IRS Issues Second Guidance on Cadillac Tax

by Ballard Spahr LLP
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The Internal Revenue Service has issued a new notice addressing issues relating to future rules governing the calculation and payment of the so-called “Cadillac tax” under the Affordable Care Act. Beginning in 2018, the ACA will impose a 40 percent nondeductible excise tax on the value of group health coverage that exceeds a baseline amount of $10,200 for self-only coverage and $27,500 for family coverage (regardless of family size).

The new guidance supplements an earlier IRS Notice Notice 2015-16, which also described certain complicated issues and possible approaches that the IRS is considering as it prepares regulations interpreting and implementing the Cadillac tax. The new guidance discusses:

  • Who is responsible for paying the Cadillac tax. The tax is to be paid by insurers for fully insured plans and employers for certain account-based plans, such as health savings accounts (HSAs), flexible savings accounts (FSAs), and health reimbursement accounts (HRAs). For other types of group health coverage, the ACA imposes the burden on “the person that administers the plan benefits.” In interpreting this provision, the IRS is considering two alternatives--imposing payment responsibility on the day-to-day administrator (most likely a third-party administrator) or imposing the responsibility on the person that “has the ultimate authority or responsibility” to make “final decisions on administrative matters” (most likely an employer, committee, or board of trustees).
  • The need for practical guidance relating to how the burdens for determining, reporting, and paying the Cadillac tax are allocated and appropriate information transferred. The statute requires employers to calculate the amount of the tax payable by each of its coverage providers and notify the party responsible as well as the IRS.
  • The time and manner in which the tax will be paid. The statute is silent on this subject, and the IRS is considering the use of Form 720, Quarterly Federal Excise Tax Return, for payment of the tax. Although that form is filed quarterly, the IRS will likely designate one quarter each year for payment of the Cadillac tax.
  • The fact that insurers and others that pay the Cadillac tax will likely seek reimbursement for the amount of the tax from the employers and other plan sponsors with whom they contract. Because those who pay the tax cannot claim a deduction for the Cadillac tax and because they will be taxed on reimbursements that they receive for payment of the tax, they may also seek to be grossed-up for the taxes they pay on reimbursements. The calculation of the gross-up can be complex because reimbursements for the Cadillac tax paid are taxable, and reimbursements for tax paid on those reimbursements are taxable, etc. The IRS is considering how to address these situations and, in particular, the extent to which any gross-up can be excluded from the cost of coverage subject to the Cadillac tax.
  • Possible approaches for determining the applicable cost of coverage under account-based arrangements such as HSAs, FSAs, and HRAs. The IRS may propose certain safe harbors. For example, it may allow employers to allocate the amount that an employee or employer contributes to one of these accounts in the course of a year to each month on a pro-rata basis, making for an even allocation for all months, regardless of when the contributions are actually made. The IRS is also considering guidance, including safe harbors, on valuing coverage when employers provide their employees with flex credits, or when unused amounts in an account can carry over to the following year.
  • The permitted increase in the baseline dollar limits for plans that cover employee populations with higher-than-average costs based on age and gender. The notice suggests that the regulations may allow employers to take a snapshot of their demographics as of the first day of the year. The adjustment would require plan sponsors to examine the size of their populations in different age brackets broken down by gender and to apply cost factors that the IRS publishes based on those different brackets. It is expected that separate adjustments would apply for single and family coverage.

The new notice reflects the complexity of the challenge faced by the IRS in implementing the Cadillac tax, and the potential challenges that lie ahead for both employers and coverage providers. Although actual guidance has not yet been issued, employers should begin now to think about ways to reduce their exposure to the Cadillac tax. Employers may need to keep in mind that the impact of the Cadillac tax is expected to grow over time. Even though the baseline dollar limits under the Cadillac tax are indexed for inflation, the indexing is not likely to keep pace with medical inflation.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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