New ACA Rules for HRAs, Flex Credits and Opt-Out Payments
New ACA Rules for HRAs, Flex Credits and Opt-Out Payments
Late last year, the IRS issued Notice 2015-87 to provide guidance on Affordable Care Act (ACA) compliance for several types of group health plan features, including:
- Health Reimbursement Arrangements (HRAs) and Other Employer Payment Plans,
- Employer "Flex Credits" under Cafeteria Plans, and
- Opt-out Payments to Employees Who Waive Coverage.
In July, the IRS issued proposed regulations to expand the rules regarding treatment of opt-out payments to employees who waive employer-sponsored group health coverage.
Although the rules in Notice 2015-87 generally apply for plan years beginning on or after December 16, 2015, under transition relief, many of the new rules will take effect for plan years beginning on or after January 1, 2017. Final regulations regarding opt-out payments will likely be issued later this year, and will also have a general effective date of January 1, 2017.
In planning for next year, employers and plan sponsors that include any of these features in their health plans should review plan documents and operations for compliance with the new requirements, several of which are explained in this article.
Additional Guidance On Using HRAs to Reimburse Individual Coverage
In Notices 2013-54 and 2015-17, the IRS previously advised that HRAs and employer payment plans must be “integrated” with group health coverage in order to comply with the “market reform” requirements of the ACA. Generally, an HRA or employer payment plan is "integrated" with group health coverage if:
- The employer offers group health coverage that is compliant with the ACA;
- Employees receiving the HRA are actually enrolled in group health plan coverage;
- The HRA is only available to employees who are enrolled in group health coverage;
- Employees may opt out of the HRA coverage at least annually and upon termination of employment (or upon termination, unused amounts in the HRA are forfeited); and
- Either reimbursements are limited as described in Notice 2013-54, or the group health coverage of employees who receive the HRA provides "minimum value" within the meaning of the ACA.
Under these integration rules, an HRA or employer payment plan that covers more than one current employee may not be used to reimburse the cost of individual health coverage. This means that employers may not reimburse or directly pay for employees' premiums or other expenses for coverage under an individual health insurance policy. This includes coverage under a plan offered through an ACA insurance exchange, such as Covered California (an “Exchange”). In Notice 2015-87, the IRS provided additional guidance about the HRA integration rules for group health plans.
HRAs That Cover Both Current Employees and Retirees May Not Reimburse Expenses for Individual Coverage: An HRA that covers both current employees and retirees may not be used to reimburse individual health coverage purchased by retirees. This rule was not clear under prior IRS guidance, which provided that unused amounts credited to an HRA while the HRA is integrated with other group health plan coverage may be used to reimburse medical expenses after an employee ceases to be covered by the group health plan. (See Notice 2013-54, Q&A-5.) The earlier guidance implied that, if an HRA plan permits a run-out of unused balances at retirement, a retiree could use the remaining amounts for any qualified medical expense, including premiums for individual insurance. The IRS clarified that any unused amounts in an employee’s HRA at retirement (or other termination of employment) may not be used to reimburse the cost of individual coverage purchased by the retiree or terminated employee. (See Notice 2015-87, Q&A-2.) No transition relief was provided for this rule, meaning it is in effect for plan years beginning on or after December 16, 2015.
Retiree-Only HRAs May Reimburse Individual Coverage Expenses: Retiree-only HRAs may be used to reimburse the cost of individual health coverage, even if the amounts available under the HRA are based on amounts credited when the retiree was an active employee and covered by an HRA that was integrated with another group health plan. This type of reimbursement for individual coverage is permissible because retiree-only HRAs are not subject to the ACA market reforms. To meet the definition of a “retiree-only” HRA, the HRA may cover no more than one current employee. As a practical matter, this arrangement would be possible only if the employer had two separate HRAs – one for current employees and one for retirees only – and a rule that permitted employees to rollover any unused balance from the current-employee HRA to the retiree-only HRA at retirement or termination. Unused amounts in a current-employee HRA that are not rolled over to a separate retiree-only HRA when an employee retires or terminates may be used only to reimburse expenses for retirees' group health coverage. (See Notice 2015-87, Q&A-1.)
HRAs May Not Cover Spouses or Dependents of Employees with Self-Only Group Health Coverage: A current-employee HRA may be not be used to reimburse expenses for a covered employee’s spouse or dependent, unless the spouse or dependent is also covered under the employer’s integrated group health coverage. The guidance clarified that an employer’s HRA is integrated with the employer’s group health plan only as to the individuals who are enrolled in both the HRA and the employer’s group health plan. An HRA may be structured so that eligibility for expense reimbursement is linked to coverage under the employer's group health plan, meaning HRA eligibility would automatically expand or contract as an employee switched between self-only and family coverage. This rule will apply for plan years beginning on or after January 1, 2017. Prior to the effective date, the IRS will not treat an otherwise-integrated HRA that reimburses expenses for an employee's family members who are not enrolled in the employer's group health plan as non-compliant with the HRA integration rules. (See Notice 2015-87, Q&A-4.)
Excepted Benefits-Only HRAs May Reimburse Expenses for Individual Coverage: The ACA market reforms do not apply to a group health plan that provides solely excepted benefits, such as limited scope dental and vision benefits. The IRS clarified that, because excepted benefits are not subject to the market reform rules, an HRA may reimburse premiums and other expenses for covered employees' individual coverage consisting solely of excepted benefits, so long as the terms of the HRA plan prohibit reimbursement for any individual coverage other than excepted benefits. (See Notice 2015-87, Q&A-5.)
Employers May Not Use Cafeteria Plans to Reimburse Individual Coverage: The IRS clarified that an employer payment offered through an Internal Revenue Code section 125 cafeteria plan may not be used to reimburse the cost of individual health coverage, regardless of whether the plan is funded solely by salary reduction or through "flex credits" or other employer contributions. However, as with HRAs, an employer payment plan offered through a cafeteria plan may be used to reimburse individual coverage that consists solely of excepted benefits, if the terms of the plan prohibit reimbursement for any individual coverage other than excepted benefits. (See Notice 2015-87, Q&A-6.) No transition relief was provided for this rule, meaning it is in effect for plan years beginning on or after December 16, 2015.
Treatment of Opt-Out Payments, "Flex Credits" and Employer Contributions to HRAs In Determining Whether an Employer's Coverage is "Affordable"
The IRS provided new guidance on how opt-out payments to employees who waive coverage, employer "flex credits" provided under cafeteria plans, and employer contributions to HRAs must be treated in determining whether an employer's coverage is "affordable" within the meaning of the ACA employer penalty rules. As a refresher, effective for 2016 plan years, a large employer (generally those with at least 50 full-time employees or full-time equivalents) could be subject to a tax penalty unless the employer offers at least 95% of its full-time employees health coverage that provides "minimum value" and is "affordable."
The test for "affordability" is based on the employee's “required contribution" toward self-only coverage under the lowest-cost minimum value benefit package offered under the employer's plan. The ACA defines "required contribution" as "the portion of the annual premium which would be paid by the individual (without regard to whether paid through salary reduction or otherwise) for self-only coverage." Under the new guidance, determining that amount may not be as straightforward as it seems.
Effect of Opt-Out Payments on Affordability: Different Rules for Two Types of Opt-Out Payments: Some employers offer "opt-out" payments to employees who waive the employer's coverage, typically to avoid the expense of providing "dual coverage" for employees who have coverage under a spouse’s or domestic partner's group health plan. Under Notice 2015-87 and proposed regulations, the IRS has distinguished between two types of out-out payments:
- unconditional opt-out payments, meaning payments made available if an employee merely declines the employer’s coverage, and
- conditional opt-out payments, meaning those that are available only if the employee also satisfies a "meaningful requirement related to the provision of health care to employees, such as a requirement to provide proof of coverage provided by a spouse's employer."
For purposes of determining whether an employer’s offer of coverage is affordable, an unconditional opt-out payment will be treated differently than a conditional opt-out payment that meets the requirements of an “eligible opt-out arrangement,” explained below.
The Value of Unconditional Opt-Out Payments Must Be Added to the Employee's Required Contribution: The IRS views an opt-out payment that is available if an employee waives the employer's coverage as analogous to an option to use salary reduction to pay for coverage under a cafeteria plan. In both cases, the employee must forego a specified amount of salary or compensation to "purchase" the employer's health coverage. For example, if employees pay nothing toward the cost of the employer's coverage, and may receive an opt-out payment of $1,000 for waiving the employer's coverage, the employee's required contribution for purposes of the affordability test under the employer penalty rules is considered to be $1,000.
The IRS further views an employer's offer of an opt-out payment for waiving coverage as increasing the actual amount paid by employees who enroll in the employer's coverage. For example, if an employee must pay $200 per month through salary reduction toward the cost of the employer's self-only coverage, but would receive $100 per month in taxable compensation for waiving the coverage, the employee's required contribution for that coverage is "effectively" $300 per month.
Based on this analysis, the IRS determined that employers will need to add the value of an unconditional opt-out payment to the employee’s share of premium costs for self-only coverage under the lowest-cost minimum value coverage option in calculating the employee's required contribution for purposes of determining whether the employer's coverage is affordable.
The Value of Conditional Opt-Out Payments Need Not Be Included in the Employee's Required Contribution, If Certain Conditions Are Met: The IRS views the economic effect of a conditional opt-out payment differently. When an opt-out payment is conditioned on an employee having other coverage, the IRS does not view the payment as increasing the cost of the employer’s coverage, because not every employee who elects the employer’s coverage is necessarily foregoing the value of the opt-out payment – it could be that the employee does not have access to other coverage, and so would not be qualified to receive the opt-out payment in any event. In other words, it cannot be said that a conditional opt-out payment costs all employees who enroll in the employer’s coverage the value of the opt-out payment, in addition to the employee’s premium share. On that basis, the IRS has decided that certain conditional opt-out payments need not be included in the employee's required contribution for purposes of determining whether an employer's coverage is affordable.
Specifically, the value of a conditional opt-out payment need not be included in the employee’s required contribution, if the payment is available only to employees who attest that the employee, and all of his or her tax dependents, will have minimum essential coverage, other than individual coverage, for the plan year to which the opt-out payment applies. The opt-out arrangement must also provide that no payment will be made if the employer knows, or has reason to know, that the employee or any tax dependent will not have alternative coverage. Under the proposed regulations, this is called an "eligible opt-out arrangement."
The rules for opt-out payments will likely take effect for plan years beginning on or after January 1, 2017 (except that the rule for unconditional opt-out payments applies now for unconditional opt-out payment arrangements adopted after December 16, 2015). In addition, the rules will not apply to opt-out payments required under a collective bargaining agreement in effect before December 16, 2015, until the later of: (1) the beginning of the first plan year that begins following the expiration of the collective bargaining agreement (disregarding any extensions on or after December 16, 2015), or (2) the applicability date of the final opt-out payment regulations.
Employers should also be aware that, under the recent Ninth Circuit case Flores v. City of San Gabriel, Case Nos. 14-56421; 14-56514 (9th Cir. June 2, 2016), the value of opt-out payments may need to be included in calculating non-exempt employees' "regular rate of pay" for purposes of compliance with the overtime payment requirements of the Fair Labor Standards Act (FLSA). Please see our Client Alert regarding this case.
"Flex Credits" Provided under Cafeteria Plans That May Be Used Exclusively for Health Coverage Reduce the Employee's Required Contribution: Some employers make "flex credits" or non-elective employer contributions to cafeteria plans, which employees may use to pay for benefits offered under the plan, or, in some cases, may elect to receive as taxable compensation.
The IRS previously issued guidance on the treatment of employer flex credits for purposes of determining an employee's required contribution under the exemption from the "individual mandate" for individuals without access to affordable coverage. Under those rules, an employer flex credit only reduces the employee's required contribution toward employer-sponsored health coverage if the flex credit may not be cashed out, and may be used exclusively to pay for medical care within the meaning of Internal Revenue Code section 213, including minimum essential coverage.
In Notice 2015-87, the IRS clarified that only a flex credit that is limited as described above, referred to as a "health flex contribution," will reduce the employee's required contribution for purposes of determining whether an employer's coverage is affordable under the employer penalty rules. Accordingly, when an employer makes a health flex contribution under a cafeteria plan, the employee's required contribution toward the cost of the employer's health coverage is reduced by the amount of the health flex contribution, even for employees who do not use the flex credits to pay for the employer's health coverage.
On the other hand, employer flex credits that are "non-health flex contributions," meaning flex credits that employees may cash out or use to pay for non-medical benefits, such as dependent care, will not reduce the employee's required contribution toward the cost of the employer's health coverage, even for employees who elect to use the flex credits to pay for their coverage under the employer's health plan.
Note that, under the proposed IRS regulations on opt-out payments, described above, an amount provided as an employer contribution to a cafeteria plan that is permitted to be used by the employee to purchase minimum essential coverage is not an opt-out payment, whether or not the employee may receive the amount as a taxable benefit. It is unclear how this rule will apply to flex credits that are provided only in the event an employee waives the employer’s coverage – in that scenario, the flex credit could be viewed as one that the employee may not use to purchase minimum essential coverage, which would mean the flex credit is not exempt from the opt-out payment rules.
The rules for flex credits apply for plan years beginning on or after January 1, 2017. For earlier plan years, employers may apply "non-health flex contributions" to reduce the employee's required contribution for purposes of the affordability analysis and required IRS reporting, so long as the flex credits may be used to pay for the employee's actual cost of coverage (except for "non-health flex contribution" arrangements that are adopted, or that substantially increase the amount of the flex contribution, after December 16, 2015.) (See Notice 2015-87, Q&A-8.)
Employer Contributions to Integrated HRAs May Reduce the Employee's Required Contribution: Employer contributions to an integrated HRA will reduce the employee's required contribution for purposes of determining whether the employer's group health plan coverage is affordable, if the following conditions are met:
- The HRA may be used to pay for premiums, other cost-sharing or non-covered benefits under either the employer's plan, or another employer-sponsored group health plan that is integrated with the HRA; and
- The amount of the employer's annual contributions to the HRA is set forth in the HRA plan document or otherwise determinable within a reasonable time before the employee must decide whether to enroll in the employer's group health plan.
If these conditions are met, employer contributions to the HRA made on an annual basis will reduce the employee's monthly required contribution on a pro-rata basis for each month of the year, regardless of whether employees use the HRA to pay for the employer's group health coverage. The IRS explained that these rules also apply to determinations of affordability made under one of the "safe harbors" provided in the employer penalty regulations. (See Notice 2015-87, Q&A-7.)
Affordability Analysis Could Affect Liability Under "Penalty A" If Coverage That’s Unaffordable Is Mandatory: Some employers permit only those employees who provide proof of other health coverage to waive coverage under the employer's plan, and make enrollment in the employer's coverage mandatory for all other employees. As explained below, the affordability analysis is especially important for employers with mandatory coverage.
The two penalties that can apply to large employers under the ACA are typically described as “Penalty A” and “Penalty B.” Penalty A applies if a large employer does not offer at least 95% of its full-time employees (and their dependent children under age 26) the opportunity to enroll in minimum essential coverage, and at least one full-time employee purchases individual coverage at an Exchange and qualifies for a premium tax credit toward the cost of that coverage. The amount of Penalty A is $2,000 (indexed) per year, multiplied by the number of full-time employees (minus 30). For example, if an employer with 1,000 full-time employees offers coverage to less than 95% of them, and one full-time employee purchases health coverage at an Exchange and receives a premium tax credit, the penalty would be $2,000 (as indexed) X (1,000 less 30) or $1,940,000.
Penalty B applies if a large employer does offer at least 95% of its full-time employees (and their dependent children under age 26) coverage, but the coverage is not affordable or does not provide minimum value, and at least one full-time employee purchases individual coverage at an Exchange and qualifies for a premium tax credit toward the cost of that coverage. The amount of Penalty B is $3,000 (indexed) per year, multiplied by the number of full-time employees who obtain a premium tax credit toward the cost of coverage purchased at an Exchange. For example, an employer has 1,000 full-time employees, and offers minimum essential coverage to all 1,000 employees, but the coverage is unaffordable for 20 full-time employees. If all 20 employees purchase health coverage at an Exchange and receive a premium tax credit, the penalty is $3,000 (as indexed) X 20 or $60,000.
As these examples show, an amount assessed under Penalty A has the potential to be much greater than under Penalty B. While the new rules described above appear to affect an employer’s liability for Penalty B, because they affect the test for affordability, employers with mandatory coverage must be careful to avoid Penalty A as well. Under the Penalty A rules, an employer’s offer of coverage must include an effective opportunity to decline the coverage, if the coverage is not affordable. If an employer’s coverage is unaffordable, and employees may only waive the coverage by providing proof of other coverage, the employer could be liable under Penalty A, if just one full-time employee purchases coverage at an Exchange and qualifies for a premium tax credit.
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In planning for the 2017 plan year, employers may need to review their group health plan features, such as:
- HRAs and employer reimbursement arrangements;
- cafeteria plan flex credits, and
- opt-out payments to employees who waive coverage.
The design and administration of these features could affect compliance with the ACA market reforms or the determination of whether the employer's group health coverage is affordable for purposes of the employer penalty rules.