Where you have employer subsidized self-insured medical benefits being provided to highly compensated individuals (“HCIs”) after employment and that subsidy is only offered to HCIs, you run the risk that the actual medical benefits provided (not the premiums) may be taxable to the executive under 105(h).
105(h) Implications of Self-Insured Arrangements
As you know, it has been a common practice among US companies to provide senior executives with employer-paid COBRA benefits for some period after termination. This is largely because in the 30 or so years that Code Section 105(h) has been on the books, enforcement of 105(h) by the IRS has been rare.
However, the recent enactment of health care reform has caused companies to re-examine the potential 105(h) implications of their self-insured arrangements. Code Section 105(h), by its terms, only applies to self-insured plans but health care reform has created a new anti-discrimination paradigm applicable to fully-insured plans which is to be based on the principles in 105(h).
It is generally anticipated that in connection with the development of that paradigm, you may well see the IRS attempt to more rigorously enforce 105(h) on self-insured plans.
Sometimes you will see continuation arrangements structured to avoid the 105(h) issue. Often the executive pays the full COBRA premium on an after-tax basis and then the employer cuts a check back to the executive for the employer subsidy. Assuming that there is no binding obligation that the employer provided payment be used to pay for the health coverage and that the executive is treating those checks as income, there is an argument that the benefits are being provided under a program financed with employee after-tax dollars thereby making the benefits exempt from tax under Code Section 104 and eliminating the 105(h) issue.
Given that you typically provide the COBRA subsidy for the person’s relevant severance period, the most simple way to achieve the above would be to increase the severance amount in an amount equal to the monthly premium and just have the executive pay his entire unsubsidized COBRA premium on an after-tax basis. Often you will see that additional amount grossed up for taxes to put the executive in the same economic place as if they had received the subsidy.
The COBRA obligation ceases if the person becomes covered under a subsequent employer’s group health plan. Employers using the after-tax approach described above usually do not want to continue to provide the “additional” severance if the executive is no longer eligible for COBRA. Accordingly, they will establish a separate severance amount (equal to the grossed up premium) that will shut off if the person loses COBRA coverage eligibility.