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The effects of health care reform's provisions could impact employers' tax obligations
The health care reform legislation enacted last March will bring about significant changes in the U.S. health care system and in many employers’ tax practices and payments.
The most significant changes in health care will take effect in 2014, when the state health insurance exchanges are to be operating. By then, employers will have faced, or will be facing, critical decisions on how much health coverage to offer or even whether to offer coverage at all.
In the meantime, employers should not overlook the tax-related changes already taking hold or about to become effective. To avoid problems, employers need to be diligent in learning about and responding to a range of tax-related changes brought about by the health care reform legislation— formally, the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act of 2010.
Employers are used to adapting their policies and practices to reflect the adjustments made in the U.S. tax code. “Any one change is not that big of a deal, because the tax code changes every year and most companies are able to cope,” says Karen Field, principal in KPMG’s national tax practice in Washington, D.C.
However, the health care reform law’s tax changes will require companies in many instances to gather different information than they had assembled in the past. This could cause them to overlook tax compliance issues as they focus on making sure that their existing systems are capable of gathering the required data.
For example, starting with year-end tax reporting for the 2011 tax year, employers must include the value of benefits plans on federal forms W-2 for all employees.
“This reporting is for informational purposes only, to show employees the value of their health care benefits so they can be more-informed consumers,” according to the Internal Revenue Service. The value of the employer’s contribution to an employee’s health coverage remains excludable from the employee’s income and is not taxable. Nonetheless, employers will face a challenge in acquiring information on the cost of the various health insurance premiums they pay on employees’ behalf or the cost per employee for self-funded health care plans.
Employers may already have some of this information and may even be providing this information to employees as part of total rewards statements. However, as with any tax reporting issue, accuracy will be more important than it would be for informal internal reporting.
In addition, employers need to be mindful of the tax effects they could encounter if they fail to comply strictly with some coverage provisions of the law. “Health plans have historically received favorable tax treatment,” says Ian Herbert, a shareholder of law firm Greenberg Traurig LLP in Washington, D.C. “Many of the structural provisions of health care reform—including coverage for adult children, no pre-existing condition exclusions and no lifetime limits—have been incorporated into the tax code. While they don’t necessarily affect an employer’s basic tax liability, failure to comply with these requirements can subject the employer to a significant excise tax that could effectively wipe out the favorable tax treatment.” Moreover, employers are now required to self-report the failures that can subject them to these excise taxes.
Finally, health care reform grants grandfathered status to health plans in place when the reform law was enacted last March 23. A grandfathered plan can maintain that status as long as it is not altered in material ways spelled out in the regulations. With grandfathered status, an employer’s plan is exempt from certain requirements of the law or implementation is delayed. For more on grandfathered status, see “Keep Grandfather? Or Let Him Go?” at www.shrm.org/hrmagazine/0910TylerSpecialReport.
If a health benefits plan does lose its grandfathered status, the result could be greater exposure to tax-related complications. An important risk for employers centers on nondiscrimination requirements. They have been in place for years for self-funded plans—also called self-insured plans—where the employer pays for medical claims and fees out of current revenue, in effect acting as its own insurer. Now, under the health care reform law, nondiscrimination requirements will be applied to fully funded plans—also called fully insured plans—where the employer pays a fixed premium to a third-party commercial insurance carrier that covers the medical claims. Essentially, fully funded health plans that are not shielded by grandfathered status cannot discriminate in favor of highly compensated individuals with regard to level of benefits or eligibility to participate.
What’s more, the costs of maintaining a discriminatory plan differ according to how the plan is funded. If it is self-funded, all benefits provided to highly compensated employees must be counted in those employees’ incomes. But if the plan is fully insured and is determined to be discriminatory in favor of highly compensated employees, the employer can be liable for an excise tax of $100 per day per participant for all participants in the discriminatory plan.
Wait, There’s More
Other tax-related provisions in the health care reform law include the following:
Small-business health care tax credit. Businesses with 25 or fewer employees and average annual per-employee pay of less than $50,000 can obtain a tax credit equal to as much as half of the nonelective health insurance premium contributions the business makes on behalf of its employees. Nonelective contributions are those made by an employer regardless of whether the employee makes a salary reduction contribution to the plan. Businesses with 10 or fewer employees and average per-employee pay of up to $25,000 can claim a tax credit for 100 percent of such payments.
“There is a transition rule for 2010 that allows an employer to claim the credit if it pays a uniform percentage of the cost of single coverage for everyone,” Herbert says. “Starting next year, the employer must pay the same percentage of the premium for family coverage as it does for single coverage.”
Because many employers subsidize employee-only coverage to a greater extent than they subsidize family coverage, they may need to crunch some numbers. “Employers in this situation that are otherwise eligible for the credit should consider whether the value of the credit outweighs the cost of providing a greater subsidy for family coverage,” Herbert says.
“Cadillac” plan tax. Beginning in 2018, there will be a 40 percent excise tax on the portion of a health care plan’s value exceeding $10,200 for individual coverage or exceeding $27,500 for family coverage. The thresholds will be indexed for inflation; the costs of dental and vision benefits are not included. For example, an individual plan valued at $12,200 per employee covered would be $2,000 above the threshold, and the tax would be 40 percent of $2,000, or $800, for each employee covered by the high-cost plan. The excise tax will be paid by the issuer of the health coverage—an insurance company for a fully insured plan, or the employer for a self-insured plan.
“The dollar limits are somewhat low,” says Deb Walker, a partner with Deloitte Tax LLP in Chicago, particularly considering the current rate of health care inflation and the fact that the provision does not kick in for seven years. Higher limits apply to individuals working in certain high-risk professions, such as firefighters.
Small-business simple cafeteria plans. Starting next year, small employers can avoid the nondiscrimination requirements for cafeteria plans in general and for specific benefits offered through a cafeteria plan—such as group term life insurance and dependent care assistance programs— by using a safe harbor created by the health care reform law. By using the safe harbor, employers offering a cafeteria plan only need to make sure the plan satisfies minimum eligibility, participation and contribution requirements.
Three Years and Counting
From now to 2014, employers with 50 or more full-time employees will have to make decisions on how to structure their health care coverage—or how to cope with possible excise taxes and penalties if they offer coverage that any employees can’t afford, or if they don’t offer any coverage at all.
David Pearson, a partner in the law firm of Constangy, Brooks & Smith LLP in Tampa, Fla., says: “The ultimate tax issue is going to be the decision whether to pay or play. Employers must decide whether they are going to pay a penalty or have a qualifying health plan that provides the minimum essential benefits package and with an employer-provided contribution that represents a large enough percentage of the cost to avoid the penalty.”
There are many factors involved in this decision beyond the financial ones. Pearson adds: “The choice is going to be driven by the tax because ultimately employers have to factor in what the penalty is going to be.”
Life Is Full of Tax Changes
Many of the tax provisions in the health care reform law are summarized below, with the tax year they go into effect:
• Over-the-counter drugs can no longer be reimbursed through a health flexible spending arrangement.
• The value of health care coverage must be included on employees’ forms W-2, although the amount is not taxable.
• The tax on nonmedical withdrawals from health savings accounts will double, to 20 percent from 10 percent.
• Medicare taxes will increase for highly compensated employees, and those amounts must be withheld and reported on forms W-2.
• Employee health flexible spending account contributions will be capped at $2,500.
• Employers will no longer be able to deduct the subsidies they receive from the U.S. Department of Health and Human Services for providing a qualified retiree prescription drug plan; therefore, the employer’s deduction will be limited to its costs minus the amount of any subsidy received.
• A health care plan cannot have a waiting period for enrollment of more than 90 days. Part of the calculus involves the state-based health insurance exchanges slated to be up and running by 2014. The exchanges will be marketplaces where health coverage providers will compete to sell plans for individuals who don’t have access to employer-sponsored coverage and who are not eligible for Medicaid or other programs.
People with adjusted gross income up to 400 percent of the federal poverty level—currently up to $88,000 for a family of four—will be eligible for premium subsidies from the federal government for plans purchased through the exchanges. A family of four with income less than $30,000 per year will become eligible for Medicaid under the new law.
Starting in 2014, according to a Congressional Research Service report, an employer with 50 or more employees “will be subject to a penalty if any of its full-time employees receives a premium credit toward their exchange plan.”
Walker says, “The penalty tax is a stick to encourage employers to continue to provide benefits.”
Employers that do not offer health care coverage and that have at least one employee receiving a credit for health coverage premiums will have to pay a monthly penalty at a rate of $2,000 per year for each full-time employee. The first 30 employees are excluded from the headcount.
If, on the other hand, an employer does offer health coverage, the employer would still be liable for a penalty if any of its full-time employees “obtains coverage through an exchange and receives a premium credit,” according to the research service report. An employee could qualify for coverage through an exchange if, among other things, the employee’s required contribution toward the employer-sponsored plan premium for self-only coverage exceeds 9.8 percent of the person’s household income, or if the plan pays for less than 60 percent, on average, of covered health care expenses.
If the premium is 8 percent to 9.8 percent of an employee’s household income, the employer must provide a free voucher that the employee can use to purchase health care coverage through an exchange. The value of the voucher must be equal to the contribution the employer makes toward the employer-provided plan on a participating employee’s behalf.
An employer in that situation—offering health coverage, but with at least one employee receiving a premium credit because the coverage exceeds affordability standards—would then be subject to a monthly penalty at the rate of $3,000 per year for each employee receiving the credit, or $2,000 per employee for all fulltime employees on the payroll, whichever amount is lower. The first 30 employees are excluded from the calculation.
Although it is relatively simple to determine the difference in costs between paying for health care benefits for employees and simply paying the penalties imposed by the health care reform law, employers will have to consider other issues. For example, some elements of the law need to be clarified by regulators. The term “minimum essential coverage” must be defined. And it remains to be seen whether the state exchanges will resemble existing programs such as Medicare or Medicaid, or whether they will operate differently. “There are a lot of pieces we do not have yet,” says Field. “There are an awful lot of moving parts that somehow have to come together by 2014.”
Moreover, the existence of penalties and vouchers creates challenges for employers. For example, some of the penalties and credits related to health benefits are based on an employee’s household income. Yet “the employer has no way of knowing an individual employee’s household income, and it is not the employer’s business,” Field says. “This is going to raise some important privacy concerns.”
Methods for employers to obtain such information, along with the question of whether an employer should be involved in acquiring such information, will need to be resolved before this part of the law takes effect.
The road toward health care reform is just beginning. In coming months and years, federal officials will be issuing regulations designed to help employers implement these requirements. The content of those regulations will likely have a tremendous impact on employer actions and decision-making. Therefore, employers must keep tabs on developments and consider new information as it becomes available.
A team made up of representatives from HR, information technology, payroll and finance departments can work together to determine what information they need to meet the requirements of health care reform and what actions they need to take internally to ensure smooth implementation.
The author is a New Jersey-based business and financial writer.
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