Author, Laura R. Westfall, New York, +1 212 556-2263, lwestfall@kslaw.com.

On December 16, 2015, the IRS issued Notice 2015-87 (the "Notice"), which provides "question-and-answer" guidance regarding how various Affordable Care Act (the "ACA") provisions apply to employer-provided group health plans. Among other things, the Notice provides additional rules regarding the application of the ACA's market reforms (such as the ACA's annual dollar limit) to health reimbursement arrangements ("HRAs"), including integration issues, and gives additional clarification regarding the application of COBRA to carryovers of unused funds from year to year in health care flexible spending accounts ("FSAs"). The Notice also provides penalty relief for information reporting requirements under the ACA. Employers should be aware that the guidance provided in the Notice may require additional changes to employer health plans, including HRAs and health FSAs—even if such plans were already in compliance with prior ACA guidance. In most cases, the guidance in the Notice applies for plan years beginning on and after December 16, 2015 (e.g., Jan. 1, 2016, for calendar year plans), although some transition relief is available.

The ACA's HRA Integration Requirements

HRAs must generally be "integrated" with other group health plan coverage to comply with the ACA's annual dollar limit prohibition and preventive services requirements. In Notice 2013-54, the IRS established standards that, if satisfied, would qualify an HRA as "integrated" with a group health plan (and therefore deemed to comply with such ACA requirements). An HRA that is not integrated—i.e., a "stand-alone" HRA—will generally trigger penalties on the plan sponsor for failure to comply with such requirements.

However, Notice 2013-54 was silent on the matter of who must be covered under the group health plan and the HRA in order for the HRA to be "integrated." The Notice clarifies that an HRA will be considered to be "integrated" with an employer's group health plan coverage for purposes of the application of the ACA insurance market reforms "only as to the individuals who are enrolled in both the HRA and the employer's other group health plan." Thus, the level of coverage that an employee elects under an integrated HRA, i.e., self-only, self + 1, family, etc., must match the level of coverage under the group health plan with which the HRA is integrated. The Notice's clarification addresses an apparent concern of the IRS that an employee might use their HRA to reimburse medical expenses incurred by their family members, regardless of whether those family members were covered by the employer's other group health plan.

• INSIGHT. The Notice seems to imply that the group health plan coverage being integrated must be offered by the same employer that offers the HRA (i.e., that in order for a spouse's medical expenses to be reimbursed from an employee's HRA account, the spouse must be covered by such employee's group health plan coverage). However, IRS representatives have informally clarified that so long as the spouse is covered by any group health plan coverage (such as coverage offered by the spouse's employer), the employee's HRA would qualify as "integrated" so long as the other integration requirements are met. Despite this clarification, plan administrators of any HRA that is intended to be "integrated" may want to confirm that their systems allow them to determine whether a request for reimbursement from such HRA relates to an expense of a family member who is covered by a qualifying group health plan.

Transition relief in the Notice provides that Treasury and the IRS will not treat an HRA available for the expenses of family members not enrolled in the employer's other group health plan for plan years beginning before January 1, 2016, as failing to be integrated with an employer's other group health plan for plan years beginning before January 1, 2016. Further, transition relief is available for plan years beginning before January 1, 2017, so long as the HRA and group health plan would otherwise be integrated based on the terms of the plan as of December 16, 2015 (i.e., the only noncompliant aspect of the HRA as of that date was the HRA's coverage of expenses of family members that were not also enrolled in the employer's other group health plan (or other qualifying group health plan coverage). Employers should note that they have until the first day of their 2017 plan year to amend the HRA to comply with the Notice's requirement.

Consistent with previous guidance, the Notice states that an HRA covering active employees cannot reimburse participants for the cost of premiums for health insurance policies obtained on the individual market. However, an HRA may reimburse premiums for health insurance policies obtained on the individual market, if the health insurance policy covers only "excepted benefits" (i.e., dental or vision insurance policies). In addition, the Notice reiterates that retiree-only HRAs are still permitted to reimburse retirees for the cost of premiums for individual health insurance policies, regardless of whether such policies are obtained in the private market or on the exchange. (A retiree HRA is an HRA that covers less than two active employees.)

Determination of an Employee's Cost of Coverage for the ACA's Affordability Rules

Under the ACA, the affordability of employer-provided health coverage affects whether employees and their family members can receive insurance premium tax credits or cost-sharing subsidies from public exchanges, which in turn can trigger penalties under the ACA's employer "pay or play" mandate. Waiving affordable employer health coverage also can lead to individual-mandate assessments for employees and their family members who remain uninsured. Under the ACA's employer "pay or play" mandate, an applicable large employer will not be required to pay a penalty if substantially all of the employer's full-time employees are offered affordable, minimum-value health coverage. Under the ACA, coverage is "affordable" if an employee's required contribution for self-only coverage (i.e., the "cost of coverage") under the employer's lowest-cost major medical plan does not exceed 9.5% (adjusted annually) of the employee's household income.

• INSIGHT. The amount of an employee's required contribution for coverage under an employer-sponsored plan is used for two purposes by the ACA: first, to determine whether the employer will be subject to penalties under the "pay or play" mandate, and second, for the ACA's reporting requirements under Sections 6055 and 6056 (on Forms 1094-C and 1095-C).

Previous ACA guidance addressed how various health plan features affect affordability determinations for individuals, but did not how such features affected employers. The Notice addresses the effect of HRA contributions, cafeteria plan "flex credits" and opt-out payments on affordability determinations for purposes of the ACA's employer "pay or play" mandate.

Adjustments For Inflation

To help employers determine affordability, IRS safe harbors provided in prior ACA guidance offer three affordability "safe harbors" to use instead of household income in the calculation of whether coverage is "affordable" (e.g., the Form W-2, rate of pay, and federal poverty level safe harbors). The Notice provides that the IRS will adjust the three affordability safe harbors annually for inflation. As a result, employers may use 9.56% for plan years beginning in 2015 and 9.66% for plan years beginning in 2016.

Employer HRA Contributions

In the case of HRAs, amounts made available for the current plan year that an employee may use to pay premiums for an eligible employer-sponsored plan (and, if the HRA permits it, that an employee may also use for cost-sharing and/or for other health benefits not covered by that plan in addition to premiums), are counted toward the employee's cost of coverage (thereby reducing the dollar amount of the employee's required contribution). This is the case both substantively, and for purposes of reporting on Form 1095-C. For example, if the employee's required contribution for group health coverage offered by Employer ABC is $200/month, and Employer ABC annually makes available $1,200 under an HRA (e.g., $100/month) that an employee may only use to pay the employee's required contribution for such coverage, the employee's required contribution for such coverage is $100/month (e.g., $200 contribution – $100 HRA contribution).

Cafeteria Plan "Flex Credits"

Often, cafeteria plans are funded both by salary reductions and by employer "flex contributions" (e.g. "flex credits"). Final regulations implementing the ACA's individual mandate provide that a flex credit reduces the employee's cost of coverage if and only if:

• The employee may not opt to receive the amount as a taxable benefit (e.g., as cash); and
• The employee can only use the flex credit to pay for minimum essential coverage or tax-excludible medical care (e.g., not for any nonmedical or taxable benefits).

A contribution under an arrangement that satisfies the above criteria is referred to as a "health flex credit." The Notice extends the prior IRS guidance on health flex credits to employers' affordability determinations: the Notice states that a health flex credit reduces an employee's cost of coverage dollar-for-dollar, and that conversely, an employer flex credit that is not a health flex credit does not reduce an employee's cost of coverage. Thus, for example, if an employer flex credit that is available to pay for health care is also available to pay for any non-health care benefits (e.g., dependent care or group term life insurance), that credit is not a health flex credit and, as a result, does not reduce the employee's cost of coverage.

The Notice does provide transition relief for existing arrangements: for plan years beginning before Jan. 1, 2017, employers can treat flex credits in place as of Dec. 16, 2015, as reducing an employee's cost of coverage, even if those flex credits don't qualify as health flex credits under the Notice. This relief is not available if an employer adopts or significantly increases its non-health flex credits after Dec. 16, 2015. In addition, the Notice provides that for coverage for plan years beginning before January 1, 2017, an employer may reduce the amount of the employee's cost of coverage by the amount of most non-health flex credits for purposes of the ACA's Section 6056 information reporting requirements.

Opt-Out Arrangements

In an opt-out arrangement, an employer offers an employee additional compensation in exchange for the employee's waiver of employer-provided group health coverage. Opt-out arrangements can be either unconditional (i.e., an arrangement providing for a payment conditioned solely on an employee declining coverage) or conditional (e.g., an arrangement that requires the employee to provide proof of coverage provided by a spouse's employer). Prior ACA guidance had not addressed whether opt-out payments affected employers' affordability determinations. The Notice states that Treasury and the IRS anticipate issuing additional guidance in the future, which will likely require employers to increase the cost of coverage to employees by the amount of any "unconditional" opt-out payment.

Example. An employer offers employees group health coverage through a Section 125 cafeteria plan, requiring employees who elect self-only coverage to contribute $200/month toward the cost of that coverage. The employer also offers an additional $100/month in taxable wages to anyone who waives such coverage. The $100/month "opt-out" payment has the economic effect of effectively increasing an employee's cost of coverage to $300/month: not only must the employee who elects coverage pay $200/month in salary reductions toward the cost of that coverage, the employee must also forgo $100/month in compensation.

The Notice states that until the issuance of further guidance, an opt-out payment made pursuant to any arrangement adopted prior to December 17, 2015 does not need to be reported on Form 1095-C and will not, on its own, cause an employer to be subject to a penalty under the ACA's employer "pay or play" mandate. The Notice also states that until the issuance of further guidance, an opt-out payment made pursuant to a conditional opt-out arrangement adopted at any time does not need to be reported on Form 1095-C and will not, on its own, cause an employer to be subject to a penalty under the ACA's employer "pay or play" mandate. Employers should be aware that the Notice anticipates that unconditional opt-out arrangements that are adopted after December 16, 2015 will likely not be eligible for any transition relief.

Inflation Adjustment of Employer "Pay or Play" Mandate Penalties

The Notice provides that the penalties under the employer mandate (generally, $2,000 per full-time employee for failure to offer coverage, and $3,000 for failure to offer affordable, minimum value coverage) will be adjusted for inflation in years after 2014. Accordingly, for 2015 the penalty amounts will be $2,080 and $3,120, and for 2016 the penalty amounts will be $2,160 and $3,240, respectively.

Penalty Relief for ACA Information Reporting

Under the Notice, penalty relief is available regarding the ACA's information reporting rules (Code Section 6056) from penalties for incomplete or incorrect returns filed or employee statements provided to employees in 2016 for coverage offered during 2015. The Notice provides that the IRS will not impose penalties (under Code Sections 6721 and 6722) on large employers that can show they have made good faith efforts to satisfy the ACA's information reporting rules. However, the relief is unavailable if an employer fails to timely file an information return or provide a statement, although the Notice notes that large employers might be eligible for penalty relief involving reasonable cause standards. (Similar relief had already been provided under prior ACA guidance with respect to reporting on coverage under Code Section 6055.)

• INSIGHT. Employers should note that IRS Notice 2016-04, issued in late December 2015, gives employers a two-month extension to furnish the IRS Forms 1095-B and 1095-C to employees (resulting in a due date of March 31, 2016 instead of the original deadline of February 1, 2016), and a three-month extension to file the 1094/1095 forms with the IRS (resulting in a due date of May 31, 2016, if an employer is not filing electronically, and June 30, 2016, if filing electronically).

Hours of Service: Full-Time Employee Status 

For purposes of the ACA's employer "pay or play" mandate, a person's status as a full-time employee is calculated based on that person's "hours of service." Prior ACA guidance contained some ambiguities regarding the crediting of hours of service in certain circumstances. The Notice clarifies that in determining whether an hour of service must be credited, a payment for service is deemed to be made by (or due from) an employer, regardless of whether (i) the payment is made by the employer directly, or is made indirectly through, among other sources, an insurer or trust fund to which the employer contributes or pays premiums, or (ii) contributions that are made or due to an insurer, trust fund, or other entity are either for the benefit of particular employees, or on behalf of a group of employees in the aggregate. This means that periods for which an employee did not perform services, but is receiving payments due to short-term or long-term disability, will generally be counted as "hours of service" while the recipient remains an employee, unless the payments are made from an arrangement to which the employer did not contribute directly or indirectly.

• INSIGHT. Based on the guidance in the Notice, periods during which an employee is out on sick leave as a payroll practice, or is out on disability and is receiving payments from an insured or self-insured employer-sponsored disability plan, will generally be required to be counted as "hours of service" for purposes of the ACA's employer "pay or play" mandate.

Next Steps for Employers

Employers should immediately review their current and contemplated plan designs in light of the additional guidance provided by the Notice to determine whether any changes to those plan designs are necessary. In addition, employers may wish to review their Section 125 cafeteria plans to determine whether any flex credits qualify as "health flex credits" or otherwise meet the conditions for transition relief set forth in the Notice; determine whether there are any opt-out arrangements in place that may be affected by the anticipated future ACA guidance mentioned in the Notice; and consider how the indexed affordability percentages set forth in the Notice will affect the employer's "safe harbor" calculations.

RELATED UPDATE: 

"Cadillac Tax" Delayed: The so-called "Cadillac tax" is a provision of the ACA that imposes a 40% excise tax on the value of group health coverage provided to an employee in excess of a certain threshold. Employers should be aware that the Consolidated Appropriations Act, 2016, signed into law by President Obama on December 18, 2015, delays the imposition of the "Cadillac tax" until 2020, and makes the tax deductible.