The Affordable Care Act (ACA) of 2010 made unprecedented changes to health benefit plans. The most sweeping ACA provisions took effect in 2014; other provisions have been delayed from their original implementation target dates. The Internal Revenue Service, the agency responsible for enforcing many of the ACA’s tax implications, has issued various regulations under the ACA. The IRS regulations are significant for everyone, but imperative for employers to monitor and understand.
Generally, the ACA requires employers to offer “affordable coverage” to full-time employees (all these terms being defined in the law). Coverage is “affordable” if the cost to the employee is less than a set percentage of the employee’s household income.
Many employers compensate employees who are eligible for employer-sponsored coverage but — generally because they have insurance through a spouse or other person — do not need the employer-sponsored coverage. The employer saves the cost of covering the employee, who has coverage from another source, and the employer shares a portion of the savings with the employee as cash. This compensation is known as an “opt-out” payment, or sometimes as “cash in lieu of benefits.”
In 2015, the IRS issued Notice 2015-87 (2015-15 I.R.B. 889), to provide guidance on whether an employer’s “opt-out” payment to employees who decline medical coverage affects the affordability of the employer’s offered coverage. As a general rule, Notice 2015-87 explained that an opt-out payment could be treated as increasing the employee’s required contribution to the cost of employer coverage. This treatment applied to an “unconditional” arrangement (where the employee was not required to provide proof of other coverage) or a “conditional” arrangement (where the employee had to provide proof of coverage to receive the payment). The IRS explains the treatment this way:
If an employer makes an opt-out payment available to an employee, the choice between cash and health coverage presented by the opt-out arrangement is analogous to the cash-or-coverage choice presented by the option to pay for coverage by salary reduction. In both cases, the employee may purchase the employer-sponsored coverage only at the price of forgoing a specified amount of cash compensation that the employee would otherwise receive – salary, in the case of a salary reduction, or an equal amount of other compensation, in the case of an opt-out payment. Therefore, the economic cost to the employee of the employer-sponsored coverage is the same under both arrangements.
Thus, the IRS considers the opt-out payment to increase the cost of coverage for all employees, whether or not they enroll in the employer’s coverage. That increased cost jeopardizes the affordability of the employer’s offered coverage. If an employer fails to offer affordable coverage as defined, and the employee obtains insurance in the marketplace with a premium tax credit, significant penalties can apply to the employer.
Notice 2015-87 was not a final regulation but stated the intent of the IRS and the Treasury Department to propose regulations reflecting this rule, and invited comments on the proposed rule. On July 6, 2016, after receiving public comments, the IRS issued “proposed regulations” that address, among other things, opt-out arrangements.
The proposed regulations recognize the two types of opt-out payments: conditional and unconditional. For unconditional arrangements (not requiring proof of other coverage), the offered opt-out payment is treated as a required employee contribution and thus increases the cost of the employer’s coverage. A temporary exception applies to unconditional arrangements adopted under a collective bargaining agreement in effect before December 16, 2015: those arrangements would not affect affordability until (1) the plan year after the agreement expires or (2) the effective date of the final regulation, whichever is earlier.
For conditional arrangements, the proposed regulations provide happier news. Specifically, they recognize an “eligible opt-out arrangement” where the offered payment is disregarded for purposes of determining affordability.
An eligible opt-out arrangement has two conditions: (1) the employee must decline enrollment in the employer-sponsored coverage, and (2) the employee must provide, at least annually, “reasonable evidence” that the employee and all members of the employee’s “tax family” have alternative “minimum essential coverage,” not including coverage obtained in the individual market. Reasonable evidence may consist of the employee’s “attestation,” and it must be required by the employer within a reasonable period before each plan year for which the employee opts out (the open enrollment period meets this requirement). The opt-out payment continues to be disregarded for purposes of affordability even if the employee terminates the other coverage without the employer’s knowledge.
The proposed regulations, with some exceptions, apply to plan years beginning January 1, 2017. Opt-out arrangements should be reviewed and brought into compliance before the end of 2016.
Employers with unconditional opt-out plans should immediately determine whether these arrangements will affect affordability determinations — i.e., whether the arrangement falls within the collective bargaining agreement exception, and for how long. Negotiating an eligible (conditional) alternative may be necessary to avoid exposure to penalties.
Employers with conditional opt-out plans should review the terms of those arrangements, in particular the requirement that employees provide proof of other coverage. Reasonable evidence (including an attestation) of alternative coverage that is not individual coverage must be required every year. The alternative coverage must apply to the employee’s entire family, i.e., spouse and dependents. Collectively bargained conditional opt-out arrangements should be modified through negotiations to comply with the regulatory requirements.
The proposed regulations address many other aspects of the ACA. This article concerns only one provision of the proposed regulations. Employers should ensure their plans comply with all applicable regulations and provisions of the ACA.