered is self-only coverage). This number is then multiplied by $1 to determine the Research Tax owed by the plan sponsor.

The Research Tax applies with respect to individuals residing in the United States. The plan sponsor may rely on the most recent address on file when making this determination. The “United States” includes Puerto Rico and certain other possessions.

Future Changes. The $1 per covered life fee increases to $2, generally next year. The $2 fee increases in future years based on certain health expenditure data. The fee ceases in approximately 2019.

Payment of Tax. The Research Tax must be paid by July 31 of the calendar year immediately following the last day of the plan year. Thus, an employer with a calendar year plan will pay its first tax by July 31, 2013. Employers will file IRS Form 720, which will be revised to reflect the new Research Tax. While the regulations do not contain specific recordkeeping requirements, IRS Form 720 does contain some recordkeeping requirements. It appears that third parties (such as a third-party administrator) will not be able to report and pay the tax on behalf of a plan sponsor.

Additional guidance from the Department of Labor is expected to clarify whether ERISA-covered plan assets can be used to pay the Research Tax. The guidance, however, is not expected to address state law issues with using plan-related funds.

Effective Date of Regulations. The regulations are only proposed, not final. However, the IRS states that the regulations may be relied upon.

Links to Further Guidance. The proposed regulations can be found here.