Employers now have an answer to their single biggest and most vexing question about the elaborate new federal subsidy arrangement under the Consolidated Omnibus Budget Reconciliation Act (COBRA), but it may not be the answer they were hoping for or expecting. Under new IRS Notice 2009-27, an “involuntary termination” would include certain employee-initiated “good reason” terminations, layoffs with recall rights, and even certain cases where employees took severance buy-outs.

“An involuntary termination,” says Notice 2009-27, which interprets the COBRA provisions of the American Recovery and Reinvestment Act of 2009 (ARRA), “means a severance from employment due to the independent exercise of the unilateral authority of the employer to terminate the employment, other than due to the employee’s implicit or explicit request, where the employee was willing and able to continue performing services.”

Except for the “implicit or explicit request” nuances, that definition is very similar to what most employers probably understood the ARRA to mean by “involuntary termination” – which for terminations on or after September 1, 2008 and before January 1, 2010, would generally trigger a 65 percent COBRA premium reduction and an employer payroll tax credit under the ARRA, and could also permit certain second-chance elections (see Ogletree Deakins’ February 17, 2009 E-Alert).

But the Notice goes on to say that an “employee-initiated” termination could also be considered involuntary if it is a termination for good reason due to employer action that causes a “material negative change in the employment relationship for the employee.” No further definition of “material negative change” was included.

Moreover, Notice 2009-27 provides that a layoff with recall rights or a temporary furlough (i.e., a reduction in hours to zero) will be considered an “involuntary termination” for purposes of the COBRA subsidy. Some commentators had suggested that this situation would be treated as a “reduction in hours” under COBRA for which no subsidy would be available, rather than an involuntary termination, with its attached subsidy rights.

The Notice clarified two other issues. First, while an employee’s absence due to illness or disability will not constitute an involuntary termination, an employer’s action to terminate the employee while he or she is absent due to illness or injury will be deemed an involuntary termination. Second, an employee’s voluntary resignation, under circumstances indicating that his or her services would otherwise be terminated by the employer, will be treated as an involuntary termination.

In addition, the IRS indicates that terminations under certain severance packages which employers may have characterized as “voluntary” would actually be “involuntary” for subsidy purposes. Specifically, under Notice 2009-27, an involuntary termination occurs if an employee elects to be terminated in return for a severance package, or buy-out, “where the employer indicates that after the offer period for the severance package, a certain number of remaining employees in the employee’s group will be terminated.”

Beyond the portions of the Q&A section that cover involuntary terminations, the Notice also provides other important guidance to employers, including:

  • When an assistance eligible individual who had employee-only coverage on his or her termination date later elects COBRA coverage for an individual who is not assistance eligible (such as adding a spouse and dependents at open enrollment), any cost of coverage for the new enrollees is not subject to the ARRA premium reduction.
  • If the terms of the plan permit an assistance eligible individual (e.g., during open enrollment) to change to a more expensive coverage option than the one he or she had prior to termination, the premium reduction will apply to the increased premium for the new option.
  • Although vision-only or dental-only coverage with another employer do not constitute the type of coverage that will cause an individual to lose entitlement to the premium reduction, the Notice makes clear that coverage under vision-only or dental-only plans (as well as so-called “mini-med” plans) will be eligible for the premium reduction.
  • Under the ARRA, an individual who is eligible for coverage under another employer’s plan, but declines that coverage, will generally lose eligibility for the premium reduction (though not for COBRA coverage). If the other employer’s plan imposes a waiting period, however, the individual will lose eligibility for premium reduction only upon the expiration of the waiting period.
  • Employers may not refuse to provide the subsidy to an individual based on the individual’s income. Even if the employee’s income is greater than the eligibility limits imposed by the ARRA – the subsidy is fully phased out for someone with a modified adjusted gross income exceeding $145,000 ($290,000 for joint filers) – the employer must provide COBRA coverage upon receipt of the 35 percent payment. Recovery of any overpayment will be pursued by the Treasury Department.
  • Although the ARRA is silent with respect to the time period an employer must provide for assistance eligible individuals to remit payment following a second-chance election, the Notice directs employers to COBRA’s general requirement to permit 45 days for payment of the initial premium due.