On March 29, 2011, the Internal Revenue Service (IRS) issued interim “Q&A” guidance—in Notice 2011-28, 2011-16 I.R.B. 656 (April 18, 2011)—regarding the new requirement under the Patient Protection and Affordable Care Act (PPACA) that employers report the cost of employer-sponsored health coverage provided to each employee for each year. New Internal Revenue Code section 6051(a)(14) requires employers to report on Form W-2 the “aggregate cost of applicable employer-sponsored coverage” provided to employees, calculated under rules similar to those used to determine the “applicable premium” for continuation coverage under COBRA. Among other things, the new guidance identifies which employers are subject to the reporting requirements, explains the types of coverage that must be reported and discusses calculation methods for determining the cost of coverage.
The reporting requirements are “informational only,” and will not cause any health coverage that was previously nontaxable to become taxable. The purpose of the requirement is merely to “provide useful and comparable consumer information to employees on the cost of their health care coverage.”
Employers will need to begin reporting the cost of health coverage on 2012 Forms W-2 that they are required to issue to employees in January 2013. The statutory effective date for the reporting requirement was originally Jan. 1, 2011, meaning employers would have been required to comply beginning with 2011 Forms W-2 (which generally must be issued to employees in January 2012). (PPACA section 9002(b)) However, the IRS previously issued guidance that made the reporting optional with respect to 2011 Forms W-2. (Notice 2010-69, 2010-44 I.R.B. 576 (Nov. 1, 2010))
The new interim guidance in Notice 2011-28 further provides that where an employee terminates employment midyear, and submits a written request to receive his or her Form W-2 for the year of termination before the end of that calendar year, the employer will not need to report on the “early” Form W-2 the cost of employer-sponsored coverage provided to the employee for that year. For example, if an employee terminates employment during 2012 and requests to receive his or her Form W-2 before the end of the year, then that “early” 2012 Form W-2 will not need to include any information regarding the cost of health coverage provided to the employee. Accordingly, the reporting requirement will not be effective for any Forms W-2 furnished to employees prior to January 2013, and the new guidance clarifies that it will not apply to any Forms W-2 issued before then (unless an employer chooses to voluntarily report the cost of employer-sponsored coverage on an earlier-issued Form W-2).
Potential Penalty for Failing to Comply
Under current law, an employer could be subject to significant penalties each year for failing to properly report the cost of employer-sponsored health coverage. Specifically, there is a potential penalty of $100 per Form W-2, capped at $1.5 million per year, for both (1) the failure to properly report the cost of coverage on the Form W-2 filed with the IRS, and (2) the failure to properly report the cost of coverage on the Form W-2 furnished to the employee. This penalty may be reduced in certain cases where the failures are corrected within a specified period of time. In practice, the IRS tends to apply only one of these two sets of penalties per Form W-2, but it does not seem to be prohibited from imposing both of them.
The new guidance provides transition relief for certain smaller employers. Specifically, employers need not comply with the reporting requirements for any calendar year if they were required to furnish fewer than 250 Forms W-2 for the preceding calendar year. For example, if an employer is required to furnish fewer than 250 Forms W-2 for 2011 (which generally must be issued in January 2012), then it will not need to report the cost of health coverage on any 2012 Forms W-2 (which generally must be issued in January 2013).
Types of Coverage Reportable on Form W-2
With some exceptions, described below, the total cost of all “applicable employer-sponsored coverage”—which the new guidance defines to include all medical coverage that is either nontaxable to the employee, or is of such a nature that it would be nontaxable to the employee if it were employer-paid—must be reported in box 12 of Form W-2, using Code DD. That being said, the reportable cost of coverage also includes coverage provided to any person as a spouse or dependent of the employee, even if the employee is taxed on the coverage provided to such other person.
For example, if an employer offers health coverage to an employee’s domestic partner who does not qualify as the employee’s “dependent” for income tax purposes—meaning the value of that coverage would be subject to federal (and possibly state) income tax—then the cost of the coverage would still be included in the amount reported on the employee’s Form W-2. The reportable amount generally includes both the portion of the cost of coverage paid by the employer and the portion of the cost paid by the employee, regardless of whether the payments are made with pretax or after-tax dollars.
Certain Health Insurance Portability and Accountability Act-excepted benefits are not included in the cost of coverage required to be reported on Form W-2, such as liability and supplemental liability insurance, long-term care, accident, disability, workers’ compensation, stand-alone dental and vision, automobile medical payment, credit-only, and certain specified-disease or hospital indemnity coverage. In addition, the reportable cost of coverage does not include any amounts contributed to a health savings account (HSA), Archer medical savings account (Archer MSA), or flexible spending arrangement (FSA) (with the exception of employer “flex credits” contributed to a health FSA). Also exempt is coverage provided under a multi-employer plan, health reimbursement arrangement (HRA), self-insured plan that is not subject to federal continuation coverage requirements (e.g., a self-insured church plan that is exempt from COBRA), or governmental plan maintained primarily for members of the military. The cost of coverage provided by an employer’s on-site medical clinic, however, must be included in the amount to be reported on Form W-2.
Calculating the Cost of Coverage
There are essentially three available methods of calculating the cost of coverage:
The COBRA applicable premium method.
The modified COBRA premium method.
The premium charged method (for insured plans only).
An employer is not required to use the same method for each different plan that it offers, but must use the same method, within each plan, for every employee who receives coverage under that plan.
COBRA applicable premium method. Under the COBRA applicable premium method, the employer may simply calculate the premium amount that a terminated employee would need to pay under COBRA for the coverage at issue—in good-faith compliance with a reasonable interpretation of the COBRA rules—and report that amount on Form W-2.
Modified COBRA premium method. An employer may use the modified COBRA premium method only where the employer either subsidizes the cost of COBRA coverage (so that individuals on COBRA pay less than the full amount that they could be charged for the coverage under COBRA) or uses the COBRA premium that applied for a prior year as the actual premium charged for COBRA coverage.
If the employer subsidizes the cost of COBRA coverage, the employer may determine the reportable cost based upon a reasonable good-faith estimate of the full COBRA premium for that period. For example, assume that an employer reasonably and in good faith estimates the full COBRA premium for self-only coverage under a health plan to be $300 per month in 2012, and subsidizes 50 percent of that cost (i.e., $150 per month). If the employer elects to use the modified COBRA premium method, the monthly reportable cost for self-only coverage on the 2012 Form W-2 will be $300.
If the employer uses the COBRA premium that applied for a prior year as the actual premium charged for COBRA coverage, the employer also may use that prior year’s COBRA premium as the reportable cost for the current year. For example, assume that an employer determines the premium for self-only COBRA coverage to be $350 per month in 2011 (and therefore charges $357 per month, including a 2 percent administrative fee as permitted under COBRA), and chooses to use that same COBRA premium for 2012. Under the modified COBRA premium method, the monthly reportable cost for self-only coverage on the 2012 Form W-2 will be $350 (excluding the 2 percent administrative fee).
Premium charged method (insured plans only). For an insured group health plan, an employer may use the premium charged method to simply report the premium that the insurance carrier charges for the employee’s type of coverage (e.g., self-only coverage, family coverage, etc.) on the Form W-2.
Special Rules Relating to Midyear Changes
If an employee terminates employment midyear and elects to continue his or her health coverage under COBRA, the employer may generally choose whether or not to include the cost of the COBRA coverage in the amount reported on Form W-2, provided that whatever the employer chooses applies consistently to all employees who terminate employment midyear. Again, however, if an employee terminates employment midyear and requests a Form W-2 before the end of that year, the employer is not required to report any amount of health coverage on the “early” Form W-2.
If the cost of coverage changes during the year, the amount to be reported on Form W-2 must reflect that change. For example, if an employee changes from self-only to family coverage halfway through the year, the total reportable cost for the year must reflect the cost for six months of self-only coverage and six months of family coverage. An employer may use any reasonable method to determine the reportable cost if the change in coverage occurs during a period such as mid-month where the cost is determined on a monthly basis.
Notice 2011-28 neither provides any additional guidance regarding how to calculate the cost of coverage (i.e., the “applicable premium” under the COBRA rules), nor indicates whether or when such additional guidance may be expected in the future. The notice does request comments on all aspects of the Form W-2 reporting requirement, including areas that should be addressed in future regulations or other guidance.
Notice 2011-28 also notes that future IRS guidance may limit the availability of some or all of the transition relief provided under the interim guidance (e.g., relating to “smaller” employers; employers required to furnish a Form W-2 before the end of the year, pursuant to a terminated employee’s written request; coverage provided under a multi-employer plan; stand-alone dental and vision coverage; and employers with self-insured plans that are not subject to federal continuation coverage requirements). However, any such guidance will be prospective only, will apply no earlier than Jan. 1 of the calendar year beginning at least six months after the guidance is issued, and will in no event apply to 2011 or 2012 Forms W-2 (which are generally required to be furnished in January 2012 and 2013, respectively).
Although the new reporting requirements do not apply until 2012 Forms W-2 are issued in January 2013, employers should begin working to coordinate their tax and human resource/benefits departments to ensure that the total cost of employer-sponsored health coverage will be properly tracked, calculated and reported. Moreover, given the potentially hefty penalties that could be imposed for failures to properly and timely report the cost of coverage on Forms W-2—and the fact that the IRS and Treasury Department are likely to replace the current interim guidance with additional guidance or final regulations in the future—it is important for employers to remain apprised of new developments in this area.
Fred Oliphant, chair of the Employee Benefits Department at law firm Miller & Chevalier in Washington, D.C., has broad experience with nearly all types of employee benefits and executive compensation offered by Fortune 500 companies, focusing in particular on the federal tax aspects of such arrangements. Over the last 30 years, his practice has routinely involved representing clients before the Internal Revenue Service and the U.S. Department of the Treasury, as well as the U.S. Department of Labor.
Garrett Fenton, senior associate at law firm Miller & Chevalier in Washington, D.C., practices in the areas of tax, employee benefits, and executive and deferred compensation. Within these areas, he has assisted numerous clients with respect to a broad range of issues, including tax-qualified retirement plan drafting and operational issues, Internal Revenue Code Sections 409A and 162(m), fringe benefits, payroll taxes, and health and welfare benefits.