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Individual Medical Policy Arrangements May Result in Significant Excise Tax Liability

The Employers Council on Flexible Compensation (ECFC) is an industry association made up of leading cafeteria and related benefit plan service providers and plan sponsors. In the aftermath of agency guidance (outlined below), ECFC has received numerous inquiries from employer plan sponsors and member companies as to whether employers can make available individual major medical coverage to employees on a tax-free basis as part of an employer-sponsored arrangement. This practice may have significant adverse tax consequences for employer plan sponsors. This Employer Alert Bulletin is intended to direct employers (and their counsel) to authoritative guidance on the issue.

As recently reported in ECFC’s article titled “Agency Guidance Prohibits Pre-Tax Funding of Individual Medical Coverage For Active Employees” (linked here and attached as Appendix A) (the “ECFC Article”), the Department of Treasury and the Department of Labor (DOL) issued guidance that affects employers’ ability to pay for individual market (IM) policies, (i.e., major medical coverage that is subject to the Affordable Care Act (ACA))1 through a cafeteria plan (the “Agency Guidance”).

The ECFC Article provides that IRS Notice 2013-54 and related sub-regulatory guidance make it clear that a violation of the ACA would arise (resulting in the imposition of an excise tax against employers) due to any pre-tax funding of individual major medical (IM) coverage for active employees through a cafeteria plan. The Agency Guidance clearly provides that an employer’s payment (or reimbursement) of IM premiums for employees violates the ACA and may result in a $100 per employee per day excise tax.

Beware of Entities Promoting Pre-Tax Arrangements to Reimburse or Pay for Individual Health Coverage

Despite the Agency Guidance, ECFC has continued to receive numerous inquiries based on the alleged position of some in the industry that the pre-tax payment of IM coverage premiums by an employer through a cafeteria plan remains a viable benefit option. One of the vendors’ primary assertions is that payment of IM policy premiums through a cafeteria plan is not prohibited by the Agency Guidance because the cafeteria plan is not a group health plan subject to the ACA.

We agree that the payment of IM policy premiums is a permissible cafeteria plan qualified benefit and that the provision of such coverage through the cafeteria plan continues to be exempt from income and employment tax under the Internal Revenue Code. We also agree that a cafeteria plan, in and of itself, is not a group health plan subject to the ACA. However, the Agency Guidance clearly states that any arrangement, which pays or reimburses an employee’s IM policy premiums on a pre- tax basis would be an “employer payment plan,” which the Agency Guidance clearly indicates is a “group health plan” subject to the ACA. The Agency Guidance is also clear that an employer payment plan violates the ACA and employers who sponsor such arrangements would be subject to a potential excise tax of $100 per employee per day. See the ECFC Article–Practice Pointer on page 2, the second entry in the table on page 3, and Section IV.A. on pages 9-12–for a complete discussion.

1 For purposes of this discussion, IM coverage includes both private IM coverage and IM coverage that is a qualified health plan offered through a government exchange established pursuant to the ACA. IM coverage does NOT include excepted benefit coverage (e.g., accident, vision, dental, and certain specified disease and hospital indemnity plans).

What to Do?

The general information and discussion above is provided to assist employers and their counsel and agents/brokers to analyze compliance issues related to the potential impact of IRS Notice 2013-54 on employer pre-tax funding of individual major medical health coverage and does not constitute legal, financial, or tax advice.

Employers who are considering implementing an arrangement involving pre-tax funding of IM coverage for active employees (through a cafeteria plan or otherwise) should consider the following actions:

  • Seek the advice of independent legal counsel to determine the application of IRS Notice 2013-54 to the employer’s specific circumstances.
  • Request a binding legal opinion from the vendor stating that no adverse tax (including excise tax) or financial consequences will result from adoption of such an arrangement.
  • Request that the vendor provide indemnification for any excise taxes imposed as a result of the pre-tax funding of IM coverage.

Practice Pointer: Indemnification that covers only a finding that the arrangement is impermissible is likely insufficient. As noted above and in the ECFC Article, neither payment of IM Coverage premiums through a cafeteria plan nor establishment of an employer payment plan is illegal. However, the failure of the employer payment plan to comply with the ACA’s market reform requirements will result in significant excise tax liability (up to $100 per employee per day or $36,500 per employee per year).