Affordable Care Act Cadillac Tax Questions Answered
The Cadillac tax of the Affordable Care Act (“ACA”) begins in 2018. While many employers recently have adjusted health benefit coverage levels to satisfy the legal minimums of the Employer Mandate, the Cadillac tax may require these same employers to once again adjust coverage levels but this time to avoid exceeding maximum levels specified by ACA.
This brief Q&A describes the tax and the recent IRS Notice 2015-16 describing tentative rule-making proposals by the IRS.
Q1: What is the Cadillac tax percentage?
Q2: To what health care costs does the 40% apply?
A2: The tax does not apply to an employer’s entire cost of coverage for its employees during a tax year. It applies only to the portion of an employer’s health care costs that exceed applicable thresholds set forth in the Code for such tax year. If an employer’s cost exceeds the applicable threshold, an employer is deemed to provide high cost or Cadillac coverage and is subject to the tax.
Q3: What are the thresholds?
A3: The thresholds for 2018 are $10,200 annually for single coverage and $27,500 annually for family coverage.
Q4: How are the thresholds adjusted?
A4: There are several adjustments contemplated by the Code:
- The thresholds are increased by $1,650 and $3,450 respectively if a majority of employees covered by the plan are engaged in a high risk profession. The Code defines construction as a high risk profession among numerous others.
- For multiemployer plans, the threshold for all employees is the family threshold (adjusted for high risk, if applicable).
- The Code contains special rules for 2018 inflation adjustments to the thresholds.
- After 2018, the thresholds will increase according to a cost of living formula.
- The Code also provides an age and gender adjustment to the thresholds but only if the demographics of an employer’s plan population substantially vary from the demographics of the national workforce.
Q5: Who is liable for the tax?
A5: If an employer provides high cost fully-insured coverage, the insurance company is liable for the tax. If multiple insurance companies issue coverage to a plan, the tax is apportioned ratably on the basis of each carrier’s premiums. If an employer provides high cost self-insured coverage, the employer generally is liable for the tax if it administers the plan. For a multiemployer plan, the board of trustees will be liable for the tax if it provides high cost coverage.
Q6: Who is required to calculate the tax liability for high cost coverage?
A6: The employer is required to calculate the tax and, for a fully-insured plan, notify its insurance carrier of tax owed by the carrier, if any. The employer must also notify the Secretary of the Treasury. For a multiemployer plan, the board of trustees must calculate the tax, if any, and notify the Secretary.
Q7: Are there penalties if an employer miscalculates and/or underpays tax for high cost coverage?
A7: Yes. In addition to paying any unpaid tax (or coordinating payment of unpaid tax by the plan’s insurance carrier), the employer also is subject to an excise tax equivalent to the amount of the underpayment plus interest. The IRS may forgive the excise tax if an employer demonstrates that the error occurred despite the exercise of reasonable diligence or if a good faith error is corrected within 30 days of its discovery.
Q8: How is the annual cost of coverage determined?
A8: For a fully-insured plan, the annual cost is equivalent to the annual premiums. For a self-insured plan, the Code requires annual cost to be determined in a manner similar to COBRA. The IRS dedicated much of its recent Notice 2015-16 to the issue of how to calculate the annual cost of coverage in self-insured plans. The agency discussed the COBRA methodology and announced in the Notice that it will issue regulations on the issue.
Q9: What COBRA methodology is relevant to determining the cost of self-insured coverage under the Cadillac tax?
A9: COBRA permits two methods of calculating the cost of self-insured coverage: the actuarial method and the past-cost method. The actuarial method sets the cost by actuarial projection before the tax year begins based on plan design and plan demographics. The past-cost method looks back to total plan costs incurred during a prior 12-month determination period and then sets the annual cost before the current tax year begins based on that past amount adjusted by an inflation factor as published by the Department of Commerce. The IRS in Notice 2015-16 has requested comments on the specific costs to be incorporated into these calculations (i.e. claims submitted v. claims incurred, administrative expenses, a ratable portion of overhead, etc).
Q10: Is an employer free to choose either cost calculation method for a self-insured plan?
A10: Yes. The employer generally may elect either method. However, an employer is not permitted to use the past-cost method where a significant demographic change occurred in the plan population during the determination period. Also, per its Notice, the IRS is considering a rule requiring an employer to maintain its elected method for a minimum period of 5 years following its election. The IRS believes this would prevent abuse that could occur if employers swapped methodologies from one year to the next.
Q11: Are there drawbacks to the actuarial or past-cost method for self-insured coverage?
A11: Yes. The IRS Notice acknowledges the awkwardness of adapting these COBRA methodologies to the Cadillac tax in that both methodologies result in an employer’s tax liability generally being established at the outset of the applicable tax year. This is so because COBRA requires premiums to be set in advance and therefore both methodologies result in the cost of coverage being determined prospectively; however, traditionally, taxes are determined retrospectively based on actual facts and circumstances that occurred during a taxable period. In the Notice, the IRS requested comments on the feasibility of basing the potential tax liability on actual costs incurred during a tax year (rather than using the COBRA methodologies which establishes costs in advance of the tax year).
Q12: Can an employer have multiple cost calculations within a single plan for a tax year by separating or combining employees into sub-groups based on objective criteria?
A12: Yes. There are several methods required and/or permitted:
- The IRS requires that an employer separate employees based on single or family coverage. The cost for the single group would then be determined separately from the cost of the family group.
- The IRS Notice proposes a required separation by benefit package (i.e. HMO v. PPO, gold plan v. silver plan). The cost for each benefit package would then be determined separately.
- The IRS Notice proposes a permissive separation based on other traditional criteria such as nature of compensation, job category, collectively-bargained status, geography, and similar categories.
- The Code permits pre-65 and post-65 retirees to be combined into one group.
Each level of separation or combination is layered on top of the prior level. For example, an employer with single and family HMO and PPO coverage would have four sub-groups of cost calculation: single HMO, single PPO, family HMO and family PPO. After separating and/or combining the various groups, the employer would determine whether it exceeded the Cadillac tax threshold per each group and it would be liable for the tax on a group-by-group basis (i.e. not on its total plan population).
Q13: Are pre-tax salary reduction contributions included in an employer’s cost calculation?
A13: For Health FSAs, the Code states that such contributions are included in the cost calculation. For HSAs, the IRS Notice proposes that such contributions be included in the cost calculation.
Q14: How should an employer determine the annual cost of an HRA?
A14: The IRS Notice proposes that an employer determine the annual cost of an HRA by adding all claims paid by the HRA during the tax year and dividing it by the number of participants.
Q15: Does the Cadillac tax take effect for all employers on January 1, 2018?
A15: It depends. The tax applies to taxable years beginning on or after January 1, 2018. A taxable year is a company’s fiscal year. If an employer’s taxable year is the calendar year, the tax begins on January 1, 2018; otherwise, the tax will begin on some later date in 2018. For fully-insured plans, the insurance carrier’s taxable year may also be relevant because the insurance carrier is the entity liable for the tax. For self-insured plans, the effective date is generally the start date of the employer’s taxable year. For multiemployer plans, the effective date is the first day of the plan year.
Editor’s Note: This article was written, and is reprinted with permission, by Mark Levengood) and Jennifer Abrams of the law firm of Susanin, Widman & Brennan, P.C., located in Wayne, PA. Susanin, Widman & Brennan, P.C., concentrates its practice in labor law, employment law, employee benefits, and construction law. In addition to construction claims and litigation, the firm provides advice to and representation of management in employment discrimination litigation; sexual and other forms of harassment claims; wage and hour investigations; occupational, safety and health inspections; employee benefits; unfair labor practice charges; collective bargaining negotiations; and labor disputes, union campaigns, strikes, pickets, grievances and arbitrations. Its practice is national in scope, and its clients range in size from small, privately held businesses to Fortune 500 companies. Visit Susanin, Widman & Brennan at www.swbcounsellors.com.
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