IRS Releases Initial Guidance on The Cadillac Tax
The IRS recently released Notice 2015-16, its first guidance on the excise tax on high cost employer-sponsored health coverage (i.e., the Cadillac tax) which will become effective in 2018. The Cadillac tax is a 40 percent nondeductible excise tax on the aggregate cost of “applicable employer-sponsored coverage” (referred to in the Notice and here as “applicable coverage”) that exceeds certain dollar limits.
The Notice is intended to “initiate and inform” the process of developing regulatory guidance on the Cadillac tax and, as such, does not offer guidance on which taxpayers may rely. However, it does discuss some of the major issues surrounding the implementation of the Cadillac tax and offers potential approaches for resolving those issues. It also seeks comments from interested parties on these issues as well as on related issues under COBRA.
The Notice focuses on three key topics relating to the Cadillac tax:
- What types of coverage constitute applicable coverage subject to the Cadillac tax.
- How to determine the cost of applicable coverage.
- How to apply the annual statutory dollar limits to the cost of applicable coverage.
What Constitutes Applicable Coverage Subject to the Cadillac Tax?
The statute contains a general definition of applicable coverage that includes any coverage under a group health plan made available to an employee by an employer (including governmental employers) if the coverage would be excludible from the employee’s income if paid by the employer. The statute also specifically indicates that certain types of coverage will constitute applicable coverage, including Medical Flexible Spending Accounts (FSAs), Health Savings Accounts (HSAs), governmental plans, retiree coverage, multiemployer plans and on-site medical clinics.
However, the statute expressly exempts certain types of employer-sponsored coverage from the Cadillac tax, including the following:
- Dental or vision insurance that is issued under a policy, certificate or contract of insurance that is separate from the group health plan;
- Long-term care insurance;
- Coverage only for accident, or disability income insurance, or some combination of the two;
- Liability insurance;
- Coverage issued as a supplement to liability insurance;
- Workers’ compensation or similar insurance;
- Coverage for a specified disease or illness and hospital indemnity or other fixed indemnity insurance that is not excludible from income.
The Notice addresses several open questions relating to the statute’s definition of applicable coverage and leaves several open questions, as follows:
Health Reimbursement Arrangements and Executive Physical Programs: Although they are not specifically identified as applicable coverage under the statute, future guidance will likely provide that Health Reimbursement Arrangements (HRAs) and executive physical programs are also included in the definition of applicable coverage, since these forms of coverage meet the general definition of applicable coverage under the statute and are not specifically excluded.
On-site Medical Clinics: The IRS is considering excluding certain on-site medical clinics from the definition of applicable coverage, namely, those that provide only de minimis medical care (such as first aid) to employees. On the other hand, on-site medical clinics providing primary care will be included in applicable coverage.
Self-insured Dental and Vision Coverage: The IRS notes that many commentators have interpreted the statute to mean that only fully insured stand-alone dental and vision benefits are specifically excluded from the Cadillac tax. The Notice states that the IRS is considering using its regulatory authority to also exclude self-insured dental and vision coverage, provided that such coverage qualifies as an excepted benefit under previously issued regulations that apply for other Health Care Reform purposes.
Employee Assistance Programs: The IRS is also considering excluding employee assistance plans (EAPs) that qualify as an excepted benefit.
How is the Cost of Applicable Coverage Determined?
The Cadillac tax is 40 percent of an employee’s “excess benefit” for each calendar month. The excess benefit is the amount that the aggregate cost of each type of applicable coverage in which the employee is enrolled exceeds 1/12th of the annual dollar limit.
The Notice indicates that the cost of coverage under a group health plan will likely be determined using the same principles that apply for purposes of calculating the “applicable premium” under COBRA. The applicable premium under COBRA is based on the cost of coverage for similarly situated non-COBRA beneficiaries. The IRS acknowledges, however, that the current COBRA regulations lack definitive guidance on a number of issues relevant to the calculation of the applicable premium, such as:
- How a group of similarly situated non-COBRA beneficiaries is determined.
- The methods that self-funded plans may use to calculate COBRA premiums.
- How COBRA premiums are calculated for HRAs.
As a result, the Notice discusses potential approaches for each of these items for purposes of determining the cost of coverage under the Cadillac tax. It also indicates that the IRS may consider these approaches for purposes of determining the applicable premium under COBRA.
The Notice also confirms specific rules set forth under the statute for determining the cost of applicable coverage, such as:
- Separate costs must be calculated for “self-only” coverage and “other than self-only” coverage (i.e., employee-plus-one and family coverage).
- The cost of applicable coverage is based on the coverage in which the employee is actually enrolled (rather than on the coverage offered to the employee, but in which the employee does not enroll).
- The cost of coverage under a Medical FSA will be the sum of employee pre-tax contributions to the Medical FSA, plus any reimbursement in excess of the employee’s pre-tax contributions (i.e., due to employer contributions to the Medical FSA).
- The cost of coverage under an HSA is the sum of employee pre-tax contributions and employer contributions to the HSA. The Notice confirms, however, that after-tax contributions made outside a Section 125 Cafeteria plan are not included for purposes of determining the cost of coverage under an HSA.
- The plan may treat pre-age 65 retirees and post-age 65 retirees as similarly situated beneficiaries in determining the cost of retiree coverage.
How are the Annual Dollar Limits Applied to the Cost of Applicable Coverage?
In 2018, the first year that the Cadillac tax is imposed, the annual dollar limit for self-only coverage is $10,200 and for other than self-only coverage is $27,500. In general, the prorated dollar limit that applies to an employee for any month is determined based on whether the employee is enrolled in self-only or other than self-only coverage as of the beginning of the month. The Notice indicates that the IRS is considering how to apply the dollar limits when an employee simultaneously has one type of coverage that is self-only coverage and another type of coverage that is other than self-only coverage.
The annual dollar limits will be subject to various adjustments that will be addressed in future regulations, including the following:
Health Cost Adjustment: A one-time adjustment designed to increase the baseline annual dollar limit amounts in the event that the actual growth in the cost of U.S. health care between 2010 (i.e., the year that Health Care Reform was enacted) and 2018 (i.e., the year the Cadillac tax is effective) exceeds the projected growth for that period.
Cost-of-Living Adjustment: An annual adjustment beginning in 2019 to reflect the changes in the cost-of-living.
Age and Gender Adjustment: An annual adjustment if the age and gender characteristics of the employer’s workforce are different from those of the national workforce.
High-Risk Profession Adjustment: An annual adjustment for participants in a plan sponsored by an employer in which the majority of the employees enrolled in the plan are engaged in certain high-risk professions (as defined in the statute).
Qualified Retiree Adjustment: An annual adjustment for participants who are “qualified retirees” (as defined in the statute).
Other Issues Not Addressed in Notice 2015-16
The IRS expects to release another notice that will address and invite comments on other issues relating to the Cadillac tax that are not addressed in Notice 2015-16, including procedural issues relating to assessment of the tax.
We are still awaiting guidance as to the appropriate entities responsible for paying the tax. The statute indicates that the insurer is responsible for paying the Cadillac tax for fully insured arrangements while the employer is responsible for paying the Cadillac tax for HSAs. However, for all other self-funded coverages that are subject to the Cadillac tax, the “person that administers the plan benefits” is responsible for paying the Cadillac tax. It is not clear whether this phrase means the plan sponsor (who is generally the plan administrator under a single employer plan) or if it potentially means the third-party administrator. Note that, regardless of which entity is responsible for paying the Cadillac tax, the statute is clear that the employer is responsible for calculating the amount of the Cadillac tax.
Employers, insurers and third-party administrators have long been awaiting guidance on the Cadillac tax and Notice 2015-16 indicates that the IRS has finally started to tackle the complex issues surrounding the implementation of the tax. Although the Notice does not offer definitive answers on those issues, it does provide significant insight into the IRS’s thought process and gives interested parties an opportunity to provide input on a number of critical topics. Because the Cadillac tax may potentially subject employers to a significant liability, employers—especially those negotiating collective bargaining agreements that extend into 2018—should begin to consider the implications of the Cadillac tax now.