Stacking Transition Relief under the Final Employer Shared Responsibility Regulations

As we have recounted on this blog, employer shared responsibility rules under the Affordable Care Act originally were meant to go into effect on January 1, 2014, but have been put on hold two times.  The first time was in early July 2013 pursuant to IRS and White House bulletins later set forth more formally in IRS Notice 2013-45, and the stated purpose was to allow carriers and employers more time to understand and prepare for minimum essential coverage (MEC) and applicable large employer (ALE) reporting duties otherwise slated to begin in 2014.

The IRS Notice simply provided that both the employer shared responsibility provisions for applicable large employers (and information reporting related to same) would not apply in 2014 but would be “fully effective for 2015.”  It was silent on transition guidance contained in proposed regulations issued in December 2012, and thus left employers who had planned to rely on the transition guidance (including delayed start dates for non-calendar year plans) in temporary limbo.

This limbo period ended with the release of the final employer shared responsibility regulations (“Final Regulations”), which were published in the Federal Register on February 12, 2014.  The Final Regulations carry forward the transition relief set forth in the proposed regulations and expand on it in several ways.  This post summarizes the transition relief and explains some ways in which applicable large employers can “stack” the relief by using more than one type of transition relief at a time.  As with all my posts, this is for readers’ general information and is not intended to be relied upon in any specific factual setting.

By way of introduction I am going to assume that readers are familiar with basic definitions under the ACA including “applicable large employer” or “ALE,” full-time employee,” and “full-time equivalent or FTE”.  I am also going to assume reader familiarity with “assessable payments” under Internal Revenue Code (“Code”) Section 4980H(a) and (b).  Readers who are not familiar with those terms and rules can find definitions in this helpful IRS Frequently Asked Questions list, or by searching in my blog.

Additional Delay to 2016 for Mid-Sized Applicable Large Employers

The final regulations describe an additional year’s enforcement delay – from 2015 to 2016 – for mid-sized applicable large employers – those who average between 50 and 99 full-time employees, including FTEs, over their chosen 2014 measurement period.  For the enforcement delay to apply, an ALE must meet the full-time employee size requirement and each of the following additional requirements:

  • They must not modify their plan year after February 9, 2014 to start at a later date.
  • They must also make two written certifications as part of their ALE reporting due in early 2016.  Specifically they must certify that:
    • between February 9, 2014 and December 31, 2015 they have not reduced the size of their workforce or overall hours of service other than for “bona fide” business reasons, which include sale of a division, changes in the economic marketplace in which the employer operates, or terminations for poor performance.
    • they did not “eliminate or materially reduce” group health coverage that was in place on February 9, 2014 over the “coverage maintenance period” which ends December 31, 2015 for calendar year plans, and on the last day of the 2015-2016 plan year for non-calendar year plans.  “Material” reduction means a 5% or greater reduction in the dollar amount of the employer contribution towards individual premiums, or any reduction in the percentage of the employer’s share.

Mid-sized employers that qualify for the relief and meet the necessary criteria will not be subject to employer shared responsibility taxes until January 1, 2016, or the first day of their non-calendar plan year beginning in 2016.

New Transition Relief for ALEs with 100+ Full-time Employees

In 2015, employers who on average employ 100 or more full-time employees, including FTEs, over their chosen 2014 measurement period will not be subject to the “no coverage” pay or play penalty (IRC § 4980H(a)) if they offer minimum essential coverage to at least 70% of their full-time employees.  The offer of coverage includes dependents, subject to transition relief outlined below.  The permitted percentage of excluded full-time employees (30%) shrinks back down to the “greater of 5% or 5 employees” in 2016 and subsequent; i.e. MEC must be offered to at least 95% of full-time employees.

Further, if the 4980H(a) tax does apply in 2015 (because the employer fails to offer MEC to at least 70% of full-time employees), the employer may calculate the tax after excluding the first 80 full-time employees.  The excluded group shrinks back town to 30 in 2016 and subsequent.

Note that the IRC § 4980H(b) “some coverage” penalty will still apply if the coverage that is offered to at least 70% of full-time employees is either unaffordable or less than minimum value.   However, the (b) penalty can never exceed what the (a) penalty would have been, had no coverage been offered.

This relief applies to the 2015 calendar year and to non-calendar year plans for their 2015-2016 plan year.

Non-Calendar Year Transition Relief

The proposed regulations provided that ALEs that maintained a non-calendar year group health plan as of December 27, 2012 (just prior to release of the advance copy of the proposed regulations) would not be subject to employer shared responsibility penalty taxes between the original employer shared responsibility start date of January 1, 2014 and the beginning of their 2014-2015 non-calendar year plan, provided that certain conditions were met.  So, for instance, an employer that maintained a July 1 – June 30 plan as of December 27, 2012 would not be subject to excise taxes for failing to offer its full-time employees affordable, minimum value coverage between January 1, 2014, and June 30, 2014.  It would be subject to them for July 1, 2014 onward.

The non-calendar plan year transition relief offered under the proposed regulations has been extended to prevent application of penalties from January 1, 2015 to the first day of the 2015-2016 non-calendar plan year for certain qualifying applicable large employers.  The relief is only available if the employer maintained a non-calendar plan year as of December 27, 2012 and since that time has not changed the plan year to start as a later date.

This is not “across the board” transition relief for all employers with non-calendar plans.  Instead, it only applies with respect to full-time employees who would have joined the plan as of the first day of the 2015-2016 non-calendar year plan, or in instances where, prior to issuance of the regulations, a non-calendar year plan already covered a substantial percentage of its employees.   The specifics of these relief provisions are as follows:

  • Under “Eligible Employee” Relief, no pay or play penalty will be imposed with regard to full-time employees who, under plan rules that were in place on February 9, 2014, will be eligible on the first day of the 2015-2016 plan year.
  • Under “Substantial Percentage” Relief, no pay or play penalty will be imposed with regard to any full-time employees (whether or not they would become eligible in 2015 under current plan terms) if the employer:
    • actually covered at least 25% of its total employees under one or more non-calendar year plans as of any date during the 12 months ending February 9, 2014; or
    • offered coverage to at least 33.33% of its total employees during the most recent open enrollment period prior to February 9, 2014.

This transition relief is adapted from relief set forth in the preamble to the proposed shared responsibility regulations.  The final regulations add a variation on the theme of the “Substantial Percentage” Relief, measured only with regard to full-time employees, as follows:

  • No pay or play penalty will be imposed with regard to any full-time employees (whether or not they would become eligible in 2015 under current plan terms) if the employer:
    • actually covered at least 33.33% of its full-time employees under one or more non-calendar year plans as of any date during the 12 months ending February 9, 2014; or
    • offered coverage to at least half (50%) of its full-time employees during the most recent open enrollment period prior to February 9, 2014.

Non-calendar plan year transition relief is not available with regard to full-time employees eligible under a calendar year plan maintained by the same employer.

Other Transition Relief

Definition of ALE Status and Full-Time Employee Count

For the 2015 calendar year, an employer may measure its status as an ALE (and its full-time employee headcount) by counting full-time employees and FTEs over a period of at least 6 consecutive months in 2014, starting no later than July 1, 2014.  However, if the ALE is relying on the seasonal worker exception to ALE status, it must measure full-time and FTEs over all of 2014, not the shorter six-month period.  For 2016 and subsequent, ALE measurement and full-time employee headcounts must occur over an entire 12 month period.

Transitional Measurement Period

The proposed and final employer shared responsibility regulations contain special rules applicable to seasonal employees and “variable hour” employees, meaning employees who the employer cannot, at the time of hire, accurately class as full-time or part-time.  These rules are primarily of use in the retail and hospitality sectors.  They allow an ALE to measure a new employee’s working hours over a retroactive measurement period, and, based on hours worked during that time, lock in the employee as eligible or ineligible for group health coverage for a subsequent “stability period,” regardless of the hours he or she works during the stability period.

The rules generally do not allow a lock-in stability period to be significantly longer than the retroactive measurement period it is teamed with.  However, just for purposes of stability periods beginning in 2015, employers may adopt a transitional measurement period (“TMP”) in 2014 that is shorter than a year, but at least 6 consecutive months long, and still use a 12 month stability period in 2015.  Because the same rules require that there be a period of at least 90 days between the end of the TMP and the beginning of the stability period, employers who want the 2015 calendar year to serve as a stability period should begin their TMP no later than April 1, 2014.  (April 1 – September 30 TMP followed by October 1 – December 31 transition period, with stability period beginning January 1, 2015).

Transition Relief re: First Payroll Period in 2015

Solely for January 2015, the final regulations provide that no pay or play penalty will apply between January 1, 2015 and the first day of the first payroll period in January 2015.  This will allow employers to start group health coverage on a payroll period cycle.  No comparable relief is offered for non-calendar year plans.

Transition Relief re: Dependent Coverage

Generally to avoid pay or play penalties, an ALE must offer coverage to a full-time employee’s dependents, although, unlike individual coverage, the dependent coverage on offer does not need to be “affordable.”  Extending earlier transition relief in the proposed regulations, the final regulations provide that an ALE that currently does not offer dependent coverage but that “takes steps” towards offering such coverage during its 2015 plan year will not be assessed a penalty related to dependent coverage.  This transition relief will not apply to the extent that employers offered dependent coverage either during the 2013 or 2014 plan year; in other words an ALE may not use the transition relief if it formerly offered, than terminated, dependent coverage.  As defined above, “dependents” for this purpose mean biological or adopted children to age 26.

Stacking Transitional Relief

The preamble to the final regulations specifically state that applicable large employers can combine or, as described here, “stack” different types of transitional relief under certain circumstances.   Note that ALEs who qualify for the mid-sized employer transition guidance, and who therefore have no pay or play responsibilities in 2015, will not need and cannot use transition relief for non-calendar year plans, or any of the “Other Transitional Relief” described above with the exception of the first listed – counting full-time employees over a period of at least 6 consecutive months.  This is described in example 2, below.  Non-calendar plan year relief may also apply.

The following examples illustrate potential stacking techniques:

  • Non-Calendar Year and 100+ ALE Relief

A graphic design firm with 100 full-time employees (including FTEs) has had an April 1- March 31 non-calendar plan year since December 27, 2012 and has not changed plan years to delay the starting date.

The firm offered coverage to 50% of its full-time employees between February 9, 2013 – February 9, 2014 so it qualifies for non-calendar year transition relief and will not be subject to a pay or play penalty from January 1, 2015 through March 31, 2015.

In addition, for the April 1, 2015 through March 31, 2016 plan year, the firm will not be subject to the “no coverage” penalty so long as it covers at least 70% of its full-time employees.  Penalties could still apply if the offered coverage is unaffordable or does not provide minimum value.

  • Mid-Sized Employer and ALE Measurement/Full-Time Headcount Relief

A company with three bakery locations has about 75 employees in total.  It believes it might qualify for the shared responsibility transition relief available in 2015 to mid-sized employers.  To determine its status as an applicable large employer, it counts full-time and full-time equivalent employees over a six-month period in 2014 (May to October).  During that time it averages 60 full-time employees, including full-time equivalents, per month.  Thus it is an ALE and eligible for the mid-sized employer transition relief. Between February 9, 2014 and December 31, 2014, the end of its plan year, it does not reduce its workforce other than for terminations due to poor performance and does not reduce employees’ overall hours of service.  Also during that time, it maintains group health coverage on the same terms that were in place as of February 9, 2014.   The bakery company will be exempt from assessable payments for the 2015 calendar year.  It must make attestations related to workforce and coverage maintenance, in its ALE reporting due early in 2016.

  • Mid-Sized Employer and Seasonal Worker Exception.

Same facts as above, but the employer is a vineyard with a single location.  It has a seasonal work flow so counts its full-time employees and FTEs over each month of 2014.  It finds that it exceeded 50 full-time employees, including FTEs, on fewer than 120 days in 2014 (mainly during harvest time) and, during that time, the employees that exceeded the 50 full-time limit were seasonal workers (harvesters).  The employer is not an ALE for 2015 and does not need the transitional relief for mid-sized employers.

  • 100+ ALE Relief and Dependent Coverage Relief

Same facts as the graphic designer example except the employer has a calendar year plan.  The firm offers coverage in 2015 to 75% of its full-time employees and the coverage is affordable and provides minimum value.  Therefore assessable payments would be due only with regard to dependent coverage.  The employer takes steps towards 2015 to provide dependent coverage, and did not earlier provide, then stop, dependent coverage.  The employer will not be subject to assessable payments in 2015.

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Filed under Affordable Care Act, Benefit Plan Design, Employer Shared Responsibility, Health Care Reform, Health Insurance Marketplace, Plan Reporting and Disclosure Duties, PPACA

California Bill Would Repeal 60-Day Cap on Waiting Periods

California Senate Bill 1034 sponsored by Senator Bill Monning (D-Carmel) would repeal language in the Health & Safety and Insurance Code that currently limits waiting periods under small and large group HMO contracts and health insurance policies to a maximum of 60 days.  The new bill, if enacted, would prohibit insurers and HMOs from imposing any waiting or affiliation period under group coverage in the small and large-group markets.

This would allow California employers to follow the Affordable Care Act’s maximum 90-day limit on eligibility waiting periods, recently confirmed in final regulations issued by the Departments of Labor, Treasury and Health and Human Services (the “Departments”).  In the preamble to the final regulations, the Departments make clear that state insurance laws may impose more stringent waiting period rules than the federal standard.

I previously wrote about the waiting period rule, found in California Assembly Bill 1083 (also sponsored by Sen. Monning when he was an Assemblymember), and the confusion it created for California employers who originally understood the rule to apply only to small group coverage.  AB 1083 was modified by Special Sessions bills SBX 1 2 and ABX 1 2 but the changes did not affect the 60-day cap on waiting periods.  AB 1083, as amended, went into affect with respect to plan years on or after January 1, 2014.

One of the most significant disconnects between California law and the ACA in this respect is with regard to substantive eligibility requirements.  The federal 90-day waiting period regulations define “waiting period” as the time period that must elapse before coverage begins for an “otherwise eligible” employee, and make it clear that employers may impose substantive eligibility requirements on employees – such as attainment of a certain job level – in order to receive group health coverage.  In such instances, the maximum 90-day waiting period would not begin to elapse until the employee first attained the required job level.  This dovetails neatly with the common 90-day “introductory” or “orientation” period employers use to gauge whether or not a new employee will work out on a long term basis.  Successful completion of the introductory period generally triggers eligibility for a number of employment benefits and not just group health insurance.

By contrast, the California Insurance and Health and Safety Code rules containing the 60-day limit do not reference application of any substantive eligibility criteria and would appear on their face to be triggered at hire.   I have counseled clients that state laws governing insurance policies and HMO contracts cannot deprive them of their right as employers to impose substantive eligibility requirements on group health coverage, but none of them welcome the complexity of layering employer-based eligibility rules over rules bolted onto the coverage itself.

The disconnect between the ACA and California law increased as a result of the final waiting period regulations, and a companion proposed regulation, published last month.  Specifically, the final regulations recognize a “reasonable and bona fide employment based orientation period” as a permissible substantive eligibility condition, completion of which would trigger the 90-day maximum waiting period.  The companion proposed regulation identifies one month as a reasonable orientation period, such that an employer could assess a new hire for 30 days before the 90-day waiting period began to elapse.

SB 1034 is on the radar screen of insurance and HMO regulators in the state for several weeks and, to date, no opposition to the bill has been raised.   The California Department of Insurance may or may not register a position on the bill and any opposition raised by the California Department of Managed Health Care generally would not appear until further along in the legislative process.   I am tracking the Bill’s progress and will continue to provide updates on its status.  If passed, it would go into effect for plan (policy) years beginning January 1, 2015.

UPDATE:  It has come to my attention that, notwithstanding the fate of SB 1034, at least one large insurer in California has removed 60-day waiting period language from their large group contracts so that employers in this market can impose the full 90-day waiting period permitted under the Affordable Care Act.   Apparently they have interpreted the waiting period language to be binding on carriers but subject to override by the employer purchasing the  large group policy.  I do not know if this is an isolated instance or a trend but it is welcome news to the many employers in the state in the large group market.

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March 7, 2014 · 6:41 pm

Guidance on Cost-Sharing Limits, Wellness, and Mental Health Parity in New ACA FAQs

On January 9, 2014 the Departments of Labor, Health and Human Services (HHS) and Treasury (collectively, the “Departments”) issued an 18th set of frequently asked questions about the Affordable Care Act, including issues raised by that law’s intersection with the Mental Health Parity and Addiction Equity Act (“MHPAEA”), as well as a grab-bag of other issues.  A summary of some of the points covered in the FAQs follows.

Coverage of Preventive Services re: Breast Cancer

  • For plan or policy years beginning on or after September 24, 2014, non-grandfathered group health plans must cover, with no cost sharing, medications that reduce the risk of breast cancer (such as tamoxifen or raloxifene), when recommended for preventive purposes to women at increased risk of breast cancer and at low risk for adverse side effects from the medicines.

Cost-Sharing Limitations

  • For plan or policy years beginning in 2014, the annual limitation on out-of-pocket costs for essential health benefits (EHB) provided under a non-grandfathered plan or policy is $6,350 for self-only coverage and $12,700 for coverage other than self-only.  Non-EHB items are not subject to the dollar limits.
  • In a previous FAQ, the Departments offered transition relief to plans and insurers that use more than one service provider to provide medical benefits.  The transition relief applies only to plan or policy years that begin on or after January 1, 2014.  For that plan or policy year only, the out-of-pocket maximum will be considered to be met by a plan using multiple service providers only if both of the following criteria are met:
    • Major medical coverage remains subject to the maximum out-of-pocket limits; and
    • Out-of-pocket limits that separately are imposed on coverage provided by other service providers (such as prescription drug coverage) do not exceed the maximum out-of-pocket limits.
    • The new FAQ makes clear that the transition relief is only available for plan or policy years beginning in 2014.  For plan or policy years beginning on or after January 1, 2015, all essential health benefits (EHB) are subject to the individual and non-individual out-of-pocket limits, regardless of the number of service providers used.
    • However, plans may allocate the dollar limit across multiple categories of benefits (e.g., pharmacy vs. major medical) in lieu of reconciling claims across multiple service providers, so long as the total amount does not exceed the maximum limits.  The guidance notes however that it would not be permissible, under the MHPAEA, to impose an out-of-pocket maximum on mental health or substance use disorder benefits that accumulates separately from an out-of pocket limitation on medical/surgical benefits.
    • Significantly, plans and policies may, but do not have to, count dollars spent on out-of-network items and services towards the maximum out-of-pocket limits.
    • Plans and policies also may, but are not required, to count an individual’s out-of-pocket spending for non-covered services, such as cosmetic services, towards annual maximum out-of-pocket costs.
    • Also keep in mind for this purpose that large-group and self-funded plans are not required to offer EHB, but EHB items or services they do offer are subject to the out-of-pocket maximum limits.  The FAQ provides that self-insured and large group health plans can use any definition of EHB that is authorized by the Secretary of HHS, which at this point primarily includes the state base-benchmark plans.

Wellness Programs

  • A wellness program need not provide the opportunity to avoid the tobacco surcharge to a participant who initially declines but later joins a tobacco cessation program, if the participant could have avoided the surcharge by joining the cessation program at the time of enrollment or annual re-enrollment.  The program may voluntarily provide the reward (i.e., avoidance of the tobacco surcharge) either in full or on a pro-rated basis to a participant that joins tobacco cessation program mid-year.
  • The FAQ describes an outcome-based, health-contingent wellness program (i.e., one that conditions the reward on attainment of a physical result or goal) in which a participant’s doctor advises the plan that the standard for attaining a reward is medically inappropriate for the participant, and suggests a weight-reduction program as a reasonable alternative.[1]  In such an instance, the FAQs state that the employer sponsoring the wellness program does retain a “say” in which weight-reduction program is used, but the wording of the answer suggests that the employer must “discuss different options” with the participant rather than dictate a particular weight loss plan.
  • The FAQ provides that employers and insurance providers may modify the sample notice of reasonable alternative standards that is provided in the wellness regulations so long as the modified version contains all of the required content described in the regulations.  All health-contingent wellness programs – whether activity only or outcome-based – must provide the notice of reasonable alternative standards in all written descriptions of a wellness program.  The sample notice in the regulations is set forth below; the regulations also contain other sample language for outcome-based wellness programs.

“Your health plan is committed to helping you achieve your best health.  Rewards for participating in a wellness program are available to all employees.  If you think you might be unable to meet a standard for a reward under this wellness program, you might qualify for an opportunity to earn the same reward by different means.  Contact us at [insert contact information] and we will work with you (and, if you wish, with your doctor) to find a wellness program with the same reward that is right for you in light of your health status.”

Excepted Benefits

  • The FAQ describes conditions under which fixed indemnity insurance in the individual market (such as hospital indemnity coverage) could pay benefits on a per-service basis, rather than the traditional per-period basis (e.g., per each day of hospitalization), and still qualify as “excepted benefits” that need not meet ACA market reform requirements.  The described conditions will apply only in states where HHS has direct enforcement authority over the individual market but the FAQ recommends that states with their own exchanges also treat fixed indemnity coverage meeting the conditions as an excepted benefit.

Effect of the ACA on the Mental Health Parity and Addiction Equity Act

  • The FAQ summarizes the intersection of these two laws, namely that EHB includes mental health and substance use disorder services, and Section 1563 of the ACA extends mental health parity protections to the entire individual market, including both grandfathered and non-grandfathered coverage.  As a consequence:
    • Non-grandfathered individual market coverage:  policies must provide mental health and substance use disorder benefits in accordance with interim final MHPAEA regulations  for policy years beginning on or after January 1, 2014.   For policy years beginning on or after July 1, 2014 (January 1, 2015 for calendar year policies), policies must comply with final MHPAEA regulations.
    • Individual policies that were to be cancelled by insurers but were covered by the HHS transition policy announced on November 14, 2013, are excepted.
    • Grandfathered individual market coverage:  these policies are not subject to EHB requirements and need not cover mental health or substance use disorder benefits.  However, beginning on or after July 1, 2014 (January 1, 2015 for calendar year policies) coverage must comply with final MHPAEA regulations to the extent that mental health or substance use disorder benefits are provided voluntarily.
    • Non-grandfathered small group market coverage:  Non-grandfathered small group coverage that is not subject to the cancellation transition policy must include coverage for mental health and substance use disorder benefits for plan years beginning on or after January 1, 2014, and the coverage must comply with the interim final MHPAEA regulations from February 2010.  The coverage must comply with final MHPAEA regulations for plan years beginning on or after July 1, 2014 (January 1, 2015 for calendar year plans.)
    • Grandfathered small group market coverage:  These plans are not required to comply with either EHB or mental health parity rules.


[1] Under final wellness regulations issued on June 3, 2013, employees in outcome-based wellness programs may request to involve a personal physician at any time, and if the physician agrees to participate, he or she may adjust recommendations at any time, consistent with medical appropriateness.

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Filed under Affordable Care Act, Benefit Plan Design, Health Care Reform, Mental Health Parity and Addiction Equity Act, PPACA, Preventive Services

Implementing the Health FSA Carryover: Tips and Traps

The IRS recently issued guidance modifying the “use it or lose it” rule, which has long been the most unpopular feature of health flexible spending accounts (health FSAs) commonly offered under a Section 125 cafeteria plan.

As a result of the change, set forth in Notice 2013-71,  individuals who participate in health FSAs, and who have not used their full budget of deferrals by the end of a given plan year may carry over up to $500 in unused funds to the next plan year.  (This discussion assumes a Sec. 125 cafeteria plan with the same plan year as the health FSA.)

Even if an employee carries over the full $500 amount, he or she may elect to defer the maximum amount currently permitted, $2,500, such that a health FSA may reimburse up to $3,000 in qualifying medical expenses in a given plan year (that, by necessity, follows a plan year in which no more than $2,000 in expenses were reimbursed).

Employers are eager to make use of this new feature, as the possibility of forfeiting even a small amount of hard-earned wages has kept significant number of employees away from health FSAs for years.  However there are some tips and traps that employers should consider before implementing the new plan feature.

  • Make a Choice.  First, an employer whose health FSA currently includes a grace period cannot implement the carryover feature alongside a grace period.  It is an “either or” choice.
    • A grace period is a period of up to 2 ½ months following the end of a plan year, during which prior year amounts may be used to reimburse expenses incurred during the grace period portion of the new plan year.
    • The main advantage of the grace period is that the full health FSA budget may be used within the grace period, whereas the carryover is limited to $500 (and employers may set a lower level if desired).   On the other hand, the grace period does not eliminate the hurried spend-down that occurs at the end of a cafeteria plan year, it just postpones it slightly.
    • By contrast, the carryover amount (up to $500) can be used at any time in the following cafeteria plan year and even in subsequent plan years, if no medical expenses require it be used in the interim.  Example 4 in Notice 2013-71 describes an instance in which $600 in unused funds from the 2014 calendar plan year, after reduction by $100 to meet the maximum carryover rule, is used to reimburse medical expenses in 2016.  Thus the carryover eliminates the spend-down scramble, but only for amounts up to $500.
    • Note that you do not need to eliminate a claim run-out period, if your plan includes one.  A claim run-out period is period following the end of a plan year, during which expenses incurred in the preceding plan year may be reimbursed using prior year amounts.  Teaming the claim run-out period with a carryover (or a grace period) requires some reimbursement ordering rules, which are discussed below under “Sequence Your Reimbursement Buckets.”
  • Timing is Everything.  For calendar year cafeteria plans, it is probably too late in the year to replace a grace period with a carryover, because employees may have scheduled procedures for after the first of the year that exceed $500 in out-of-pocket costs for the participant.
    • Because employees may have acted (or failed to act) in reliance on the grace period remaining in place, legal principles of “equity” and contract law would prevent employers from removing the feature at such a late date.  (The IRS Notice specifically references “non-Code legal constraints” that would apply; a similar concept is the “anti-cutback” rule applicable in the retirement plan sphere.)
    • Employer flexibility in this area may exist, including under non-calendar year plans, and even for calendar year plans depending on the number of participants in the health FSA and on participants’ forfeiture history.  If forfeitures consistently have been below $500 (which typically is the case), then dropping the grace period in favor of the carryover would allow employees additional time to spend the funds on medical expenses.
    • Employers must also be mindful of deadlines set forth in Notice 2013-71 for amending their cafeteria plans in relation to the carryover rule.  Amendments simply to add a carryover feature generally must be made before the last day of the plan year from which amounts are carried over.  However, only for amendments to add a carryover feature effective for the 2013 plan year (without eliminating a grace period), the amendment may be made by the last day of the 2014 plan year.  Amendments to remove a 2013 grace period (occurring early in 2014) must also be made by the last day of the plan year from which amounts may be carried over, retroactive to the first day of the plan year, but no transition relief is offered.  Therefore, an amendment to remove a grace period from the 2013 plan year, separately or in exchange for a new carryover feature, must be made by the end of the 2013 plan year, subject to the timing concerns raised above.
  • Communicate and Document.  A health FSA is an employee welfare benefit plan subject to ERISA documentation and disclosure duties.  The Notice requires plan sponsors that wish to add the carryover feature, either on its own, or in place of a grace period, to amend their cafeteria plan documents accordingly.  Plan amendments that make a material change to the contents of a cafeteria plan document must in turn be communicated to participants in the form of a written summary.  (Note:  generally this rule applies in the context of Summary Plan Descriptions (SPDs), and Summaries of Material Modifications (SMMs) to same.  However it is not uncommon for cafeteria plan documents, including health FSA components to be set forth in a single plan document without any abbreviated SPD.)
    • For a plan amendment simply adding a carryover feature, the written summary of the change must be furnished within 210 days after the end of the plan year in which the change was adopted.
    • For a plan amendment replacing a grace period with a carryover, a much shorter deadline applies:  the change must be communicated to participants in writing within 60 days after the date the employer adopts the change.

In either event, however, employers should try to provide the written summary of the change to employees as promptly as is possible, because the change likely will impact their health FSA spending before the mandatory notice periods have expired.

  • Sequence Your Reimbursement Buckets.  For your cafeteria plan to run smoothly you need to adopt “ordering rules” for reimbursing medical expenses.  It may be helpful to think of unused health FSA deferrals from the prior year as one “bucket” from which medical expenses may be reimbursed, and the new/current plan deferral amount as another “bucket.”  Important Note:  if your plan includes a claim run-out period, you will not know how much is in your “carryover” bucket until the claim run-out period has expired.  The carryover bucket can never hold more than $500.
  • One Possible Ordering Sequence:
    1. Apply prior year’s unused health FSA balance first to reimburse prior year expenses submitted during the claim-run out period.
    2. At the end of the claim run-out period, funds remaining in the prior year’s unused health FSA “bucket” are treated as follows:
      • Up to $500 remains in the bucket, which is now a carryover bucket.
      • Amounts exceeding $500 are forfeited.
  • Alternative Sequence.  The Notice also permits use of this alternative sequence:
    1. Apply current year unused health FSA balance first to claims incurred in the current plan year.  (Remember that under the uniform coverage rule, the maximum health FSA reimbursement budget elected by an employee is available to reimburse expenses as of the first day of a plan year, without regard to actual employee salary deferrals under the health FSA.)
    2. Apply prior year’s unused health FSA balance only after exhaustion of current year amounts.  Prior year unused amounts used to reimburse a current year expense (a) reduce the amounts available to pay prior plan year expenses during a claim run-out period, while applicable; (b) must be counted against the permitted carryover of up to $500, and (c) cannot exceed that maximum amount.

In either instance, current year health FSA funds may only be used to reimburse claims incurred in the current plan year, (except to the extent they remain unused at the end of a claim run-out period and are carried over to a subsequent plan year).

  • Beware of HSA Complications.  Tax-advantaged contributions to a Health Savings Account (HSA) may not be made by or on behalf of an individual who has coverage (as a participant or dependent) under a group health plan other than a high-deductible health plan (HDHP) (“disqualifying coverage”).  Eligibility under a health FSA that permits reimbursement of all expenses for medical care as defined in Code Section 213(d) is disqualifying coverage.  Coverage under a health FSA whose reimbursements are limited to dental and vision expenses, and or to other medical expenses incurred after the HDHP deductible amount is met, is not disqualifying coverage.  Notice 2013-71 does not address how the carryover feature impacts HSA eligibility.  Two possible approaches that representatives of the Groom Law Group informally have discussed with the IRS include restricting carryovers to a limited purpose health FSA, or permitting participants in general purpose health FSAs to opt out of participation in the health FSAs for years in which they want to preserve eligibility under an HSA arrangement.  Until further guidance is issued employers should assume that a participant who has a carryover balance under a general purpose health FSA, and his/her eligible spouse and dependents, will not be able to contribute to a health FSA while the carryover balance is available.

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Filed under Benefit Plan Design, Cafeteria Plans, ERISA, Flex Plans, Health FSA, Health Savings Accounts, Plan Reporting and Disclosure Duties

IRS Announces 2014 Benefit Limits

On October 31, 2013 the IRS announced 2014 cost-of-living adjustments for annual contribution and other dollar limits affecting 401(k) and other retirement plans.  The announcement had been delayed until the September 2013 Consumer Price Index for Urban Consumers (CPI-U) was available, which in turn was delayed by the government shutdown over the budget and debt ceiling debate.   A modest 1.2% rise in the September CPI-U over 2013 left a number of the dollar limits unchanged for 2014, although a few limits have increased (citations are to the Internal Revenue Code).
Some limits that did not change for 2014 are as follows:
–Salary Deferral Limit for 401(k), 403(b), and 457 plans remains unchanged at $17,500. The age 50 and up catch-up limit also remains unchanged at $5,500 for a total contribution limit of $23,000.
–The compensation threshold for “highly compensated employee” remained at $115,000 for a second year in a row.
–Traditional and Roth IRA contributions and catch-up amounts remain unchanged at $5,500 and $1,000, respectively.
–SIMPLE 401(k) and IRA contribution limits remain at $12,000.
Limits that did increase are as follows:
–Maximum total contribution to a 401(k) or other “defined contribution” plans under 415(c) increased from $51,000 to $52,000 ($57,500 for employees aged 50 and older).
–Maximum amount of compensation on which contributions may be based under 401(1)(17) increased from $255,000 to $260,000.
–Maximum annual benefit under a defined benefit plan increased from $205,000 to $210,000.
–Social Security Taxable Wage Base increased from $113,700 to $117,000.
–The dollar limit defining “key employee” in a top-heavy plan increased from $165,000 to $170,000.

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Filed under 401(k) Plans, 403(b) Plans, Benefit Plan Design, COLA Increases, ERISA, IRA Issues, Nondiscrimination Rules for Insured Health Plans, Profit Sharing Plan

Roundup of DOMA Guidance re: Benefit Plans

The Internal Revenue Service and Department of Labor have in recent months issued initial guidance to employers on the benefit plan consequences of the U.S. Supreme Court’s June 2013 decision in U.S. v. Windsor, 133 S.Ct. 2675 (2013), which ruled Section 3 of the federal Defense of Marriage Act (“DOMA”) to be unconstitutional on equal protection grounds.  That now defunct DOMA provision limited the federal law definitions of “marriage” and “spouse” to refer only to unions between members of the opposite sex.

The recent guidance, which I summarize below (and have separately addressed in earlier posts), represents early stages in the process of fully implementing the US v. Windsor holding within ERISA’s extensive compliance regime.  Please note that this post focuses on the federal tax consequences of same-sex benefits; state taxation of such benefits, and those provided to domestic partners, depends upon the revenue and taxation laws of each state.

IRS and DOL Adopt “State of Celebration” Rule

In U.S. v. Windsor the Supreme Court held that federal law will recognize all “lawful marriages” between members of the same sex, but left open the question of which state’s law will determine whether a same-sex marriage is lawful:  the state of domicile (where the married couple lives), or the state of “celebration” (where the marriage took place).

This is an important question because the Supreme Court decision left intact Section 2 of DOMA, under which a state, territory or Indian tribe need not give effect to another state’s laws regarding same-sex marriage.  The “state of domicile” rule, if it determined whether or not a same-sex couple was legally married, could cause benefits chaos.  For instance, an employer with operations in multiple states would be required to track where each employee in a same-sex relationship lived, and possibly modify their benefit offerings if they moved from a state that recognizes same-sex marriage, to a “non-recognition” state.

Note:  As of the date of this post, the District of Columbia and 14 states recognize same-sex marriage: California (since June 28, 2013, also prior to November 5, 2008); Connecticut; Delaware (eff. 7/1/2013); Iowa; Maine; Maryland; Massachusetts; Minnesota (eff. Aug. 1, 2013); New Hampshire; New Jersey (eff. October 21, 2013); New York; Rhode Island (eff. Aug. 1, 2013); Vermont; and Washington.  (Follow updates to this list here.)

The U.S. v. Windsor ruling also gave rise to some confusion over the status, under federal law, of domestic partnerships, civil unions, and other formalized same-sex relationships that fall short of marriage.

Fortunately, both the IRS and the DOL have resolved these issues in separate guidance released in September 2013.

Specifically, in Revenue Ruling 2013-17, the IRS announced that:

  • The IRS will recognize, as a legal marriage for all federal tax purposes, a marriage of same-sex individuals that was validly entered into in a domestic or foreign jurisdiction that recognizes same sex marriage, regardless of where the couple lives.
  • Under federal tax law, the terms “husband,” “wife,” “husband and wife,” “marriage” and “spouse” includes lawful same-sex marriages and individuals in such marriages.
  • “Marriage” for federal tax purposes does NOT include domestic partnerships, civil unions, or other formal relationships falling short of marriage.

To reach these conclusions the IRS invoked a prior Revenue Ruling from 1958 (Rev. Rul. 58-66) that held that individuals who became common-law spouses under state law were entitled to be treated as legally married spouses for federal income tax purposes regardless of where they later resided.

The DOL also adopted the “state of celebration” rule for purposes of defining same-sex marriage under ERISA benefit plans, including retirement plans, in Technical Release 2013-14.  In this guidance, published September 18, 2013, the DOL also specifies that the terms “spouse” and “marriage,” for ERISA purposes, do not include domestic partnerships or civil unions, whether between members of the same sex or opposite sex, regardless of the standing such relationships have under state law.

The IRS ruling takes effect September 16, 2013 on a prospective basis.  The DOL Technical Release should be treated as effective immediately on a prospective basis.  The DOL will issue further guidance explaining any retroactive application of the U.S. v. Windsor ruling under ERISA, for instance with regard to previously executed beneficiary designations, plan distribution elections, plan loans and hardship distributions.

Other Tax Guidance from Revenue Ruling 2013-17 and FAQs

Revenue Ruling 2013-17 also contains guidance on prospective and retroactive tax filing aissues resulting from the U.S. v. Windsor decision, including refund/credit opportunities.  More specific guidance for taxpayers is set forth in separate IRS FAQs for same-sex married couples, and for couples in registered domestic partnerships.

In order to understand  the tax refund/credit procedures it is helpful first to review the federal tax consequences of providing employment benefits to same-sex spouses while Section 3 of DOMA remained in effect.

Through Internal Revenue Code (“Code”) Section 105(b), Federal law has long allowed employers to provide health and other benefits on a tax-free basis to employees, their opposite-sex spouses and dependents.  However, under DOMA § 3, the same benefits provided to same-sex spouses and other partners generally resulted in “imputed incometo the employee for federal tax purposes, in an amount generally equal to the value of the benefits provided.  Similarly, employees could not use Sec. 125 cafeteria plans to pay premiums for same-sex spouses/partners on a pre-tax basis.  Only in rare instances where the same-sex spouse was a dependent of the employee spouse as a result of disability, did same-sex spousal coverage not result in an additional federal tax burden to the employee spouse.

Note that benefits provided to domestic partners and partner in civil unions are still treated this way for Federal tax purposes.  For benefits provided to employees who are lawfully married to same-sex spouses, however, the new rules effective September 16, 2013 and prospectively are as follows:

  • Individuals in lawful same-sex marriages must file their federal income tax returns for 2013 and subsequent years as either married filing jointly, or married filing separately.
  • Employer-provided benefits provided to an employee’s lawfully-married same-sex spouse are excludable from the employee’s income for federal tax purposes.
  • As a consequence, employers must stop imputing income to employees, for federal tax purposes, based on same-sex spousal benefits, and must adjust affected employees’ Form W-2 income for 2013 to remove imputed income amounts.
  • The tax-qualified benefit plans that are affected are:
    • health, dental and vision coverage;
    • qualified tuition reduction plans maintained by educational organizations;
    • meals and lodging provided to employees on business premises (other specific conditions apply);
    • fringe benefit including qualified transportation fringe benefits, moving expenses, employee discounts, and work-related expenses; and
    • pre-tax participation in Section 125 cafeteria/flex plans, including health flexible spending accounts and dependent care flexible spending accounts.
  • Employees in lawful same-sex marriages can file amended personal income tax returns for “open” tax years (generally 2010, 2011, 2012) to recoup over-withheld federal income taxes resulting from imputed income and after-tax cafeteria plan participation.
  • However, if they re-file, they must re-file as married for all tax purposes, not just to obtain the refund or credit.  In many cases, the income tax adjustment will not warrant the loss of other deductions.  Employees must consult their individual CPAs and other tax advisors for answers; employers must refrain from offering any specific advice or guidance in this regard.

Corrective Payroll/Withholding Steps for 2013 and Prior “Open” Tax Years

IRS Notice 2013-61, published September 23, 2013, sets forth optional, streamlined ways for employers to claim refunds of over-withheld “employment taxes” (FICA and federal income taxes) applied to imputed income/same sex spouse benefits in 2013, and prior “open” tax years.

The “normal” over-withholding correction process – which remains available to employers in this instance – varies slightly depending on whether or not the employer is seeking an adjustment of withholding taxes, or a refund of withholding taxes, but generally includes the following steps:

  • identify the amount of over-withholding;
  • repay the employee’s portion to the employee in cash (or “reimburse” them by applying the overpayment to FICA taxes for current year);
  • obtain written statements from affected employees that they will not also claim a refund of over-withheld FICA taxes, and if an employer is seeking a refund of over-withheld taxes, obtain affected employees’ written consent to the refund; and
  • file IRS Form 941-X for each quarter affected, to recoup the employer portion of the tax.

Notice 2013-61 sets forth two streamlined correction methods permitting use of one single Form 941 or Form 941-X for all of 2013.  Under the first method, the employer takes the following steps before the end of the current year:

  • identify and repay/reimburse employees’ share of excess income tax, FICA tax withholdings resulting from same-sex spousal benefits on or before December 31, 2013; and
  • make corresponding reductions in affected employees’ wage and income-tax withholding amounts on the 4th quarter 2013 Form 941.

The second method is available if the employer does not identify and repay/reimburse employees’ share of excess income tax, FICA tax withholdings until after December 31, 2013.  In that case the employer:

  • Files one single Form 941-X in 2014 seeking reimbursement of employer’s share of tax with regard to imputed income for same-sex spouse benefits reported in all quarters of 2013.
  • In addition to the regular Form 941-X filing requirements, including obtaining written statements and/or consents from employees, employers must write “WINDSOR” at the top of the Form 941-X and must file amended Form W-2s (IRS Form W-2c) for affected employees, reporting the reduced amount of wages subject to FICA withholding.

Note:  This second correction method can apply only to FICA taxes.  Employers cannot make adjustments for overpayments of income tax withholding for a prior tax year unless an administrative error (e.g., wrong entry on Form 941) has occurred.

Employers may also recoup their share of FICA taxes for earlier open tax years (generally, 2010, 2011 and 2012) using one Form 941-X for all four calendar quarters that is filed for the fourth quarter of each affected year.  In addition to marking the Form “WINDSOR” the employer must also file amended Form W-2s for affected employees, reporting the reduced amount of wages subject to FICA withholding.

Employers making use of the correction methods set forth in IRS Notice 2013-61 for 2013 or earlier open years must take account of the Social Security Wage Base in effect for applicable years.  For employees whose 2013 compensation exceeds the taxable wage base ($113,700) even after imputed income is eliminated, no corrections for the Social Security component of FICA taxes can be made.  If retroactive corrections are made, you must observe the SS wage base limitations in effect in prior years:  $106,800 for 2010 & 2011, and $110,100 for 2012.

One final note:  many employers that provide benefits to employees’ domestic partners and/or same sex spouses have followed a practice of grossing up the employees’ taxable compensation to account for the additional federal taxes they must pay on imputed income.  The IRS guidance on recouping over-withheld taxes apply only to imputed income amounts, not to the gross-up amounts.  “Normal” over-withholding correction procedures using Forms 941 and 941-X should apply to 2013 gross-up amounts but employers should consult their payroll and tax advisors for specific advice.  Note also that California recently adopted a law that will exclude gross-up amounts from employees’ taxable compensation for state personal income tax purposes.  AB 362 takes immediate effect and is slated to expire January 1, 2019.  You can find a fuller discussion of the measure here.

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Filed under Cafeteria Plans, Defense of Marriage Act, ERISA, Fringe Benefits, Payroll Issues, Registered Domestic Partner Benefits, Same-Sex Marriage, U.S. v. Windsor

Notice of Exchange Penalties: There Aren’t Any, But Timely Compliance is Key

The Department of Labor (DOL) has clarified in a Frequently Asked Question that no fine or penalty will apply to an employer who fails timely to provide a Notice of Exchange to employees.  The Affordable Care Act amended the Fair Labor Standards Act (FLSA) to require provision of the Notice of Exchange.  The FLSA imposes corrective measures on employers that violate its other mandates, including federal minimum wage rules, but does not contain an express penalty provision for failing timely to provide the Notice of Exchange.   I earlier outlined Notice of Exchange distribution duties, which require action on or before October 1, 2013, here, and here.

This information, at this late date, is more confusing than it is helpful to employers who have already invested significant resources in preparing to deliver the Notice of Exchange.  The wording of the FAQ says that employers “should” rather than “must” provide the Notice, which is misleading, because Section 18B of the FLSA (29 U.S.C. Sec. 218B) clearly states that employers “shall” provide the Notice within the time period specified, and all prior DOL communications have used consistent wording.   The FAQ did not change this nor did it modify any prior guidance on exchange notice duties in DOL Technical Release 2013-02, including instructions on how the Notice should be delivered.   Noting the lack of express Notice-related penalties in an online article that predated the FAQ, Boston ERISA attorney Alden Bianchi identified the still-remaining risk to employers:

 “This does not mean, of course, that noncompliance is a good idea or even a viable option. The lack of penalties does not translate into a lack of consequences.  Plan sponsors still have a fiduciary obligation to be forthcoming with plan participants and beneficiaries.”

Particularly for employers with pre-existing group health plans, the Notice of Exchange potentially could be viewed by the DOL as within the scope of the employer’s required disclosures to participants and thus within the scope of an ERISA audit, or separate penalties could be imposed through amendment to the FLSA or the ACA.  (I discussed some of the existing ACA penalties in this earlier post.)

Accordingly, even in the absence of any current, known monetary penalty or fine, employers must take all measure necessary timely to provide the Notices of Exchange on or before the October 1, 2013 deadline, and to each new employee upon hire thereafter (the DOL has clarified that in 2014, providing the Notice within 14 days of hire will constitute timely delivery).

Finally the FAQ directs readers to Spanish-language versions of the DOL model Notices of Exchange.  As with the English versions there is one model notice for use by employers that do not offer group health coverage and one version for employers that do offer coverage.

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Filed under Affordable Care Act, Health Care Reform, Health Insurance Marketplace, Plan Reporting and Disclosure Duties, PPACA, Summaries of Benefits and Coverage