Employers promising to pay for health care in recruiting an executive or in negotiating an outplacment package need to pay close attention to overlooked tax provisions, some of which have been modified by the Affordable Care Act (ACA). In some cases, these rules are designed to prevent payments for health coverage that discriminate in favor of highly compensated individuals; but, in other cases, the rules effectively prohibit an employer from paying for or reimbursing any employees for purchases of individual health insurance.
Payment for health care coverage comes in many forms from a simple payment for coverage under a group plan sponsored by an employer to the more complex reimbursement for premiums for coverage obtained from other sources. Each is subject to different tax rules. Violations of some rules cause employers to incur liability for substantial federal tax penalties, while other types of violations may result in highly compensated individuals incurring additional taxable income.
A. Coverage Under Employer Group Plans
In the simplest situation, an employer will pay the cost of an employee’s coverage under a group health plan maintained by the employer for all or most of its employees. While such payments may generally be made on a tax-free basis, employers must be aware of nondiscrimination rules designed to prevent the employer from paying a disproportionate share of the premiums on behalf of highly compensated individuals. For self-insured plans, the nondiscrimination provisions have been in place for decades and, if violated, will cause highly compensated individuals to be taxed on the benefits provided under the plan.
The ACA added similar nondiscrimination provisions for insured plans. If the ACA’s new insured plan nondiscrimination rules are violated, the employer becomes subject to excise tax penalties of $100 per day for each covered life. However, the IRS delayed the application of these provisions for insured plans pending the issuance of additional guidance. Some commentators have speculated that this guidance may be issued later in 2016; but there hasn’t been any official word from the IRS.
B. Reimbursement For Coverage From Other Sources
A different analysis applies when an employer reimburses an employee for the cost of obtaining health coverage from sources other than a group plan maintained by the employer (including when the employer pays that other source directly). IRS guidance prohibits employers from paying directly or reimbursing employees for their premium payments for individual health insurance policies regardless of whether payments are made on a pre-tax or after-tax basis.
These arrangements are referred to as “employer payment plans.” Such plans are subject to the full range of ACA market reforms, which has rendered this option obsolete. For example, the ACA requires health plans to satisfy a number of requirements such as prohibitions on life time and annual limits, the provision of preventive services without copays, coverage of adult children to age 26, and many other patient protections designed to increase coverage. An employer payment plan can’t be aggregated with the underlying individual health insurance policy for purposes of satisfying each of these requirements. Therefore, the employer payment plan by itself will never be able to comply with the ACA – resulting in excise taxes imposed on the employer in the amount of $100 per day for each covered life, and for each market reform not satisfied.
This, in short, is a no-fly zone: drafters must avoid any obligations to pay or reimburse employees for individual health insurance coverage. Conversely, payments of additional taxable cash compensation are an acceptable substitute in negotiating an employee’s compensation package. Such payments, however, can’t be tied directly or indirectly to the employee obtaining individual health insurance coverage from other sources.
C. Handling COBRA Continuation Coverage
Severance agreements should continue to avoid commitments to pay COBRA continuation premiums for health coverage under self-insured plans on behalf of a disproportionate number of highly compensated individuals. Here again, the dichotomy between self-insured and insured plans remains important.
Pending IRS guidance on insured plans, there are two possible strategies. The first is to avoid any such commitments for the employer to pay a larger amount of health insurance premiums for highly compensated individuals than it pays for nonhighly compensated individuals on the assumption that the rules ultimately issued will make all such commitments discriminatory. The second is to include such provisions, but have the employer retain the unilateral discretion to alter the terms of such commitments if necessary to comply with the IRS guidance when it is issued.
Employers should also clearly communicate the terms and implications of such commitments to former employees for whom they pay COBRA premiums. Employer COBRA subsidies aren’t forever; the end of a subsidy may make COBRA continuation overly expensive in comparison to marketplace coverage. Yet, when that happens outside of an ACA open enrollment period, the former employee may be left with unaffordable coverage or no coverage. Simply stated, the ACA makes the historic practice of providing subsidized COBRA far less beneficial.
D. Reconsidering Opt-Out Credits
Some employers use opt-out credits (which offer employees an additional taxable cash incentive to enroll in health coverage other than the employer’s plan). These provisions only work when part of an employer’s cafeteria plan. Now, the limitations (even in that context) make this a burdensome and complicated option.
There is a double burden. First, cafeteria plans with such opt-out credits must condition the payments on documentation of coverage from sources other than individual health insurance coverage (so as not to violate the “employer payment plan” prohibition) or Medicare (so as not to run afoul of Medicare secondary payor rules). Second, even then, employers must also be mindful of the effect of such credits on the affordability of the employer’s other offers of health coverage under the ACA’s “pay or play” penalty structure.
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Pre-ACA experience with executive compensation or pre-ACA templates for executive compensation agreements will leave you in dangerous places without the requisite map. Noted travel writer Paul Theroux in his recent book – Last Train to Zona Verde – wrote that his favorite place is one “that doesn’t welcome tourists, that’s really difficult and off the map.” Apparently, Theroux only visits where I work every day; call if you need a tour.