Tax Law Insights

Beginning in 2018, certain employers will be liable for a new 40% federal excise tax on the value of excess benefits provided through their health plans. Health plans providing high cost benefits are referred as "Cadillac" plans, and the new federal excise tax on high cost plans has come to be known as the "Cadillac tax".

Under the Cadillac tax, if the aggregate cost of "applicable employer-sponsored coverage" provided to an employee exceeds a statutory dollar limit (revised annually), the excess is subject to a 40% excise tax.

In a prior post, I reviewed who is liable for and who must calculate the Cadillac tax. This post discusses the types of health coverage that are includable in Cadillac tax calculations (i.e., the cost of "applicable employer-sponsored coverage"). "Applicable employer-sponsored coverage" is hereinafter referred to in this post as "Includable Coverage."

I. Health Coverage that is Includable Coverage under the General Definition.

Generally, Includable Coverage is coverage under any "group health plan" made available to the employee by an employer which is excludable from the employee's gross income under Section 106 of the Internal Revenue Code (the "Code") or would be so excludable if it were employer provided coverage. See Section 4980I(d)(1) of the Code. Includable Coverage also includes coverage made available to self-employed individuals, former employees (including retirees), and surviving spouses (or other primary insureds).

There are two elements to the general definition of Includable Coverage: (1) coverage under a "group health plan"; and (2) coverage excludable (or would be excludable) under Section 106 of the Code. With respect to the "group health plan" element, a "group health plan" means a plan (including a self-insured plan) that is sponsored by, maintained by or contributed to by, an employer (or employee organization) to provide health care (directly or otherwise) to employees, former employees, or their families.

With respect to the exclusion from gross income element, subject to certain exceptions, Section 106 of the Code generally excludes from gross income the value of employer provided coverage under an accident or health plan. In effect, Includable Coverage is determined by reference to whether the health benefits are excludable or could be excludable from gross income under Code Section 106. Thus, Includable Coverage is determined without regard as to who actually pays for the coverage (e.g., employee 100%, employer 100%, or some other cost sharing arrangement). Likewise, if the health coverage could be excludable from gross income, the coverage is Includable Coverage even if the employee pays for the coverage with after-tax dollars.

The general definition of Includable Coverage includes typical employer health plans (i.e., health plans with benefits excludable under Code Section 106 whether fully insured, self-insured, high deductible plans, health maintenance organizations, etc.). The general definition of Includable Coverage is also sufficiently broad so as to include Archer Medical Spending Accounts and Health Spending Accounts.

From an employer's perspective, other than eliminating Archer Medical Spending Account or Health Spending Account coverage, the most viable option to reduce Cadillac tax liability arising from these types of health plans will be to reduce the costs of the plan through the reduction of benefits (to the extent permitted by the Health Care Reform Act) or the reduction of claims through permissible wellness programs and other cost containment programs.

II. Health Coverage that is Includable Coverage under Special Provisions.

In addition to typical group health plans, the Cadillac tax statute (Code Section 4980I) designates the following health coverage as Includable Coverage:

1. Health flexible spending accounts ("Health FSAs"), but see Part III, item (6) for the potential exclusion from Includable Coverage of self-insured limited scope dental and vision coverage that qualifies as an excepted benefit under the HIPAA regulations ("Limited Scope FSAs");
2. on site medical clinics which provide more than minimal services (i.e., clinics that (a) provide more than first aid to conditions or injuries that occur during working hours; (b) cover other than current employees; or (c) charge for services);
3. coverage for a specified disease or illness and hospital indemnity coverage, if the payment for the coverage or insurance is excluded from gross income or deductible under Code Section 162(l) (e.g., certain cancer or other specific disease or amount policies); and
4. Coverage under certain governmental plans (covering civilian employees) maintained by the federal, state, political subdivisions thereof, or agencies or instrumentalities thereof . See Code Sections 4980I(d)(1)(E) (governmental plans covering members of the military are beyond the scope of this post).

Finally, certain executive physical programs and health risk assessments (often offered in connection with wellness programs) meet the general definition of Includable Coverage (under Section 4980I(d)(1) of the Code). However, the Internal Revenue Service (the "IRS") is expected to provide future guidance on the treatment of executive physical programs and health risk assessments. See Notice 2015-16 (February 23, 2015).

Employers who become subject to the Cadillac tax, will likely re-evaluate the continued offering of the health coverage described in this Part II. A number of commentators have suggested that unlimited Health FSAs (item (1) above) and specific illness policies (item (3) above) will likely be discontinued by many employers who became subject to the Cadillac tax.

III. Health Coverage Excluded from Includable Coverage.

The Cadillac tax statute (Section 4980I of the Code) specifically excludes the following types of coverage from Includable Coverage:

1. coverage only for accident or disability income insurance or any combination thereof (e.g., typical accident and disability benefits) and automobile medical payment insurance;
2. coverage issued as liability insurance (including coverage as a supplement to such liability insurance), including general liability (insurance and automobile liability insurance);
3. workers compensation or similar insurance;
4. certain other insurance similar to the coverage listed in (1) through (3) above (including credit-only insurance) and under which benefits for medical care are secondary or incidental to other insurance benefits;
5. long term care coverage;
6. coverage under a separate arrangement which provides benefits substantially all of which are treatment for the mouth or treatment of the eye. The IRS is considering expanding this exclusion to cover certain Limited Scope FSAs; and
7. coverage for a specific disease or illness and hospital indemnity coverage, if the payment for the coverage or insurance is not excluded from gross income or not deductible (the mirror of Part II, item (3) above).

In Notice 2015-16, the IRS requested comments as to whether Employee Assistance Programs ("EAPs") which qualify as an excepted benefit under the HIPAA regulations should be excluded from Includable Coverage. We expect that the IRS will address EAPs in future guidance (and hopefully, exclude EAPs from Includable Coverage).

From an employer's perspective, the benefits described in this Part III provide limited options for reducing the employer's potential Cadillac tax liability. If IRS guidance for Limited Scope FSAs and EAPs is favorable, employers will likely take steps to exclude such coverage from Includable Coverage.

In summary, beginning in 2018, employers will need to determine whether they offer Includable Coverage which provide "excess benefits" (within the meaning of Code Section 4980I(b)). While the typical employer provided health plan, Archer Medical Spending Accounts, and Health Spending Accounts are nearly always Includable Coverage, some additional health coverage is either specifically excluded from Includable Coverage or may be modified to be excluded from Includable Coverage. Employers will need to review their health coverage offerings in connection with their Cadillac tax compliance.