Section 106, IRC, Contributions by employer to accident and health plans: (a) General rule

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1 By: Bob Butler WASB Associate Executive Director & Staff Counsel (phone) (direct phone) (fax) A few tax basics. The constructive receipt doctrine. Nonqualified deferred compensation plans. Post-employment health benefit plans Health Reimbursement Accounts IRS Notice & the ACA 1

2 Section 61 of the Internal Revenue Code (IRC): (a) Except as otherwise provided in this subtitle, gross income means all income from whatever source derived, including (but not limited to) the following items: (1) Compensation for services, including fees, commissions, fringe benefits, and similar items; Section 106, IRC, Contributions by employer to accident and health plans: (a) General rule Except as otherwise provided in this section, gross income of an employee does not include employer-provided coverage under an accident or health plan. Revenue Ruling provides that the exclusion under section 106 includes coverage for retired employees. 2

3 Section 106: Generally, Section 106 of the Code provides that health and medical benefits can be provided tax-free by an employer. However, if there is an option/choice to receive cash or another benefit, this may result in taxable wages, even if the employee does not elect to receive the cash. IRS Office of Federal, State and Local Governments, FSLG Newsletter July Section 125: A section 125 cafeteria plan is a separate written plan maintained by an employer for employees that meets the specific requirements of and regulations of section 125 of the Internal Revenue Code. It provides participants an opportunity to receive certain benefits on a pretax basis. Participants in a cafeteria plan must be permitted to choose among at least one taxable benefit (such as cash) and one qualified benefit. IRS Office of Federal, State and Local Governments, FSLG Newsletter July

4 Section 125 ( cafeteria ) plans provide a partial exception to the constructive receipt rules. These plans provide a choice between cash wages and a salary reduction to receive an excludable benefit. If the benefit is selected, the value is not included in wages. A section 125, or cafeteria plan, cannot provide for deferred compensation. Only those benefits specifically indicated in section 125 are eligible for tax-free treatment. IRS Office of Federal, State and Local Governments, FSLG Newsletter July Section 125 ( cafeteria ) Only those benefits specifically indicated in section 125 are eligible for tax-free treatment. Examples are as follows: Accident and health benefits (but not Archer medical savings accounts or long-term care insurance) Adoption assistance Dependent care assistance Group-term life insurance coverage Health savings accounts, including distributions to pay long-term care services The written plan must specifically describe all benefits and establish rules for eligibility and elections. Governments/FAQs-for-government-entities-regarding-Cafeteria-Plans 4

5 Section 125 ( cafeteria ) A section 125 plan is the only means by which an employer can offer employees a choice between taxable and nontaxable benefits without the choice causing the benefits to become taxable. A plan offering only a choice between taxable benefits is not a section 125 plan. Governments/FAQs-for-government-entities-regarding-Cafeteria-Plans Section 105, IRC, Amounts received under accident and health plans: (a) Amounts attributable to employer contributions Except as otherwise provided in this section, amounts received by an employee through accident or health insurance for personal injuries or sickness shall be included in gross income to the extent such amounts: (1) are attributable to contributions by the employer which were not includible in the gross income of the employee, or (2) are paid by the employer. 5

6 Section 105, IRC, Amounts received under accident and health plans: (b) Amounts expended for medical care Except in the case of amounts attributable to (and not in excess of) deductions allowed under section 213 (relating to medical, etc., expenses) for any prior taxable year, gross income does not include amounts referred to in subsection (a) if such amounts are paid, directly or indirectly, to the taxpayer to reimburse the taxpayer for expenses incurred by him for the medical care (as defined in section 213(d)) of the taxpayer, his spouse, his dependents (as defined in section 152, determined without regard to subsections (b)(1), (b)(2), and (d)(1)(b) thereof), and any child (as defined in section 152(f)(1)) of the taxpayer who as of the end of the taxable year has not attained age 27. Any child to whom section 152(e) applies shall be treated as a dependent of both parents for purposes of this subsection. Section 451 IRC: General rule for taxable year of inclusion (a) General rule The amount of any item of gross income shall be included in the gross income for the taxable year in which received by the taxpayer, unless, under the method of accounting used in computing taxable income, such amount is to be properly accounted for as of a different period. 6

7 26 CFR , Constructive receipt of income. (a) General rule. Income although not actually reduced to a taxpayer s possession is constructively received by him in the taxable year during which it is credited to his account, set apart for him, or otherwise made available so that he may draw upon it at any time, or so that he could have drawn upon it during the taxable year if notice of intention to withdraw had been given. However, income is not constructively received if the taxpayer s control of its receipt is subject to substantial limitations or restrictions. Section 457(f)(1), IRC, Tax treatment of participants where plan or arrangement of employer is not eligible: (1) In general In the case of a plan of an eligible employer providing for a deferral of compensation, if such plan is not an eligible deferred compensation plan, then- (A) the compensation shall be included in the gross income of the participant or beneficiary for the 1st taxable year in which there is no substantial risk of forfeiture of the rights to such compensation, and (B) the tax treatment of any amount made available under the plan to a participant or beneficiary shall be determined under section 72 (relating to annuities, etc.). 7

8 IRS publication 538: Constructive Receipt. Income is constructively received when an amount is credited to your account or made available to you without restriction. You need not have possession of it. If you authorize someone to be your agent and receive income for you, you are considered to have received it when your agent receives it. Income is not constructively received if your control of its receipt is subject to substantial restrictions or limitations. Cash basis taxpayers must include gains, profits, and income in gross income for the taxable year in which they are actually or constructively received. Under the constructive receipt doctrine, which is codified in 451(a), income although not actually reduced to a taxpayer's possession is constructively received by him in the taxable year during which it is credited to his account, set apart for him, or otherwise made available so that he may draw upon it at any time, or so that he could have drawn upon it during the taxable year if notice of intention to withdraw had been given. However, income is not constructively received if the taxpayer's control of its receipt is subject to substantial limitations or restrictions. Nonqualified Deferred Compensation Audit Techniques Guide ( ) Compensation-Audit-Techniques-Guide-( ) 8

9 What Is A Substantial Restriction Or Limitation? It depends upon whether a plan is: Funded or Unfunded. Nonqualified Deferred Compensation Audit Techniques Guide ( ) d-deferred-compensation-audit-techniques-guide-( ) What Is A Substantial Restriction Or Limitation? Unfunded Plans: Establishing constructive receipt requires a determination that the taxpayer had control of the receipt of the deferred amounts and that such control was not subject to substantial limitations or restrictions. The IRS will consider how the plan is operated. Evidence that the taxpayer has an unfettered right to receive the deferred amounts or otherwise controls the deferred amounts will support a finding of constructive receipt. Nonqualified Deferred Compensation Audit Techniques Guide ( ) Compensation-Audit-Techniques-Guide-( ) 9

10 What Is A Substantial Restriction Or Limitation? Funded plans. The doctrine requires an employee to include in current gross income, the value of assets that have been unconditionally and irrevocably transferred as compensation into a fund for the employee's sole benefit, if the employee has a nonforfeitable interest in the fund. Nonqualified Deferred Compensation Audit Techniques Guide ( ) Compensation-Audit-Techniques-Guide-( ) What Is A Substantial Restriction Or Limitation? Funded plans What Is A Non-forfeitable Interest? If an employer funds a nonqualified deferred compensation plan and if the employee can transfer money out of that plan for his personal benefit or the benefit of someone other than the employer or if the employee s interest in the plan is not subject to a substantial risk of forfeiture, then the employee has constructively received the deferred compensation when the employer funds the plan. 10

11 What Is A Substantial Restriction Or Limitation? Funded plans What Is A Substantial Risk Of Forfeiture? Property is subject to a substantial risk of forfeiture if the individual's right to the property is conditioned on the future performance of substantial services or on the nonperformance of services. In addition, a substantial risk of forfeiture exists if the right to the property is subject to a condition other than the performance of services and there is a substantial possibility that the property will be forfeited if the condition does not occur. What Is A Substantial Restriction Or Limitation? Funded plans Examples of substantial risk of forfeiture. Employee must work until age 55 and have 20 years of service employee has a substantial risk of forfeiting the benefit until he reaches age 55 with 20 years of service. The substantial risk of forfeiture exists because the employee s right to the benefit is conditioned upon continued employment. It is possible that employee might have constructive receipt of benefit under unfunded plan if employee has contractual right to receive benefit. Would requirement that employee retire to receive benefit make any difference? See Loth v. City of Milwaukee, (WI S. Ct. 2008). 11

12 What Is A Substantial Restriction Or Limitation? Funded plans Examples of substantial risk of forfeiture. Employee must retire age 60 and will forfeit part of the benefit for each year the employee works after age 60. The substantial risk of forfeiture exists because the benefit is conditioned on the employee terminating employment by a certain date. Note that the benefit in the second example would violate the Age Discrimination in Employment Act Wisconsin Act 13. Act 13 significantly modified the pension benefit reduction factors that had previously been applied to Wisconsin Retirement System (WRS) participants who chose to take an early retirement. The effect of these changes was to reduce the impact of these factors as a disincentive to early retirement. As a result, long-term WRS general employees age 57 or older could retire before age 65 with little or no reduction in pension benefits, depending on their age and years of service. 12

13 Employees and unions reacted to change in WRS by bargaining for early retirement incentives: Cash stipends. Post-employment health insurance. Employees with alternative post-employment health insurance options sought cash in lieu of insurance. Employees and unions argued that the cost of the postemployment benefits would be covered by the reduced salary cost of the new employee. Cash stipends were structured to create an incentive to retire early: Benefit reduced or eliminated if employee retired after a certain age. This feature of the benefit created a substantial risk of forfeiture. 13

14 In 1999 the EEOC started an investigation of Wisconsin school district post employment benefits. The early retirement cash stipend incentives that were reduced or eliminated after the employee reached a certain age were found to be in violation of the Age Discrimination in Employment Act. School districts modified those benefits to eliminate the upper age reduction or elimination of benefits, and in doing so, also eliminated the substantial risk of forfeiture in some cases. Definition: A nonqualified deferred compensation (NQDC) plan is any elective or nonelective plan, agreement, method, or arrangement between an employer and an employee (or service recipient and service provider) to pay the employee compensation some time in the future that do not satisfy all of the requirements of 401(a). Nonqualified Deferred Compensation Audit Techniques Guide ( ) Compensation-Audit-Techniques-Guide-( ) 14

15 Examples of qualified plans include: 403(b) plans. 457(b) plans. Wisconsin Retirement System Example of a nonqualified plan: Employee who retires at or after age 55 with 20 years of service will be paid a post-employment stipend of $5,000 per year for 5 years. If the plan is funded, the employee will constructively receive $25,000 in the year he or she meets both the age and years of service requirement, even if the employee does not retire. If the plan is not funded, the employee who retires at or after age 55 with 20 or more years of service will constructively receive $25,000 in the year he or she retires. 15

16 City Government A owes Employee Z $150,000 in accumulated sick and vacation pay as of the day of retirement. A month before Employee Z s retirement date, City A reaches an agreement to pay Employee Z $50,000 a year for 3 years. City A intends to treat each of the 3 payments as wages and subject the payment to Federal Income tax withholding, social security, and Medicare taxes in each year. This arrangement does not defer the tax due. City A may choose to make the payments over the 3 years, but because the entire $150,000 is available at retirement, it will be included in income, subject to income tax withholding and social security and Medicare taxes, as of the date the employee is entitled to the funds. IRS Office of Federal, State and Local Governments, FSLG Newsletter January If employee has a right to receive the income now the income is included in the employee s taxable compensation now even if the employee chooses to receive the money at a later date. If the employee is given a range of options, the employee has constructively received the money when he/she first has the right to exercise the option. IRS Office of Federal, State and Local Governments, FSLG Newsletter January

17 Avoid constructive receipt by offering retirement benefit through a qualified deferred compensation plan. 403(b) plan may include provisions for up to 5 years of employer post-employment 403(b) plan contributions. The employer contributions must be non-elective contributions the employee cannot have the option to receive any other compensation in lieu of the 403(b) contribution. Limitations on use of 403(b) plans for post-employment benefits. The employer must sponsor a 403(b) that meets all of the requirements for such plans: Written plan document. Plan must be operated in accordance with restriction specified in written plan document. The written 403(b) plan must include provisions allowing the employer to make post-employment 403(b) contributions. 17

18 Limitations on use of 403(b) plans for post-employment benefits Number of Contributions Post-employment 403(b) contributions may be made in the: Year of retirement and 5 years following employment. Note: if a post employment contribution is made in the same year as retirement, the former employee s pretax benefit contributions (including medical and dental plan, flexible spending account, and retirement plan contributions) must be determined. This total plus the employer post employment contribution cannot exceed the maximum contribution permitted by the IRS. Limitations on use of 403(b) plans for postemployment benefits Contribution Limits. Contribution Limits: The amount of the contribution must not exceed the lesser of: The employee s salary in the last year of employment. The section 415 maximum allowable contribution ($52,000 in 2014). Note that any elective contributions made by the employee are deducted from these amounts this is only a possible issue in last year of employment as elective contributions cannot be made after retirement. See Internal Revenue Code Section 415(c)(1)(A)) 18

19 Limitations on use of 403(b) plans for postemployment benefits Rehired Employees A rehired employee is no longer a former employee of that employer. This applies even if that former employee is rehired by his/her former employer on a part-time basis. When rehired, the former employee is not eligible to receive the post employment 403(b) contributions. Limitations on use of 403(b) plans for post-employment benefits Rehired Employees The employer s plan document may allow the rehired employee the option to: Receive employer contributions under the employer s 403(b) plan as an active employee. Receive the post employment non-elective contributions for former employees when he/she subsequently terminates employment, in essence the payments are tolled. The plan document s rehire provision should state how the contributions will be determined upon the employee s secondary retirement. 19

20 Historical note: When schools, employees and unions bargained postemployment health benefits, some employees who did not need or want the benefit demanded an alternative cash benefit. The tax consequences of how such plans were set up were sometimes not taken into account. OR Section 106: Generally, Section 106 of the Code provides that health and medical benefits can be provided tax-free by an employer. However, if there is an option/choice to receive cash or another benefit, this may result in taxable wages, even if the employee does not elect to receive the cash. IRS Office of Federal, State and Local Governments, FSLG Newsletter July

21 Revenue Ruling Sick Leave Cash Payout or Insurance Plan provides employee with choice between cash payment of unused sick leave at retirement and application of that sick leave to the cost of the employee s post-employment health insurance until exhausted. Ruling provides that employees who choose health insurance option have constructively received the cash payment as income. Revenue Ruling Health Insurance Only: Another plan provides that all accumulated unused sick leave is placed in an account to pay for post-employment health insurance until the funds are exhausted. There is no cash option and any unused funds revert to employer. Ruling states that this plan does not create a constructive receipt problem and the value of the benefit is excludable from income under section

22 Revenue Ruling : Plan provides for reimbursement of qualified medical expenses of employees, former employees, spouses and dependents. The Plan also reimburses the medical care expenses of the surviving spouse and dependents of a deceased employee. No one else may receive benefits under the plan. Upon death of employee, spouse and all dependents, remaining funds forfeited to employer. Plan not provided under salary reduction arrangement or section 125 plan. Medical expenses are reimbursed up to a maximum amount per year. Revenue Ruling : Medical expenses are only reimbursed to extent those are not reimbursed by another plan. A portion of each employee s reimbursement amount is forfeited each year if unused; the rest is carried forward to the next year. Neither the employee nor any other person has the right to receive cash or any other taxable or non-taxable benefit under the plan. When the employee retires unused sick leave and vacation is contributed to account. Employee has no option to receive sick leave or vacation pay out in cash. 22

23 Revenue Ruling : Plan benefits, as described above, are excluded from income under section 105. If employee could receive payment of unused reimbursement either at the end of the year or at retirement, then plan benefits are not excluded from income. If employee s beneficiaries or estate receive cash payment of unused benefits upon employee s death, benefits are not excluded from income. Private Letter Ruling (PLR) : School district early retirement incentive plan allowed employees a choice between receipt of health benefits up to a certain amount each year until eligible for Medicare; or Receive a one-time payment based on unused sick leave, plus a retirement bonus. Since employees had a choice between the nontaxable health benefit and taxable compensation, those employees choosing the health benefit had constructively received the taxable compensation and would be taxed on the amount they could have received had they chose that option. 23

24 PLR : Employer made mandatory contributions to a trust account for employee retirement health benefits. The trust made distributions to the employer s health plan to subsidize employee medical coverage. The employee could not elect to receive salary in lieu of making contributions. There is no constructive receipt and the contributions are not included in gross income. Section 125 ( cafeteria ) plans provide a partial exception to the constructive receipt rules. These plans provide a choice between cash wages and a salary reduction to receive an excludable benefit. If the benefit is selected, the value is not included in wages. A section 125, or cafeteria plan, cannot provide for deferred compensation. Only those benefits specifically indicated in section 125 are eligible for tax-free treatment. Former employees may participate in a cafeteria plan. 24

25 Note that cafeteria plans are subject to multiple nondiscrimination rules that prohibit discrimination in favor of highly compensated employees. The IRS has provided little guidance on how to apply these rules and has indicated that it does not plan to devote resources to providing a consolidated cafeteria plan nondiscrimination rule. Cash in lieu of health benefit plans offered only to a few highly compensated employees may have discrimination problems. IRS IRC 125 Non-discrimination Testing. IRC 125 permits employers to offer benefits on a pretax basis to employees through the use of a cafeteria plan. However, the tax advantage is conditioned upon the cafeteria plan passing three nondiscrimination tests. If a cafeteria plan discriminates in favor of highly compensated participants, those highly compensated participants will be taxed on their benefits. HCI rules are different for IRC 125 than listed in IRC 105(h). 25

26 Also note that the Affordable Care Act prohibits discrimination in the offering of health benefit plans favoring highly compensated employees. Rules interpreting that prohibition are still pending. The employer may have liability for federal income tax not withheld. Employees and retirees may have unexpected federal income tax liability for income constructively received. 26

27 PPACA Shared Responsibility Provisions - Delayed Until January 1, H of the IRC provides that an applicable large employer (as defined in 4980H(c)(2)) is subject to an assessable payment if any full-time employee is certified to receive an applicable premium tax credit or costsharing reduction and either: (1) the employer does not offer to its full-time employees (and their dependents) the opportunity to enroll in minimum essential coverage under an eligible employer sponsored plan ( 4980H(a))1; or PPACA Shared Responsibility Provisions - Delayed Until January 1, H of the IRC provides that an applicable large employer (as defined in 4980H(c)(2)) is subject to an assessable payment if any full-time employee is certified to receive an applicable premium tax credit or costsharing reduction and either: (2) the employer offers its full-time employees (and their dependents) the opportunity to enroll in minimum essential coverage that is either unaffordable as defined by law or does not provide the minimum value within meaning of the PPACA. 27

28 PPACA- The IRS announced on February 11, 2014 the transition rules for the employer mandate under the ACA's shared responsibility provisions. on-employer-shared-responsibility-provisions-under-the- Affordable-Care-Act For 2015 (and for employers with non-calendar-year plans, any calendar months during the 2015 plan year that fall in 2016), an employer that (a) had at least 100 full-time employees (including full-time equivalents) in 2014, or (b) had at least 50 but fewer than 100 full-time employees (including full-time equivalents) but does not qualify for the relief described in question 34, will be liable for an Employer Shared Responsibility payment only if: The employer does not offer health coverage or offers coverage to fewer than 70% of its full-time employees and (unless the employer qualifies for the 2015 dependent coverage transition relief described in question 33) the dependents of those employees, and at least one of the full-time employees receives a premium tax credit to help pay for coverage on a Marketplace. OR 28

29 For 2015 (and for employers with non-calendar-year plans, any calendar months during the 2015 plan year that fall in 2016), an employer that (a) had at least 100 full-time employees (including full-time equivalents) in 2014, or (b) had at least 50 but fewer than 100 full-time employees (including full-time equivalents) but does not qualify for the relief described in question 34, will be liable for an Employer Shared Responsibility payment only if: OR The employer offers health coverage to at least 70% of its full-time employees and (unless the employer qualifies for the 2015 dependent coverage transition relief described in question 33) the dependents of those employees, but at least one fulltime employee receives a premium tax credit to help pay for coverage on a Marketplace, which may occur because the employer did not offer coverage to that employee or because the coverage the employer offered that employee was either unaffordable (see question 19) to the employee or did not provide minimum value (see question 20). After 2015, 95% should be substituted for 70% in the bullets above (see question 18). PPACA Shared Responsibility Provisions Safe Harbor Wage Determination: In Notice , the IRS notes that the safe harbor it plans to develop is designed to make it easier for employers to determine whether the health coverage they offer is affordable coverage. Thus, the safe harbor would use 9.5% of wages that the employer paid to an employee, instead of the employee s household income, as the standard for affordability. Source: Implement-the-ACA-in-a-Careful-Thoughtful-Manner-.aspx 29

30 PPACA Shared Responsibility Provisions Safe Harbor Full-time Employee: In Notice , the IRS notes that the safe harbor it plans to develop is designed to make it easier for employers to determine whether the health coverage they offer is affordable coverage. Multiple definitions, including: On-going Employee : Employed for at least one standard measurement period (3-12 months as established by the employer. Source: PPACA Shared Responsibility Provisions Safe Harbor Full-time Employee: Notice (cont.) New employee Expected to work full-time 30 hours per week employers and others should determine whether a new employee "is reasonably expected to work an average of at least 30 hours per week." Source: 30

31 PPACA Shared Responsibility Provisions Educational Institution Rules School Year Employees Break Periods of less than 4 weeks Crediting of average hours worked during break periods of less than 4 weeks to a maximum of 501 hours Break periods of 4 weeks or more Anti-abuse provisions Source: PPACA Shared Responsibility Provisions Penalty The penalty is $3,000 annually for each full-time employee receiving a tax credit, up to a maximum of $2,000 times the number of full-time employees minus 30. The penalty is increased each year by the growth in insurance premiums. Source: penalty_flowchart_1.pdf 31

32 State Law on Health Insurance: If a district offers a group health insurance plan, the group health insurance offered by the district must offer insurance to all employees working on a permanent basis and having a normal work week of 30 hours or more. Wis. Stats (5)(a). Requirement is on the group insurance carrier, not the employer. Except as provided in par. (b), "eligible employee" means an employee who works on a permanent basis and has a normal work week of 30 or more hours. The term includes, but the term does not include an employee who works on a temporary or substitute basis. Federal Law on Health Insurance - General: Self-funded Plans: Existing Internal Revenue Code (IRC) section 105(h) rules on benefit testing covering self-funded plans. Cafeteria Plans/Flexible Spending Accounts: Existing IRC Section 125 Rules on Employee Contributions for fully insured plans. Health Benefits: Proposed IRS IRC 105(h) rules as proposed by the Federal Patient Protection Affordable Care Act (PPACA). 32

33 Proposed IRS IRC 105(h) rules as proposed by the Federal Patient Protection Affordable Care Act (PPACA). Nondiscrimination requirements do not apply to all insured benefit plans. Certain benefits are excepted from coverage: dental, vision, long-term care, accident or disability income, specific disease/illness coverage, Medicare supplemental coverage - if offered separately from group health plan coverage. Federal Non-discrimination Provisions re: Health Insurance - General: A group health plan cannot, under certain circumstances, discriminate in favor of highly compensated individuals (HCI) in regard to either eligibility to participate in the plan or health benefits. 33

34 Federal Law - Highly Compensated Individual: A group health plan cannot, under certain circumstances, discriminate in favor of highly compensated individuals (HCI) in regard to: either eligibility to participate in the plan or health benefits. Federal Law on Health Insurance Proposed 105(h) - Highly Compensated Individual is defined as: One of the five highest-paid officers. A shareholder who owns more than 10 percent of the employer s stock An individual who is among the highest-paid 25 percent of all employees 34

35 Federal Law on Health Insurance Proposed 105(h) - Highly Compensated Individual (HCI) is defined as: Certain individuals can be excluded from the group of the highest 25 percent of paid employees and disregarded from the testing as long as they do not participate in the plan. Excluded individuals include: Employees who have not completed three years of service Employees who have not attained age 25 Part-time (defined as less than 35 hours per week) or seasonal employees Non-resident aliens who receive no U.S. source earned income Federal Law on Health Insurance Proposed 105(h) - Highly Compensated Individual (HCI) is defined as: Certain individuals can be excluded from the group of the highest 25 percent of paid employees and disregarded from the testing as long as they do not participate in the plan. Excluded individuals include: Collectively bargained employees: Can be excluded from the eligibility test if medical benefits were the subject of collective bargaining, and if such employees were not eligible for the plan. A plan covering only collectively bargained employees cannot be discriminatory as to the eligibility test Wisconsin Act 10 and Judge Colas decision implications. 35

36 Retiree-only and grandfathered plans are excepted. Retiree-Only plans most likely are the following: Plans including only retirees; Plans experience rated for retiree groups only; Most common arrangements at the present time are group Medicare Supplemental Coverage and Medicare Advantage. Plans with fewer than two active employees. More discussion on this in the HRA section. Retiree-only and grandfathered plans are excepted. Grandfathered plans are those plans where the following changes have not been made: Elimination of all or substantially all benefits to treat a particular medical condition. Increase in a percentage cost sharing requirement, for example, raising the co-insurance by 5% or more. Increase in a deductible or out-of-pocket maximum by amount that exceeds medical inflation plus 15%. 36

37 Retiree-only and grandfathered plans are excepted. Grandfathered plans are those plans where the following changes have not been made: Increase in a co-payment by an amount that exceeds medical inflation by 15 % or if greater, $5.00 plus medical inflation. Decrease in an employer s contribution rate toward the cost of coverage by more than 5%. Imposition of annual limits on the dollar value of all benefits below specified amounts. PHS 2716 Penalty: Consequences of violation fall on the plan sponsor [district], not the HCI(s). If a fully-insured plan is found to be discriminatory, a penalty will be imposed on the employer/plan sponsor. Regulations are needed to define exactly how the employer penalty will be applied. Most likely in spring to summer 2013 regulations will be forthcoming. Currently, it appears that the employer will pay a penalty of at least $100 per day per highly compensated participant. 37

38 Limitations on the Excise Tax: Reasonable Diligence: The excise tax is not to apply where failure is not discovered exercising reasonable diligence. IRC 4980D(c)(1). Failure Corrected within 30 Days of Knowledge: No excise tax shall be imposed if the failure is due to reasonable cause and is corrected within 30 days of knowledge of the failure or exercising reasonable diligence would have been known. IRC 4980D(c)(1). Limitations on the Excise Tax: Overall Limitation for Unintentional Failures: In the case of failures which are due to reasonable cause and not willful neglect for a single employer, the tax for failures during the taxable year of that employer shall not exceed the amount equal to the lesser of: 10% of the aggregate amount paid or incurred by employer during the preceding taxable year for group health plans, or $500,

39 Potential Taxation of the HCI under Proposed Rules (similar to self-funded rules): Eligibility Test Failure: The HCI must pay taxes on an amount that equals the benefit payments to the HCI multiplied by a fraction (total benefit payments to the HCI divided by total benefit payments to all participants). Benefit Test Failure: The highly-compensated must pay tax on the excess benefit received when compared with the non-highly compensated. Payroll Reporting: District has to report taxation of discriminatory benefits. Proposed IRS IRC 105(h) rules Enforcement Commencement Date. IRS Notice , stated that compliance with 105(h) requirements by fully insured plans will not be required, and the excise tax penalties for violations will not be imposed, until plan years beginning some time after final regulations or other definitive guidance has been issued. The Department of Labor (DOL) and the Department of Health and Human Services (DHHS) have also agreed to the delayed effective date. 39

40 This notice provides guidance on the application of certain provisions of the Affordable Care Act to the following types of arrangements: (1) health reimbursement arrangements (HRAs), including HRAs integrated with a group health plan; (2) group health plans under which an employer reimburses an employee for some or all of the premium expenses incurred for an individual health insurance policy, such as a reimbursement arrangement described in Revenue Ruling , CB 25, or This notice provides guidance on the application of certain provisions of the Affordable Care Act to the following types of arrangements: arrangements under which the employer uses its funds to directly pay the premium for an individual health insurance policy covering the employee (collectively, an employer payment plan); and (3) certain health flexible spending arrangements (health FSAs). 40

41 Health Reimbursement Account: An HRA is an arrangement that is funded solely by an employer and that reimburses an employee for medical care expenses (as defined under Code 213(d)) incurred by the employee, or his spouse, dependents, and any children who, as of the end of the taxable year, have not attained age 27, up to a maximum dollar amount for a coverage period. IRS Notice , CB 93; Revenue Ruling , CB 75. Health Reimbursement Account: This reimbursement is excludable from the employee s income. Amounts that remain at the end of the year generally can be used to reimburse expenses incurred in later years. HRAs generally are considered to be group health plans within the meaning of Code 9832(a), 733(a) of the Employee Retirement Income Security Act of 1974 (ERISA), and 2791(a) of the Public Health Service Act (PHS Act) and are subject to the rules applicable to group health plans. 41

42 Employer Payment Plans: IRS Revenue Ruling holds that if an employer reimburses an employee s substantiated premiums for non-employer sponsored hospital and medical insurance, the payments are excluded from the employee s gross income under Code 106. This exclusion also applies if the employer pays the premiums directly to the insurance company. Employer Payment Plans: An employer payment plan does not include an employersponsored arrangement under which an employee may choose either cash or an after-tax amount to be applied toward health coverage. Individual employers may establish payroll practices of forwarding post-tax employee wages to a health insurance issuer at the direction of an employee without establishing a group health plan, if the standards of the DOL s regulation at 29 C.F.R (j) are met. 42

43 Health FSA: In general, a health FSA is a benefit designed to reimburse employees for medical care expenses (as defined in Code 213(d), other than premiums) incurred by the employee, or the employee s spouse, dependents, and any children who, as of the end of the taxable year, have not attained age 27. See Employee Benefits Cafeteria Plans, 72 Fed. Reg , (August 6, 2007) (proposed regulations; to be codified, in part, once final, at 26 C.F.R ); Code 105(b) and 106(f). Health FSA: While employees electing coverage under a health FSA typically also elect to enter into a salary reduction agreement, employers may provide additional health FSA benefits in excess of the salary reduction amount. See Employee Benefits Cafeteria Plans, 72 Fed. Reg , (August 6, 2007) (proposed regulations; to be codified, in part, once final, at 26 C.F.R (r), (b)). 43

44 Health FSA: For plan years beginning after December 31, 2012, the amount of the salary reduction is limited by Code 125(i) to $2,500 (indexed annually for plan years beginning after December 31, 2013). See IRS Notice , IRB 1046, for more information about the application of the limitation. Additional employer contributions are not limited by Code 125(i). What is a Group Health Plan? The Affordable Care Act contains certain market reforms that apply to group health plans (the market reforms). In accordance with Code 9831(a)(2) and ERISA 732(a), the market reforms do not apply to a group health plan that has fewer than two participants who are current employees on the first day of the plan year, and, in accordance with Code 9831(b), ERISA 732(b), and PHS Act 2722(b) and 2763, the market reforms also do not apply to a group health plan in relation to its provision of excepted benefits described in Code 9832(c), ERISA 733(c) and PHS Act 2791(c). 44

45 What is a Group Health Plan? Excepted benefits include, among other things, accident-only coverage, disability income, certain limitedscope dental and vision benefits, certain long-term care benefits, and certain health FSAs. HRA An earlier FAQ issued by Treasury (DOL Technical Release ) indicated that where an HRA participant is not enrolled in his or her employer's major medical group health plan, the participant will not be considered to be enrolled in an "integrated" HRA, and such HRA will fail to satisfy certain ACA market reform requirements. The IRS Notice re-affirms this position, defines the requirements necessary for an HRA to be considered integrated, and clarifies other issues. 45

46 HRA No Integration with an Individual Health Insurance Policy An HRA which is used to purchase an individual health insurance policy cannot be integrated with that individual policy. An HRA used to purchase coverage on the individual market (including the exchange) will violate the ACA market reform provisions prohibiting annual dollar limits and requiring preventive care services. HRA Account-based arrangements, like an HRA, are generally incompatible with these requirements. A stand-alone HRA into which the employer deposits pre-tax dollars for the purpose of helping an active employee purchase an individual health insurance policy (i.e., a "defined contribution" approach) is not permitted. 46

47 HRA Integration with a Group Health Plan An HRA that is integrated with a group health plan complies with the annual dollar limitations and preventive service requirements to the extent that such group health plan itself complies with the annual dollar limitations and the preventive services requirements. An HRA is "integrated" with a group health plan only if it satisfies one of the following two integration alternatives: The group health plan does not provide "minimum value" (the plan's share of costs does not equal at least 60%) The group health plan does provide "minimum value. HRA Application of the Affordability and Minimum Value Rules An individual is not eligible for a premium tax credit if the individual is eligible for employer-sponsored coverage that is affordable (the premium for self-only coverage does not exceed 9.5% of household income) and that provides minimum value (the plan's share of costs is at least 60%). The Notice clarifies when and how an employer can count contributions to an HRA for purposes of calculating whether its plan satisfies the affordability and/or minimum value requirements. 47

48 HRA An HRA that is integrated with a group health plan (provided the employee enrolls in such group health plan), amounts newly made available under the HRA for the current plan year can be counted in determining whether such employer's group health plan satisfies either the affordability requirement or the minimum value requirement, but not both. Minimum Value Computation: HRA contributions that can be used by the employee only to pay cost-sharing (i.e., co-payments and coinsurance) for covered medical expenses under the group health plan can only be counted toward the minimum value requirement, Affordability Requirement: HRA contributions that can be used to pay either premiums and/or cost-sharing, can be counted only toward the affordability requirement. HRA HRA with another Employer: Where an HRA is integrated with a group health plan offered by another employer (such as the employer of the employee's spouse), the HRA contributions do not count toward the affordability or minimum value requirement of the group health plan offered by the other employer. Refusal of Coverage offered by the Employer: Where an HRA is offered by an employer on the condition that the employee must refuse the coverage offered by the employer and instead enroll in non-hra coverage from a different source, the employer cannot count the HRA contributions in determining either the affordability or minimum value of the employer's group health plan. 48

49 HRA Unused Amounts Credited to an HRA Amounts credited to an HRA while such HRA was integrated with other group health plan coverage may be used to reimburse medical expenses in accordance with the terms of the HRA after the employee ceases to be covered by the integrated group health plan coverage without causing the HRA to fail to comply with the ACA market reforms. Note: Since the HRA coverage is considered to be minimum essential coverage, for any month such HRA continues, the employee will not be eligible for a premium tax credit when he or she purchases individual coverage through the ACA health exchanges. HRA Retiree-only HRAs Plans that cover only retired employees are not subject to the ACA market reform provisions. Stand-alone HRAs for Retirees: that reimburse medical expenses, or provide money to help purchase an individual health insurance policy for the retiree, remain viable. Premium Tax Credit Implications: Since the HRA is considered to be minimum essential coverage, the retiree will not be eligible for a premium tax credit for any month in which funds are retained in the HRA (including amounts retained in the HRA during periods of time after the employer has ceased making contributions). 49

50 Employer Payment Plans EPP is a group health plan, and as such, must comply with the ACA market reforms. An EPP includes any pre-tax arrangement, including a cafeteria plan, to the extent the premiums are used to purchase individual health insurance. An EPP will not satisfy either the annual dollar limits or preventive care requirements of the ACA. Premium-only cafeteria plans that allow employees to pay their share of premiums for employer-sponsored group health plan coverage on a pretax basis continue to be permitted. Employer Payment Plans Certain practices do not constitute Employer Payment Plans, and therefore are not prohibited. These include: (i) Employer-provided after-tax subsidies for the purchase of individual health insurance; and (ii) Payroll practices established by an employer pursuant to which an employee's individual health insurance premiums are forwarded to the insurer, as long as the premium payments are paid on an after-tax basis. 50

51 Health Flexible Spending Account Plans If an FSA provides only excepted benefits, the ACA market reform rules do not apply. A health FSA will be considered to provide only excepted benefits if (i) the employer also makes available group health plan coverage that is not limited to excepted benefits and (ii) the maximum benefit available to any participant under the health FSA does not exceed two times the participant's salary reduction election for the health FSA for the year (i.e., 2 times $2500), or if greater, $500 plus the amount of the participant's salary reduction election. Employee Assistance Plans Extent of Medical Care or Treatment: Until final regulations are issued (and at least through calendar year 2014), as long as an EAP does not provide significant benefits in the nature of medical care or treatment, such EAP will be deemed to constitute excepted benefits, and therefore not subject to the ACA market reform rules. Does the EAP offer Medical Care or Treatment: Employers may use a reasonable, good faith interpretation of whether an EAP provides significant benefits in the nature of medical care or treatment. Wellness Programs: It is not clear whether wellness programs would be considered to provide significant benefits in the nature of medical care or treatment and therefore additional guidance is needed. 51

52 Section 3402(a)(1) IRC requires every employer making payment of wages to withhold federal income tax from the wages of an employee. Employer may be required to withhold federal income tax from wages constructively received by the employee. In the case of a nonqualified deferred compensation plan, the deferred compensation is constructively received when the employee performs the services by which the compensation is earned or when there is no substantial risk of forfeiture of that compensation. The IRS has audited several school districts in the last two years. The focus of the audits were post-employment benefits provided in collective bargaining agreements and individual contracts. Deferred compensation. Plans allowing the retiree to choose between health benefits and cash. Health Plans. 52

53 Bob Butler has been a WASB staff counsel since He is also, along with attorney Barry Forbes, the Association s coassociate executive director. Bob directly represents more than 40 school districts in Wisconsin on employment, human resources and school law matters. Bob also provides membership services, including general legal information, to all school districts that are members of WASB. He graduated from the University of Wisconsin Law School and received his undergraduate degree in industrial and labor relations from Cornell University. Bob can be contacted at: bbutler@wasb.org (phone) (direct phone) (fax) 53

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