United States: Paying Employees To Opt Out Of Insurance? BEWARE

Seyfarth Synopsis: That "win-win" in contract negotiation wherein employees are paid to opt out of employer insurance has become much more complicated thanks to the IRS. Basically, if bargaining parties do not follow new IRS rules, those opt-out payments may end up costing an employer much more in the form of fines for not providing employees with affordable coverage under the Affordable Care Act ("ACA").

In December 2015 the IRS announced that any unconditional payment to employees to opt out of employer-sponsored insurance was basically a salary reduction towards the payment of health insurance costs, since it is lost if the employee takes employer insurance. Thus, the amount of any unconditional opt-out payment should be counted along with any other employee premium contribution obligations towards whether employer-offered insurance is "affordable." Under the ACA, if the employee cost of single coverage for the employer's lowest cost plan option exceeds 9.66% of his household income, it is considered unaffordable. For each employee offered unaffordable coverage who receives subsidized insurance from an exchange, the employer is charged an employer shared responsibility penalty of $3,240 per year. Given the size of some opt out payments, those payments — along with whatever the employee's single coverage contributions/premiums are — could exceed the affordability threshold.

Pending formal rule making the IRS provided that an employer need not count unconditional opt-out payments as employee health insurance contributions for purposes of insurance affordability provided the opt-out arrangement was adopted before December 16, 2015. For more information on this earlier guidance, see our Health Care Reform alert.

As promised, on July 6, 2016, the IRS issued proposed rules regarding opt out payments scheduled to take effect for taxable years beginning after December 31, 2016. The rules set forth when opt out payments must be added to the cost of coverage for purposes of determining whether such coverage is affordable.

Critically, the IRS rejected requests that the rules exempt conditional opt-out payments made pursuant to a collective bargaining agreement ("CBA"). The IRS did agree, however, to limited grandfathering for contractual opt-out agreements. Opt-out plans required under CBAs in effect before December 16, 2015 — for both employers and successor employers — will be treated as having been adopted prior to December 16, 2015, and excluded under the new rules until the later of: (i) the beginning of the first plan year that begins following the expiration of the CBA (disregarding any extensions); or (ii) taxable years beginning after December 31, 2016 (the applicable date of the rules).

Except for this CBA exception, going forward all opt out arrangements, union and non-union, conditional (other than those identified below) and unconditional, will be treated as part of the employee's required contribution for employer health insurance. Certain "eligible opt-out arrangements" will be excluded, however, but only if the opt out arrangement satisfies the following requirements:

  1. The employee's right to receive an opt-out payment is conditioned on the employee providing "reasonable evidence" that the employee and all other individuals for whom the employee reasonably expects to claim a personal exemption deduction for the taxable year or years that begin or end in or with the employer's plan year to which the opt-out arrangement applies (the employee's expected tax family) have or will have minimal essential coverage during the period of time for which the opt-out arrangement applies.
  2. That minimal essential coverage cannot be obtained from an individual market or an insurance exchange. In other words, the coverage must be through another employer- sponsored plan, such as a spouse's.
  3. While not the subject of these rules, the DOL has opined, in Technical Release 2013-03, that to avoid other ACA pitfalls, the health plan the employee opting out of enrolls in (just like the plan he is opting out of) also must provide "minimum value" — i.e., that it covers at least 60% of the actuarial value of health costs. Thus, the employer must further have the employee confirm that the employee's other group coverage provides "minimum value."
  4. The "reasonable evidence" of alternative coverage may include an employee's attestation of coverage for the relevant period, but the employer may always require some other reasonable evidence of coverage.
  5. The "reasonable evidence" must be provided no less frequently than every plan year to which the opt-out arrangement applies. It can be provided no earlier than a reasonable period of time before the commencement of the period of coverage (e.g., an open enrollment period) to which the opt-out arrangement applies. The employer may require evidence of alternative coverage to be provided at a later date, such as after the plan year, to enable it to require evidence that alternative coverage has already been obtained.
  6. The arrangement must provide that the opt-out payment will not be made (and the employer must not make the payment) if the employer knows or has reason to know that the employee or other members of his expected tax family does not have or will not have the alternative coverage.

This new rule applies to all employers subject to the ACA's employer mandate, both union and non-union. (But, see the note regarding minimum value in item 2 above, which applies to any group health plan, regardless of size.) Employers with represented employees must take care as their contracts expire to negotiate language either giving them the discretion to have the opt-out program comply with IRS rules or incorporating detailed compliant language in the CBA itself. Failure to do so could result in an unexpected and costly surprise in the form of employer shared responsibility penalties that cannot be rectified until the next negotiations.

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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