HSA and FSA Strategies to Avoid the ‘Cadillac Tax’

Steps to keep account contributions from triggering the tax

By Joanne Sammer December 15, 2015

The 40 percent excise tax on high-cost health plans, originally scheduled to take effect in 2018 but now delayed until 2020, will apply to plan costs above $10,200 for individual coverage and $27,500 for families.

Although the bulk of plan costs consist of premiums, the threshold for triggering the “Cadillac tax” includes the dollars that employers contribute directly, and that employees contribute through pretax salary deferral, to health savings accounts (HSAs) and flexible spending accounts (FSAs).

The tax’s threshold also includes employers’ pretax contributions to health reimbursement arrangements (HRAs). Only employers can contribute to HRAs, so unlike HSAs and FSAs, there are no employee contributions to consider.

Because employer and employee pretax contributions are included in Cadillac tax calculations, there is growing concern that the tax’s implementation will undermine employers’ commitment to providing and funding HSAs and similar accounts.

“HSAs are the cornerstone of consumerism,” said Gerry Leonard, Atlanta-based president of ADP Benefits Services. “Including HSAs [in Cadillac tax calculations] flies in the face of the stated goal of getting people to think about how they look after themselves and emphasizing health care engagement and consumerism.”

IRS Stands Firm

The IRS has not yet released final regulations on the implementation of the tax. As a result, some employers and industry and trade groups are still hoping to have contributions to HSAs and similar accounts excluded from Cadillac tax calculations. However, legal experts say there is little hope of that happening unless Congress revises the Affordable Care Act itself to modify, or even repeal, the controversial tax.

“The IRS has a lot of leeway when issuing guidance and regulations and how to interpret various statutes,” said Amy Ciepluch, a partner at law firm Quarles & Brady in Milwaukee. “But this is actually written into the statute, which means the IRS generally does not have the authority to issue guidance that carves out those amounts” from Cadillac tax calculations.

Speaking at the Society for Human Resource Management’s (SHRM’s) March 2015 Employment Law & Legislative Conference in Washington, D.C., J. Mark Iwry, senior advisor to the Treasury Secretary and Deputy Assistant Secretary (for retirement and health policy), affirmed that the “Treasury has no discretion to carve out” employee HSA contributions since “Democrats in Congress had specifically made it a point” to include HSAs under the threshold, and altering that would require statutory change.

But that view isn’t universal. For instance, a May 2015 comment letter to the IRS from the Business Roundtable, representing business leaders, stated, “We believe that HSA, HRA, and FSA contributions should not be included in the calculation, regardless of whether the contribution was pre- or post-tax.... If the agency goes forward with the anticipated treatment of employee pretax contributions to HSAs, many employer plans that provide for HSA contributions will be subject to the excise tax...unless the employer limits the amount an employee can contribute on a pre-tax basis.”

Likewise, in its comment letter to the IRS, the American Bankers Association contended that the agency can issue regulations that exclude employees’ HSA contributions from the taxable threshold without a change in the law, and the ERISA Industry Committee, representing benefit plan sponsors, submitted comments that expressed the same view. But the Obama administration is likely to old firm against a regulatory fix.

Planning Ahead

While many are working toward repealing or amending the law, only time, is likely to tell whether doing either so is possible. Until then, employers are busy trying to determine whether and when the Cadillac tax will be an issue for them.

“Most high deductibles with an HSA would still avoid the excise tax [were it to take effect] in 2018 and probably up until 2022 or 2023, depending on how they structure it,” said Leonard.

It might be even sooner than that. A 2015 survey by United Benefit Advisors (UBA), an alliance of independent benefit advisory firms, found that 30 percent of U.S. employers would have been subject to the Cadillac tax had it taken hold in 2018, assuming those employers made no changes to their plans. However, the low indexing rate included in the law (the Consumer Price Index plus one percent) is unlikely to match the actual rate of health care inflation. Therefore, more employers are likely to find themselves impacted by the tax as time goes on.

The UBA survey projects that half of employers will face the Cadillac tax by 2020 and nearly 74 percent will do so by 2022. These percentages assume a 6 percent compounded increase in health benefit costs each year.

Employers’ Options

There are workarounds for employers to keep HSAs and FSAs as viable elements of their health benefit offerings.

For example, because vision and dental benefits are not included in Cadillac tax calculations, employers could maintain their current FSAs but limit their use to vision and dental expenses. “Some talk about this situation as the death of the FSA,” said Joe Kra, a partner in Mercer’s health benefit practice in New York City. “But it might be more of an evolution of FSAs.”

HSAs can also get a makeover to avoid inclusion in Cadillac tax calculations. “Employers may have less incentive to allow pretax employee contributions to HSAs through payroll, and may instead go down the road of allowing employees to make payroll contributions to HSAs on an after-tax basis,” said Paul Fronstin, director of the health research and education program at the nonprofit Employee Benefit Research Institute (EBRI), speaking Dec. 10 in Washington, D.C.

In this scenario, an employer would have to limit HSAs to post-tax employee contributions, similar to how employees fund a Roth 401(k). The good news is that employers would still be able to offer automatic salary deferral for those post-tax employee contributions, easing administration for employees.

In addition, unlike with a Roth 401(k), employees would be able to deduct their post-tax HSA contributions on their own income tax returns, although they would have to pay FICA taxes on these amounts.

While not ideal, “if this approach is what it takes to take avoid the Cadillac tax, then we can expect employers to go that route,” said Kra.

Building a ‘Net’

In situations where employee pretax contributions to FSAs are what takes an organization above the tax threshold, “it may not result in a big dollar tax because not that many employees might participate in an FSA, but it would automatically trigger a potentially complex administrative process of calculating and paying the tax,” noted Richard Stover, a health care actuary with Buck Consultants in New York City, who spoke at the EBRI forum. “High-deductible health care plans with HSAs have a similar issue. So many employers are going to need to limit what employees can contribute on a pretax basis” to these accounts.

If an employer expects to have to shift to post-tax HSA contributions when the Cadillac tax takes hold or at some other point in the future, that employer can “encourage people to build a health care ‘net’ (through pretax HSA contributions) until it gets phased out,” said Leonard. “They have an opportunity to build up a base of pretax HSA contributions over the next couple of years, which is probably not a bad idea.”

Joanne Sammer is a New Jersey-based business and financial writer. Stephen Miller, CEBS, an online editor/manager for SHRM, contributed to this article.​


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