United States: New IRS Guidance On 40% Excise Tax Previews Future Regulatory Complexity

Although public opposition to the 40% excise tax on high-cost health care is rapidly growing, the IRS continued to develop a regulatory framework for administration of the excise tax through its issuance of Notice 2015-52 on July 30, 2015. Similar to the first notice on this topic, Notice 2015-52 merely identifies various administrative challenges without providing concrete guidance. If nothing else, the new guidance provides another preview into what will undoubtedly be a complex regulatory environment.

By way of background, the Affordable Care Act (or "ACA") added Section 4980I to the Internal Revenue Code (the "Code"), which imposes a 40% excise tax (the "40% Excise Tax") on the excess, if any, of the aggregate cost of applicable coverage provided to an employee over a set dollar limit (the applicable dollar limits will be adjusted for inflation and are subject to additional increases based on age and gender or for certain individuals in high risk professions). The 40% Excise Tax is imposed on the "coverage provider," which is the health insurance carrier in the case of an insured group health plan, the employer with respect to a health savings account or Archer medical savings account, or in all other cases, the "person that administers the plan benefits."

In February 2015, the IRS released the first notice, Notice 2015-16 (discussed here), which was intended to initiate the process of developing regulatory guidance under Code Section 4980I. Notice 2015-16 described potential approaches related to the definition of applicable coverage, the calculation of the cost of applicable coverage and the applicable dollar limit.

The new IRS guidance proposes additional approaches related to (1) identification of the person or entity responsible for paying the tax, (2) determining the cost of applicable coverage, (3) age and gender adjustments to the applicable dollar limit and (4) notice and payment of the 40% Excise Tax. Although many of the approaches described by the IRS could work in the single-employer plan context, the approaches create a number of issues for multiemployer plans and the employers that contribute to them. These issues will be addressed in a future blog. Below is a summary of the key approaches described by the IRS in Notice 2015-52.

Identification of the Coverage Provider

As noted above, Code Section 4980I imposes a tax on the "coverage provider." The coverage provider is easily identified in the case of an insured plan or a health savings account. However, in all other cases, the coverage provider is the "person that administers the plan benefits." Because neither the ACA nor ERISA contains guidance on identifying the person or entity that administers plan benefits, the IRS has proposed two approaches to assist in identifying the coverage provider.

Under the first approach, the coverage provider would be the person or entity responsible for performing day-to-day functions related to administration of the plan (e.g., processing claims or handing participant inquiries). In many cases, this would be a third-party benefits administrator. Under the second approach, the coverage provider would be the person or entity that has the ultimate authority or responsibility with respect to administration. Usually, this would be the plan administrator that is defined in the plan, such as a benefits administration committee that has been delegated administrative duties.

Either approach will present challenges for employers. For example, a single third-party rarely administers all benefits considered "applicable coverage" under Code Section 4980I. It is not uncommon to have separate administrators for medical benefits, pharmacy benefits, mental health and substance abuse benefits and flexible spending benefits. Employers would need to determine which portion of the 40% Excise Tax should be allocated to each administrator.

Calculation of the Cost of Applicable Coverage

Similar to the first notice, much of the guidance in Notice 2015-52 focuses on issues related to determining the cost of applicable coverage. Below are the key proposals.

  • Timing Issues. In order to timely pay the 40% Excise Tax, coverage providers must determine the cost of applicable coverage shortly after the taxable period (which the IRS indicated will likely be the calendar year for all taxpayers, regardless of plan year). This presents challenges for self-insured plans that cannot determine the cost of coverage until claims incurred prior to the end of the taxable period are submitted. Therefore, the IRS requested comments on whether a claims run-out period would be appropriate. Additionally, experience-rated insurance policies often provide payments or discounts following a policy year. The IRS has requested comments on how these payments or discounts should be applied to the cost of applicable coverage.
  • Excluding Income Tax Reimbursements from the Cost of Applicable Coverage. If an entity other than the plan sponsor is responsible for paying the 40% Excise Tax, that entity will likely pass the cost of the tax through to the plan sponsor in the form of increased service fees. Code Section 4980I provides that the cost of applicable coverage does not include amounts attributable to the 40% Excise Tax. However, Code Section 4980I does not address what happens when the same parties that pass on the cost of the 40% Excise Tax also seek reimbursement of income taxes incurred due to the receipt of additional service fees. This raises an important question – should the amount passed-through in the form of increased service fees to reimburse for income taxes (in addition to the 40% Excise Tax reimbursement) be excluded from the cost of applicable coverage? The IRS has requested comments on administrable methods for excluding income tax reimbursements, including what tax rate to use. The IRS anticipates that excise tax and income tax reimbursements will be excludable from the cost of applicable coverage only if separately billed and identified.
  • Annual Contributions to Account-Based Plans. The cost of applicable coverage includes employer and employee contributions to account-based plans, such as health savings accounts. The IRS recognized that annual contributions (as opposed to contributions made monthly or per pay period) could trigger a 40% Excise Tax in the month of contribution because the cost of applicable coverage is determined on a monthly basis. To avoid this result, the IRS indicated that it is considering an approach that would allow employers to apply annual contributions on a pro rata basis over the course of the taxable period when determining the cost of applicable coverage.
  • Flex-Credits and Carry-Overs under Flexible Spending Arrangements. The cost of applicable coverage for benefits provided through a flexible spending arrangement (FSA) is the greater of the employee's contribution to the FSA or the total reimbursements made from the FSA. The IRS stated that when an employer contributes non-elective flex credits to an FSA on behalf of an employee, the cost of applicable coverage includes (1) the employee's contributions, and (2) the amount of non-elective flex credits actually used for reimbursements. This would prevent unused non-elective flex credits from being included in the cost of applicable coverage. The IRS also stated that it is considering a safe harbor approach for amounts carried-over from prior years to prevent double counting. Under this safe harbor, amounts carried-over from previous years will not be included in the cost of applicable coverage. The IRS plans to restrict the availability of this safe harbor if non-elective flex credits are available.
  • Inclusion of Amounts Taxable under Code Section 105(h). Code Section 105(h) provides that the value of a discriminatory self-insured benefit provided to a highly compensated employee must be included in the employee's income. However, under 2012 guidance related to disclosing the cost of coverage for Form W-2 purposes, the IRS provided that the amount included in income should be excluded. Addressing this discrepancy, the IRS stated that it is the "coverage," not the resulting tax benefit that constitutes "applicable coverage" under Code Section 4980I. In other words, although a highly-compensated employee is taxed on the value of the discriminatory coverage, that coverage must be included in the cost of applicable coverage under Code Section 4980I.

Other Proposed Approaches

The IRS also described potential regulatory approaches related to the following:

  • Age and Gender Adjustments to the Applicable Dollar Limit. The applicable dollar limits used to determine whether there is an excess benefit may be increased upward based on the age and gender characteristics of all employees of an employer. The IRS is considering rules allowing employers to determine these characteristics based on a "snapshot" on the first day of the plan year. The IRS also indicated that it is developing age and gender adjustment tables to assist employers in applying the adjustment.
  • Notice and Payment of the 40% Excise Tax. Under Code Section 4980I, employers are required to calculate the 40% Excise Tax and notify the coverage provider and the Treasury of the amount of the tax, if any. The IRS has not yet determined the form of this notice, but has indicated that coverage providers will likely pay the 40% Excise Tax using Form 720. Form 720 is a quarterly-filed form, but similar to payment of the PCORI fee, the 40% Excise Tax will only be paid once per year.

The IRS set October 1, 2015 as the due date for comments on the latest notice. Given that late date, it is not likely that proposed regulations would be completed before 2016. Employers considering filing comments on IRS Notice 2015-52 should begin to consider those comments now so they can be filed by the due date.

New IRS Guidance On 40% Excise Tax Previews Future Regulatory Complexity

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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