On July 8, 2016, the Internal Revenue Service issued proposed regulations detailing the rather remarkable position that opt-out or waiver payments to employees who decline employer-provided health insurance are a form of salary reduction for employees who take the coverage instead of the payment and therefore must be counted when determining whether the coverage is affordable under the Affordable Care Act. Fortunately the regulations outline a strategy to avoid this strange result if certain conditions are met.
The Affordable Care Act (“ACA”) provides that if health care coverage offered by Large Employers to employees who average 30 or more hours of paid service per week is not affordable the employer will potentially be subject to an excise tax penalty. In 2016 the affordability penalty will be $3,240 for every employee who is offered unaffordable coverage and instead gets coverage through an ACA Marketplace (also known as an “Exchange”) and receives a tax credit or subsidy for doing so. The Act defines affordable coverage as coverage that does not require an employee contribution for self-only coverage that is more than 9.5% of the employee’s household income. The 9.5% affordability threshold has been increased by the IRS to 9.66% for 2016 and 9.69% for 2017. In addition, the regulations permit employers to use the alternate affordability safe harbors of W-2 income, rate of pay or the federal poverty level instead of household income.
Before December 2015 it was generally assumed by most employers that the only employee contribution that needed to be considered when determining the affordability of coverage was the actual part of the premium paid by the employee. On December 16, 2015, the IRS took a dramatically different position in IRS Notice 2015-87, which indicated that under certain circumstances the IRS was planning to count opt-out payments made to employees who do not receive health insurance coverage as a form of employee premium contribution for affordability purposes. For example, suppose an employer offers health insurance to employees that costs approximately $20,000 per year and also provides a $3,000 opt-out payment to those who waive coverage. In the view of the IRS, the employees who do not get that $3,000 because they instead receive the health care coverage have suffered a $3,000 salary reduction. This directly conflicts with the traditional view of opt-out payments as either an alternative form of compensation for employees who do not receive employer-provided health insurance or an incentive to waive coverage. In reality the $20,000 cost of coverage far exceeds the cost of the $3,000 opt-out payment and most employers and employees would not view an employee who gets health insurance coverage instead of the opt-out payment as incurring a $3,000 salary reduction.
Counting opt-out payments as employee contributions in addition to the employee’s share of the premium cost will render some coverage unaffordable and result in excise tax liability for some employers. Fortunately the Proposed Regulations outline a path to avoid having to count at least some opt-out payments as employee contributions, based on a distinction between unconditional and conditional opt-out payments.
An unconditional opt-out payment is one that is paid merely due to the fact that an employee opted out of coverage. Under the Proposed Regulations unconditional opt-out payments will always need to be counted as an employee contribution when determining affordability. In contrast, if the employer meets the requirements for an “eligible opt-out arrangement” it will not need to count conditional opt-out payments as an employee contribution for affordability purposes. An eligible opt-out arrangement is one where the right to receive an opt-out payment is strictly conditioned on an employee who has opted out providing reasonable evidence that the employee and his or her tax dependents have or will have alternate minimum essential coverage. However, due to tax credit considerations individual market coverage, including individual coverage obtained through an Affordable Care Act Marketplace, will not qualify as alternate coverage. Thus, unless something changes in the Final Regulations, opt-out payments paid to employees who obtain alternate individual market coverage will need to be counted as an employee contribution for affordability purposes. In contrast, alternate coverage obtained through a spouse’s employer would potentially qualify as acceptable alternate coverage. An employer may rely on an employee’s “attestation” or statement that all relevant individuals have appropriate alternate coverage, but is free to require other reasonable evidence to verify that claim. The opt-out program must require that no opt-out payment will be made “if the employer knows or has reason to know that the employee or any other member of the employee’s expected tax family does not have, or will not have, the alternative coverage.” Proof of alternate coverage must be provided at least once per plan year. In addition, the proposed regulations further indicate that “[a]n amount provided as an employer contribution to a cafeteria plan that is permitted to be used by the employee to purchase minimum essential coverage is not an opt-out payment, whether or not the employee may receive the amount as a taxable benefit.”
For most opt-out arrangements the new requirements will take effect after the Final Regulations are issued, and are expected to be in effect for plan years starting in 2017. Opt-out payments made pursuant to a collective bargaining agreement that was in effect before December 16, 2015 will not need to meet the requirements before expiration of the CBA or the effective date of the Final Regulations, whichever comes later. The IRS has indicated, however, that if an opt-out arrangement was first adopted on or after December 16, 2015, the date of Notice 2015-87, it intends to treat opt-out payments as employee health care contributions now. Employers who adopted opt-out arrangements on or after that date should act now to meet the requirements for eligible opt-out arrangements and other employers should plan to take action in the near future. Although this may involve addressing these issues with unions representing bargaining unit employees, the self-attestation of alternate coverage offers an easy and unburdensome way to meet the requirements.
The endorsement of proof of alternative coverage requirements by the IRS in the Proposed Regulations is inconsistent with the position previously taken by some of its auditors, who indicated to some municipalities that requiring proof of alternate coverage for opt-out payments is a form of impermissible premium reimbursement that could subject the employer to a $100 per day excise tax under other provisions of the Affordable Care Act. Hopefully in light of the Proposed Regulations that argument will not be raised again by IRS auditors reviewing opt-out arrangements that qualify as eligible opt-out arrangements. However, in a footnote to the Proposed Regulations the IRS ominously notes that providing opt-out payments conditioned on employees obtaining individual coverage could be treated as an impermissible reimbursement arrangement. It should also be noted that a recent federal court of appeals decision, which is currently being appealed to the United States Supreme Court, held that opt-out must be included in the regular rate for overtime purposes under the Fair Labor Standards Act. Although that case is not currently binding precedent in Pennsylvania, a Supreme Court ruling could make it so and even before that happens it is possible that Pennsylvania courts could reach the same conclusion.
Although the Final Regulations are expected to impose a major change on how affordability is calculated in certain circumstances, in practical terms this change may have limited impact. If an employer offers unaffordable coverage to an employee, no penalty is due unless the employee decides to instead get coverage through an ACA Marketplace and receives a tax credit or subsidy for doing so. Employees who are covered by their employer’s health insurance coverage and who do not currently receive an opt-out payment are unlikely to drop the employer’s coverage and instead go out and get Marketplace coverage just because they did not get an opt-out payment because they took the employers coverage. Nevertheless there will be at least some employees who are offered coverage that will be made unaffordable due to the existence of an unconditional opt-out payment who get Marketplace coverage and trigger a penalty. As is the case with other aspects of the Affordable Care Act, stay tuned for further adjustments and changes.