Cadillac tax

What Your Clients Should Know About the ‘Cadillac Tax’

Oct 6th 2015
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The Affordable Care Act imposes a tax on workplace health coverage exceeding specified limits. Slated to go into effect in 2018 and commonly called the “Cadillac tax,” it has been the subject of repeal and amendment efforts in Congress, even as the IRS continues to work out how the tax will be administered. To date, the IRS has issued two notices – Notice 2015-16 and Notice 2015-52 – outlining detailed proposals and requesting comments on various aspects of the tax.

Basics of the Tax: A Rock and a Hard Place for Many Employers?
Imposed under Internal Revenue Code Section 4980I, the Cadillac tax is a nondeductible 40 percent excise tax on the “excess benefit” provided to current or former employees, including, for example, retirees. The excess benefit is the amount by which the value of an employee's health coverage – called the “cost of coverage” – exceeds $10,200 for an employee with self-only coverage or $27,500 for an employee with any kind of family coverage. These limits are subject to adjustment in 2018 for healthcare cost increases and in later years for annual cost-of-living increases. Importantly, the cost-of-living increases are not tied to – and may not keep up with – medical inflation, making taxes more likely in later years.

Other adjustments are also permitted (e.g., for high-risk workers, like firefighters), but notably there is no geographic adjustment allowed, even though health costs vary widely across the country. The limited nature of the adjustments creates a rock-and-hard-place concern for employers because even the “minimum value” coverage required to avoid taxes under the Affordable Care Act's shared responsibility rules (generally 60 percent bronze-level coverage) could trigger the Cadillac tax.

Employers Subject to Tax
All employers are subject to the tax, whether private-sector, church, or governmental. Grandfathered health plans (exempt from certain Affordable Care Act mandates), multiemployer plans, and retiree plans are also subject.

According to an August 2015 Kaiser Family Foundation projection, 16 percent of employers offering a major medical plan with a health savings account (HSA) or health reimbursement arrangement (HRA) are expected to have at least one plan that exceeds the self-only limit in 2018. For employers that also have a health flexible spending account (FSA), a higher percentage is predicted – 26 percent in 2018, increasing to 30 percent in 2023.

Employee-by-Employee Determination
Whether a tax is owed is determined employee by employee on a monthly basis by calculating the cost of the coverage elected by each employee, determining whether the cost exceeds the applicable limit, and calculating the tax on any excess. What matters is the coverage actually elected, not what is offered. For employees who elect more than one plan – for example, a major medical plan and salary reductions under a health FSA or HSA – all elected coverage must be included (unless an exception applies, as discussed later).

Types of Coverage Included
The Cadillac tax applies to employer-sponsored plans providing medical benefits, pulling in a wide variety of plans, including account-based plans, such as health FSAs and HRAs. Importantly, even 100 percent employee-paid coverage and coverage paid for on an after-tax basis is generally included, although the IRS has proposed an exception for after-tax employee contributions to HSAs.

There are also other exceptions (e.g., for certain dental/vision plans). Understanding the types of coverage that must be included will be one of the compliance challenges for employers.

Determining Cost of Coverage
Determination of the cost of coverage starts by aggregating employees enrolled in particular benefit packages (e.g., a plan with both PPO and HMO options would have two packages). IRS proposals under consideration may allow further disaggregation based on either bona-fide employment-related criteria (such as job category) or standards to be specified (such as geographic distinctions). Then, the cost of each type of coverage would be determined using rules similar to those for calculating COBRA premiums (with self-only and family coverage calculated separately).

The analysis is easier for insured plans, with the cost generally equal to the premium paid to the insurer. For self-insured coverage, the employer will generally use the past-cost method (adjusted by the implicit price deflator) or obtain an actuarial determination. This is another challenge for employers because the COBRA rules – although in existence for many years – are not well-developed, especially for certain types of coverage (e.g., HRAs). The IRS has made several proposals regarding how to determine the cost of coverage and has requested comments on this topic.

Calculating and Paying the Tax
While the employer is responsible for calculating the Cadillac tax, “coverage providers” must pay it. For insured coverage, the coverage provider is the insurer. For HSAs, the coverage provider is the employer making contributions. For other coverage, the coverage provider is the “person that administers the plan benefits,” which the IRS has proposed to be either the person or entity responsible for day-to-day administration of plan benefits (generally one or more of a plan's third-party administrators), or the person or entity with ultimate administrative authority or responsibility under the plan (generally, but not always, the employer-plan sponsor).

The IRS recognizes that the tax may be “passed through” to the employer when insurers and other third parties are responsible for paying it, and it has issued complex proposals regarding the implications of this expected practice. The IRS has said it may designate Form 720, Quarterly Federal Excise Tax Return, for payment of Cadillac taxes.

Planning and Action Items
As with other aspects of healthcare reform, the Cadillac tax has been controversial. Bills to repeal the tax have been introduced in Congress; there are also proposals to reduce the tax's impact (e.g., by exempting some types of coverage). But given the time required to evaluate and potentially redesign benefits – and to communicate changes to employees – many employers have begun planning their compliance strategies and are considering steps to reduce coverage costs, including:

  • Increasing deductibles and coinsurance.
  • Changing benefits (e.g., adding preauthorization or telemedicine provisions).
  • Restricting contributions to account-based plans.
  • Shifting employee contributions to after-tax under HSAs.
  • Limiting or excluding spousal coverage.

About the authors:
Brigid Carroll Anderson, J.D., is director of EBIA seminars with the Tax & Accounting business of Thomson Reuters. Brigid has more than 25 years experience in the field of employee benefits law. She is a contributing author to EBIA's “ERISA Compliance” manual and has been a lead author of EBIA's “Employee Benefits for Domestic Partners,” “Record Retention Requirements,” and “Form 5500 Workbook” publications.

Susan Monkmeyer, J.D., is a senior editor of EBIA products with the Tax & Accounting business of Thomson Reuters. Susan has more than 25 years experience in the field of employee benefits law. She has been the editor and a contributing author of EBIA's “Cafeteria Plans” manual since 2005.

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