IRS releases final rule on premium tax credits, notice addressing employer coverage

Original post by Timothy Jost,

Implementing Health Reform. On December 16, 2015, the Internal Revenue Service (IRS) released a final regulation containing a number of premium tax credit eligibility provisions. Several of these concern the question of when an employer-sponsored health benefit plan offers affordable coverage that meets the minimum value requirement, but the rule also addresses other miscellaneous issues.

At the same time the IRS released a long and complicated notice addressing various issues that have arisen under the Affordable Care Act (ACA) with respect to employer-sponsored coverage, focusing particularly on account-based employee benefits such as section 125 cafeteria plans and health reimbursement arrangements.

Premium Tax Credit Final Rule

The rule finalizes a minimum value rule proposed over two years ago in May of 2013. The IRS had also recently proposed additional regulatory provisions relating to minimum value, while Department of Health and Human Services regulations address other issues related to minimum value. Parts of the earlier proposed rules are finalized in this rule, and other parts remain to be finalized later.

Premium Tax Credit Eligibility

The final rule begins by cleaning up one premium tax credit eligibility issue that has nothing to do with minimum value of employer-sponsored coverage. Eligibility for premium tax credits is based on household income, including the income of children or other members of the family who are required to file tax returns. Under certain circumstances parents are allowed to include their children’s income in their tax returns.

The regulatory language clarifies that when a parent does this, the household’s income includes the child’s gross income included on the parent’s return. The amount included for determining tax credit eligibility, however, is the child’s modified adjusted gross income (MAGI), which is not necessarily the amount reported as gross income on the tax return. MAGI would also include, for example, the child’s tax exempt interest and nontaxable Social Security income. The final rule clarifies how this is to be handled.

The rule next clarifies how wellness incentives are handled for determining the affordability of coverage for purposes of premium tax credit eligibility. Premium tax credits are not normally available to individuals who are offered health insurance coverage by their employer. Employees may, however, be eligible for premium tax credits if the employer coverage does not provide “minimum value” (MV) or if the employer coverage is “unaffordable.” Generally, a minimum value plan must have an actuarial value of at least 60 percent and cover substantial hospital and physician services. To be “affordable” a plan must cost no more than 9.56 percent (for 2015) of an employee’s MAGI. An employer that offers a health plan that fails to provide MV or that is unaffordable may also be assessed a penalty if one or more of its employees turns to the exchange for premium tax credits.

Under the ACA, employers can offer wellness incentives that reduce the cost of the employee contribution or cost-sharing for program participants. The question arises, therefore, whether affordability and minimum value should be determined with or without the application of wellness incentive premium and cost-sharing reductions. The final regulations provide that affordability and minimum value should be determined by assuming that employees fail to qualify for the wellness incentive premium or cost-sharing reductions with one exception — if the wellness incentive relates to tobacco use affordability will be determined based on the assumption that the employee qualifies for the incentive and is thus not subject to the tobacco use surcharge.

Extension Of The ‘Family Glitch’

The final regulation proceeds, however, to extend the “family glitch.” One of the most criticized IRS rules implementing the ACA provides that if an employer offers an employee affordable sole-employee coverage, the employee’s entire family is ineligible for premium tax credits even though employer-sponsored family coverage is unaffordable.

Under the minimum value final rule, if an employee uses tobacco and does not join a tobacco cessation program, and thus coverage is in fact unaffordable with the tobacco surcharge or does not offer minimum value, not only the employee, but also the employee’s entire family, is ineligible for premium tax credits as long as coverage would have been affordable or offer minimum value had the employee complied with the smoking cessation program. This is true even if no one else in the family smokes.

Health Reimbursement Arrangements

The final regulation next addresses the effect of health reimbursement arrangements (HRAs) on affordability. Amounts newly made available to an employee through an HRA that is integrated with ACA-compliant employer-sponsored health coverage when the employee may use the HRA to pay premiums are counted toward an employee’s required contribution to determine affordability. Amounts newly made available to an employee through an HRA that is integrated into with eligible employer-sponsored coverage that an employee may only use to reduce cost-sharing is counted toward determining minimum value. If HRA contributions may be used either to cover premiums or reduce cost-sharing, they are considered for determining affordability and not minimum value.

HRA contributions, however, are only taken into account if the HRA and the primary employer-sponsored coverage are offered by the same employer. They are also taken into account for determining affordability or minimum value if the amount of the annual contribution is determinable within a reasonable time before an employee must decide whether or not to enroll.

Cafeteria Plans

The final rule also provides that employer contributions to flex arrangements under section 125 cafeteria plans are considered for determining affordability and minimum value if 1) the employer contribution cannot be taken as a taxable benefit, 2) it may be used to pay for minimum essential employer coverage, and 3) it may only be used to pay for medical care, as opposed to other benefits like dependent care that can be paid for under a section 125 plan. The guidance also released on December 16 discusses HRAs and 125 plans in much greater detail, and is examined below.

Continuation Coverage Eligibility And Tax Credits

The rules next address the effect on eligibility of former employees and retirees for continuation coverage under federal or state law, such as Consolidated Omnibus Budget Reconciliation Act (COBRA) coverage, on eligibility for premium tax credits. The rule provides that eligibility for continuation coverage does not disqualify former employees or retirees, or their dependents, from premium tax credit eligibility unless the individual actually enrolls in the coverage. If continuation coverage is offered to current employees because of a reduction in hours, however, it will disqualify the employee from premium tax credits if it is affordable and offers minimum value. Of course, continuation coverage offered current part-time employees will often not be affordable.

Tax Credits And Coverage For Partial Months

The final rule concludes by addressing premium tax credit issues that arise when an individual is enrolled in coverage for a partial month. When a child is born, adopted, or placed with a family for adoption or foster care, or placed by court order, that child can be covered as of the date of birth, adoption, placement, or the order. The rule clarifies that when this happens, the child is treated as enrolled from the first day of the month for purposes of determining premium tax credit eligibility, even though the child is enrolled during the middle of the month. The adjusted monthly premium is determined as if all members of the coverage family were enrolled as of the first of the month in this situation.

The rule next addresses how premium tax credits are calculated where there is a partial months of coverage, which can occur when a child joins the plan mid-month by birth, adoption, placement or court order or when coverage is terminated mid-month, for example by a death. In this situation, the premium tax credit covers the lesser of the actual amount of the pro-rated premium charged for the month (taking into account any premium refunds) or the excess of the benchmark plan premium for a full month of coverage over the full amount that the eligible household would be required to contribute for coverage given its income level.

Thus if a taxpayer has a $500 premium and would normally be entitled to a premium tax credit of $300 based on a $450 benchmark premium and a $150 contribution amount, and the taxpayer dies mid-month and is refunded $250, the taxpayer would be entitled to a $250 premium tax credit based on his or her actual expenditure, but if the taxpayer is refunded $150, the taxpayer would be entitled to a $300 tax credit based on the benchmark plan cost.

The final rule provides that if family members live in different states the benchmark plan premium is determined by summing the benchmark premiums for the different states as they apply to the family members in each state. The rule updates the table of percentages, which determines how much individuals must contribute of their own income toward the cost of premiums to be eligible for premium tax credits given their income. And, finally, the rule analyzes how qualified health plan premiums and benchmark plan premiums should be allocated for determining premium tax credit eligibility when either the premiums of a plan in which an individual is enrolled or a state’s benchmark plan covers services that are not essential health benefits and thus not eligible for premium tax credit payments.

IRS Notice 2015-87

The notice (IRS Notice 2015-87) addresses a range of issues relating to the ACA and employer coverage, elaborating on some issues addressed by the final rule. Many of the questions it raises elaborate on IRS Notice 2013-54, issued in 2013. The notice states that a number of these issues will be addressed by future rulemaking and requests comments. It clarifies existing requirements as to some issues and allows plans a grace period before employers must come into compliance. The notice also, however, allows employees to claim the benefit of some of the requirements even though employers have not yet come into compliance.

Health Reimbursement Arrangements

The notice begins by addressing a series of issues raised by health reimbursement arrangements (HRAs). It first clarifies that an HRA that covers only former employees or retirees is not required to be integrated with an employee-sponsored plan that meets ACA requirements. A former employee covered by such an HRA, however, is ineligible for premium tax credits as long as funds remain available in the HRA.

If an HRA covers current employees, a former employee who is no longer covered by the group health coverage that must be integrated with an HRA for the HRA to comply with ACA requirements may not use funds remaining in his or her HRA to purchase individual coverage. Amounts credited to an HRA prior to January 1, 2013, or during 2013 under terms in effect prior to January 1, 2013, may, however, be used for medical expenses under the terms then in effect even though those terms do not comply with ACA requirements that went into effect in 2014.

The notice provides that HRAs available to cover medical expenses of an employee’s spouse or children (family HRAs) may not be integrated with employee-only coverage but must be integrated with coverage in which the dependents are enrolled to comply with ACA requirements. Recognizing that many employer plans do not conform to this requirement, the IRS is allowing plans a grace period to come into compliance with this requirement.

Under earlier guidance, the IRS had made it clear that HRAs could not be used to purchase individual health insurance coverage. This guidance clarifies that HRAs can be used to pay the premiums for excepted benefit coverage, such as dental or vision plans. The notice further clarifies that section 125 cafeteria plans cannot be used to purchase individual coverage, even if the 125 plan is funded fully by employee contributions.

The Notice explains at great length and in detail how HRAs and flex contributions to a section 125 cafeteria plan are treated for determining affordability and minimum value of employer-sponsored coverage. This issue is also addressed by the rule and discussed above. The notice offers several examples of how these rules are applied.

Flex Plans And Opt-Out Payments

One of the requirements of the rule and notice is that employer contributions to flex plans will only be considered for determining affordability or minimum value of employer coverage if the flex plan can only be used for health spending. Solely for purposes of determining affordability for application of the employer mandate (which imposes a penalty of employers who do not offer affordable, minimum value coverage if their employees receive premium tax credits) and for employer reporting requirements, contributions to flex accounts that can be used for non-health as well as health purposes will be considered to reduce employee contributions for plan years beginning before January 1, 2017 for arrangements adopted on or before December 16, 2015. However, they will not be considered for determining affordability of employer coverage for an employee either for determining liability under the individual responsibility provision or eligibility for premium tax credits.

If an employer offers an employee payments that are available only to an employee if the employee declines health insurance coverage (an opt-out payment), the IRS will consider the opt-out payment as an additional charge for the coverage for determining its affordability for application of the employer mandate penalty. The employee has the option of receiving additional salary for foregoing coverage, and thus is being charged the amount of the additional salary if he or she accepts coverage.

The IRS intends to issue a rule on this issue, and might treat opt-out payments differently if they are subject to additional requirements, such as proof of coverage under a spouse’s plan. The IRS will offer a transitional period for plan years beginning before January 1, 2017 based on arrangements established on or before December 16, 2015, for purposes of the employer mandate penalty and employer reporting, but individual taxpayers may consider opt-out payments as increasing the cost of coverage for application of the individual mandate or premium tax credit eligibility requirements.

Complex issues are presented by the McNamara-O’Hara Service Contract Act and the Davis-Bacon and related acts, which require federal contractors to pay prevailing wages and fringe benefits or cash out fringe benefits for workers. Until these issues are resolved employers may for purposes of the employer mandate and reporting requirements consider cash payments in lieu of fringe benefits as increasing the affordability of coverage, although employees are not required to consider the payments as making coverage more affordable for purposes of the individual mandate affordability exemption or premium tax credit eligibility. Recognizing that the disconnect between employer reporting requirements and employee premium tax credit eligibility requirements during transitional periods for this and other requirements may cause difficulties for employees in establishing tax credit eligibility, the notice urges employers to work with employees to provide necessary information.

Affordability Under The Employer Mandate

For purposes of the employer mandate affordability requirement and related regulatory requirements, including affordability safe harbors, affordability of coverage is defined as costing no more than 9.5 percent of household income (or for safe harbors, 9.5 percent of W-2 or hourly wages or the poverty level). The 9.5 standard is adjusted annually and is set at 9.56 percent for 2015 and 9.66 percent for 2016. The notice makes clear that this adjustment applies to all provisions that use the 9.5 percent standard.

The notice also provides the inflation updates for the statutory penalties under the employer mandate. The $2,000 per full-time employee penalty that applies when an employer fails to offer minimum essential coverage and an employee receives premium tax credit will increase to $2,080 for 2015 and $2,160 for 2016; while the $3,000 penalty that applies on a per-employee basis for employees who receive premium tax credits when coverage does not meet affordability or minimum value standards will increase to $3,120 for 2015 and $3,240 for 2016.

The notice provides a complex analysis of when “hours of service” that would count for crediting hours for Department of Labor regulations do or do not count as “hours of service” for calculating whether an employee is a full-time employee for purposes of the employer mandate. This analysis is beyond the scope of this post.

Service Breaks

A number of ACA rules that apply to full-time employees assume that employees are continuously employed without long breaks in service. Special rules apply for employees of educational institutions who routinely have long breaks in service between school years. Under IRS rules, employees of educational institutions cannot be treated as having terminated employment and then been rehired unless they have a break in service of at least 26 consecutive weeks.

Some educational institutions have been attempting to get around this rule by claiming that their employees are actually employed by staffing agencies with which they contract, and thus, for example, terminated at the end of the school year and rehired in the fall. The IRS is considering a rule that would provide that the educational institution exception would also apply to employees who provide services primarily to educational institutions and are not offered a meaningful opportunity to provide service during the entire year. An individual who worked in a school cafeteria nominally employed by a staffing agency rather than the school, for example, would be protected by the break in service exception unless the staffing agency offered employment in another position throughout the summer.

The notice clarifies that AmeriCorps members are not employees for purposes of the employer mandate, but that individuals offered TRICARE coverage by virtue of their employment are offered minimum essential coverage. The notice discusses how employer aggregation rules apply to government employers. It requires each separate government employer entity to have an employer identification number. The notice also discusses special rules that apply to health savings accounts contributions for individuals eligible for VA coverage and the application of COBRA continuation coverage to flexible spending account carryovers, both topics beyond the scope of this post.

Finally, the notice reiterates that the IRS will not impose penalties on employers that provide incorrect or incomplete 1094-C and 1095-C reports to employees in 2016 for 2015 coverage if they can demonstrate good faith efforts to comply with requirements. Employers who fail to file reports on a timely basis will also be provided relief from penalties if they can show reasonable cause for their failing to do so.

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