On July 30, the Internal Revenue Service (IRS) released Notice 2015-52 (the Notice) addressing issues raised by the excise tax on high cost employer-sponsored health coverage (often referred to as the “Cadillac tax”). Beginning in 2018, the Cadillac tax is a nondeductible 40% excise tax on the aggregate cost of applicable employer-sponsored health coverage in excess of a baseline amount of $10,200 (for self-only coverage) and $27,500 (for family coverage). The guidance in Notice 2015-52 supplements Notice 2015-15, which was issued in February 2015.
The development of guidance on the Cadillac tax can be seen as a case study in how a federal agency develops regulations for a dysfunctional statutory provision. In less partisan times, we may have expected a technical corrections bill or follow–on legislation, but for a variety of reasons—not the least of which is the partisan political climate—we don’t anticipate that a legislative fix or repeal of the Cadillac tax is likely, at least prior to the 2016 election.
Below are some of the key questions the Notice addresses about the new tax:
Who is responsible for paying the “Cadillac tax”?
Insurers pay the tax for fully insured plans. Employers pay for certain account-based plans, such as health savings accounts. In all other cases, the “person that administers the plan benefits” is responsible for payment. The IRS has proposed two approaches to imposing the obligation: on the day-to-day administrator (typically, a third party administrator) or on the person with “the ultimate authority or responsibility” to make final administrative decisions (typically, the plan administrator). Complicating the issue is that a single third party administrator is unlikely to administer all of the arrangements that need to be taken into account in determining whether tax is due. Under the statute, an employer has the obligation to calculate the excise tax payable by each administrator, a task that the employer may find challenging.
What is the cost of applicable coverage?
This determination is made month by month, and the tax is imposed if the cost of the applicable coverage for an employee during any month exceeds the dollar limit. Determining costs on a monthly basis has its own set of issues, particularly when (as is often the case) myriad arrangements are in place and costs may not be known until well after the coverage year ends. The Notice includes several approaches to calculating the cost.
What is the effect of tax reimbursements?
If an entity other than the employer (such as an insurer) is responsible for payment of the excise tax, that entity will undoubtedly want to be made whole. The Notice states that an excise tax reimbursement would be additional taxable income to the coverage provider. Because the Cadillac tax payment would not be tax deductible, the party making payment would also likely seek reimbursement for the income tax on the additional taxable income. All-in, the excise and income tax reimbursements could effectively double the cost of the Cadillac tax to the employer. The Notice provides that excise tax reimbursements will be excluded from the cost of applicable coverage, but that income tax reimbursements would need to be separately billed and identified as attributable to the cost of the excise tax to be excludable. The Notice identifies some of the complexities of determining applicable income tax rates for a reimbursement formula and includes several approaches to simplify the calculation.
How should age and gender adjustments to the dollar limits be applied?
The statute provides for an increase in dollar limits based on the age and gender characteristics of all employees of an employer. The Notice contemplates that employers may take a snapshot of their demographics on the first day of the plan year to capture census data. The adjustment would depend on the distribution of men and women in different age groups. Notably, the statute does not provide a geographic adjustment, even though health coverage is much more costly in some parts of the country.
The Notice covers a variety of other topics, including the treatment of amounts in flexible spending arrangements that carry over from one year to the next, how to allocate contributions to account-based plans, and the time and manner in which the tax is to be paid.
What is the bottom line? We expect that the IRS will struggle to produce coherent and workable rules sufficiently in advance of 2018 to enable employers, insurers, and other interested parties to meet their compliance obligations. In the meantime, employers should take steps to reduce exposure to the Cadillac tax and should consider providing input in the regulatory process—directly and through trade groups.
To view a copy of Notice 2015-52, click here. The IRS invites comments regarding the Notice by October 1, 2015.