As the cost of providing health coverage increased over the past fifteen years, many employers began to offer employees cash payments if they “opted out” of coverage. Some expected that the Affordable Care Act (ACA) would put an end to opt-out incentive programs. The ACA does not prohibit opt-out payments; however, the IRS recently issued proposed regulations that highlight how the ACA impacts these payments. The IRS’s proposed regulations recognize two types of opt-out arrangements: a) unconditional opt-out payments; and b) eligible opt-out arrangements.
Unconditional Opt-Outs. An “unconditional” opt-out payment offered to an employee for having declined health coverage will be viewed by the IRS as increasing the employee’s required contribution for purposes of determining the affordability of the health plan to which the opt-out payment relates. This is true regardless of whether the employee enrolls in the plan or elects to opt-out and takes the payment. Put another way, the cost of coverage to employees for purposes of determining affordability under the ACA must include not only monthly employee contributions, but also the amount of any opt-out payment that is offered to them. If an opt-out payment incentive increases the total employee cost of coverage above applicable affordability thresholds (9.66% for 2016), the employer may face a pay or play penalty.
Eligible Opt-Out Arrangements. Employers may avoid the potential affordability problem outlined above by offering an “eligible opt-out arrangement.” An eligible opt-out arrangement conditions the payment of the incentive on the employee’s declining coverage and providing, at least annually, reasonable evidence that the employee and his or her “tax family” (those for whom the employee expects to claim a personal exemption) will have minimum essential coverage (other than individual market coverage) during the period covered by the opt-out arrangement. If the opt-out payment covers a full plan year and the employee’s “tax family” includes a spouse and one child, payment must be conditioned upon reasonable evidence that all three individuals will have coverage for the full year. Requiring such evidence allows employers to exclude opt-out incentives from the cost of coverage they offer for purposes of calculating affordability.
Effective Dates and Transition Relief. The IRS proposed regulations will apply for plan years beginning on or after January 1, 2017. Although the regulations are in proposed form, employers and plan administrators may rely on them immediately. Unconditional opt-out arrangements that were adopted before December 16, 2015 may be exempted from the affordability calculation if certain conditions are met. Similarly, unconditional opt out arrangements that are included in a current collective bargaining agreement (CBA) are exempt from the affordability calculation until the later of (1) the start of the first full plan year after the CBA expires (excluding any CBA extensions on or after December 16, 2015), or (2) the start of the first plan year beginning on or after January 1, 2017.
What To Do Now? Employers that wish to continue offering opt-out incentive payments may certainly do so under the proposed regulations. However, it is now important that opt-out payments be structured as an “eligible opt-out arrangement” which clearly conditions payment on sufficient proof of other coverage (other than individual market coverage). Employers should also be aware that opt-out payments could impact the calculation of non-exempt employee overtime earnings under the Fair Labor Standards Act (regardless of whether the employee opts out and receives payment), unless properly structured.
In sum, opt-out incentive programs have survived the ACA. However, employers must be careful in designing these programs or they may run afoul of affordability requirements.
