You might scratch your head and wonder why a law that is intended to improve the quality of health care for U.S. citizens would penalize employers that are trying to do their part. The reason is simple: Since the value of health benefits is not taxable to employees, the more generous the health plan, the more Americans benefit from this “tax loophole.”
Reducing “tax expenditures” is a goal of budget hawks. What is a “tax expenditure?” It’s something the government cannot collect tax on. Health benefits are a major tax expenditure (other examples are charitable deductions and mortgage interest). Advocates of lowering marginal income tax rates recognize that to do so without adding further to the federal deficit, tax expenditures have to be reduced or eliminated.
The “Cadillac tax,” which is part of the Affordable Care Act (ACA), opens the door to reducing the health benefit tax expenditure. However, it’s the employer who pays the tax (a whopping 40 percent on coverage deemed to be excess) — not the employee. Of course, the effect for most employees who might otherwise enjoy a generous health plan will be a reduction in the value of that benefit. In this case, the term “employee” also includes former employees, surviving spouses and other primary insured individuals.
What exactly is a “Cadillac” health benefit? The definition begins by defining a more basic term, that is, “applicable coverage.” Applicable coverage refers to the benefits that are counted towards the Cadillac tax dollar thresholds.
As the IRS describes it, this ACA Code Section “provides that applicable coverage means ‘with respect to any employee, coverage under any group health plan made available to the employee by an employer, which is excludable from the employee’s gross income under Code Sec. 106, or would be so excludable if it were employer-provided coverage, within the meaning of such Code Sec.106.'” (More on this below.)
The ACA defines a Cadillac plan as one with “applicable coverage” worth more than $10,200 for self-only coverage, and $27,500 for “other than self-only” coverage.
If the value of a health policy for self-only coverage is deemed to be worth $15,200 in 2018, the employer would end up paying $2,000 in tax on the excess. Here’s how:
The coverage value, $15,200 less the Cadillac plan limit of $10,200 leaves an excess value of $5,000 times the applicable tax due on excess coverage, which is 40 percent. $5,000 times 40 percent is $2,000.
Limit Adjustment Provisions
The law does provide “for various adjustments to increase the applicable dollar limits in certain circumstances” after 2018, the IRS notes. Those can include inflation and an “age and gender adjustment” to account for unusually high or low plan costs based on demographics. The details have not been worked out yet.
In new guidance on the Cadillac tax (IRS Notice 2015-16), the IRS tried to put some flesh on the bones of guidance it has already issued on how it will work. The guidance is tentative, however — subject to future, more definitive rules.
One area that needs some sharper definitions is that of “applicable coverage” — the benefits counted towards the limits. In general, the ACA will use the same basic rules used for purposes of charging employees for COBRA coverage.
Notice 2015-16 indicates that the value of employer contributions to health reimbursement accounts are part of the equation. This is probably also true for executive health/fitness programs, although this is subject to further deliberation.
HSA Contributions and Other Points
Employer contributions to health savings accounts (HSAs) and Archer Medical Savings Accounts are also expected to be factored into the valuation of coverage. However, the after-tax contributions made by employees to their HSAs will not be included in that calculation.
What about on-site medical clinics? The IRS indicates the answer depends on what services the clinics offer. If it’s merely basic first aid and “de minimis” health care, it is not included.
Also likely to be excluded from the calculation are “limited scope dental and vision benefits.” These are defined under Internal Revenue Code Section 4980i as “any coverage under a separate policy, certificate, or contract of insurance which provides benefits substantially all of which are for treatment of the mouth (including any organ or structure within the mouth) or for treatment of the eye.”
Employee assistance programs will probably also not be counted towards the value of the health benefit.
Notice 2015-16 contemplates that self-insured employers will have two methods of establishing the value of their health benefits (similar to the way they handle COBRA calculations): the actuarial method or the “past cost” method. Using the “past cost” method requires an affirmative decision. If there is no affirmative decision, the actuarial method will be assumed.
The IRS says it plans to “issue another notice inviting comments on certain additional issues not addressed in this notice,” and that “it is expected that the comments responding to the notices will be used to inform proposed regulations that will be issued in the future for further public notice and comment.”