The IRS issued Notice 2015-16 to start the process of developing guidance around the excise tax on high-cost employer-sponsored health coverage, commonly known as the "Cadillac Tax." Beginning January 1, 2018, a 40% excise tax will apply on the cost of applicable coverage that exceeds prescribed thresholds (described later in this article). We will look at how the limit may apply with respect to the cost of coverage and methods to determine the cost of applicable coverage.
The statute provides two baseline per-employee dollar limits for 2018: $10,200 for self-only coverage, $27,500 for other forms of coverage. The guidance clarifies that the amounts are subject to adjustments.
Health cost adjustment percentage will be applied to the per-employee dollar limit for 2018 to determine the actual dollar limits for that year. For taxable years after 2018, a cost-of-living adjustment based on the Consumer Price Index for all Urban Consumers plus one percent will be applied to determine applicable dollar limits. An additional amount is added to the dollar limits for qualified retirees and individuals who participate in a employer plan where the majority of employees covered by the plan are engaged in high-risk professions or repair/install electrical or telecommunication lines.
This new excise tax will apply on the excess, if any, of the aggregate cost of applicable coverage of an employee for a month over the applicable dollar limit. Under the existing framework, rules similar to COBRA’s rules for determining applicable premium will be used to determine the cost of applicable coverage. Given that the regulators have provided limited guidance on determining the cost of COBRA coverage, in particular for self-insured plans and HRAs, guidance issued under section 4980I is likely to affect existing COBRA rules (section 4980B). Currently, the COBRA applicable premium must be determined for a 12-month period, and must be determined before the start of such period. For self-insured plans there are two methods to determine the COBRA applicable premium, the actuarial basis method, and the past cost method.
Absent guidance, employers and plans must operate in good faith compliance with a reasonable interpretation of the section 4980B statutory requirements.
Briefly, the Notice outlines potential approaches to determining the cost of applicable coverage: The IRS proposes determining similarly-situated individuals through mandatory aggregation – aggregating individuals by elected benefit package (e.g., PPO, HMO, or HDHP). Then, individuals will be disaggregated by those who have self-only coverage and those with other than self-only coverage. This is referred to as mandatory disaggregation. In addition, the IRS is considering whether to allow permissive disaggregation, meaning separate determination of costs of coverage within family coverage based on the number of covered individuals. Another type of permissive disaggregation under consideration is disaggregation based on an employee’s similarly-situated status such as bona fide employment-related criteria (current employee versus former employee status, compensation, bona fide geographic distinctions, etc.). The IRS has requested comments on these various aggregation methods.
For self-insured plans, the IRS is looking to provide guidance that will likely affect not only how the cost of applicable coverage is determined for purposes of the excise tax, but how self-insured plans determine the COBRA applicable premium. With limited exception, the method chosen (actuarial or past cost) would need to be used for at least five years (exception for the past-cost method due to significant plan changes).
Under the actuarial method, a reasonable estimate of the cost of providing coverage under the group health plan would be based on the actual cost the plan is expected to incur and not minimum or maximum exposure. The IRS asks for comments on whether an accreditation of individuals making these actuarial estimates should be required and whether it would be preferable to provide a specific list of factors that must be satisfied to make this actuarial determination.
For the past-cost method, the IRS proposes specific cost factors that would be taken into account to determine cost and how those factors can be applied.
The IRS has issued very limited guidance on determining the COBRA premium for HRAs. Briefly, it has stated that the COBRA applicable premium for an HRA may not be based on a qualified beneficiary’s reimbursement amounts available from the HRA. The IRS also seeks comments as to how the determination period should be set for COBRA and whether that same determination period can be used to determine the cost of applicable coverage. Under existing COBRA rules, the method for calculating the applicable premium must be elected prior to the determination period for which the applicable premium applies.
Determining the cost of applicable coverage raises a number of issues that affect the Cadillac Tax, COBRA continuation of coverage, and other areas of benefits law (e.g., W-2 health coverage reporting). This Notice provides early indications of how the IRS contemplates addressing these issues. Future guidance will have a broad impact on employer-sponsored group health plan compliance and plan designs.
We will monitor future regulatory developments, along with legislative changes that may impact the 2018 excise tax. This is the start of a long regulatory process and additional guidance and opportunity for comments will be forthcoming.
Brian McLaughlin is vice president of USI Affinity’s Benefit Solutions Group.