Category Archives: COBRA

You Just Formed a New Business Entity. What Could Possibly Go Wrong?

What if a somewhat arcane area of tax law had potentially serious ramifications for attorneys and other tax advisors across a broad range of practices, but was not consistently identified and planned for in actual practice? That is an accurate description of the rules surrounding “controlled group” status between two or more businesses, which I have seen arise in business formation/transactions, estate planning, employment and family law settings.  The purpose of this overview is to briefly survey controlled group rules for non-ERISA practitioners, so that they can become aware of the potential complications that controlled group rules can create.

  1. Why Do Controlled Groups Matter?

The main reason they matter is because the IRS treats separate businesses within a controlled group as a single employer for almost all retirement and health benefit plan purposes. In fact, annual reporting for retirement plans (and for health and welfare plans with 100 or more participants) requires a statement under penalty of perjury as to whether the employer is part of a controlled group.  Therefore controlled groups are most frequently a concern where business entities have employees and particularly when they sponsor benefit plans, whether retirement/401(k), or health and welfare plans.  Note, however, that creation of a business entity that has no employees can still create a controlled group issue when it acts as a conduit to link ownership of two or more other entities that do have employees.

Being part of a controlled group does not always mean that all employees of the member companies have to participate in the same benefit plan (although it can sometimes mean that). However it generally means that separately maintained retirement plans have to perform nondiscrimination testing as if they were combined, which not infrequently means that one or more of the plans will fail nondiscrimination testing.  This is an event that usually requires the employer sponsoring the plan to add more money to the plan on behalf of some of the additional counted employees, or to pay penalty taxes in relation to same.  Similar complications can arise in Section 125 cafeteria or “flexible benefit plans,” and for self-insured group health plans, which are subject to nondiscrimination requirements under Code § 105(h).  Nondiscrimination rules are meant to apply to insured group health plans under the Affordable Care Act (“ACA”), so additional complications could arise in that context when and if the rules are enforced by the IRS, following publication of regulatory guidance.

Controlled group status can also mean that several small employers together comprise an “applicable large employer” subject to the ACA “pay or play rules,” and related annual IRS reporting duties. Small employer exceptions under other laws, including COBRA and the Medicare Secondary Payer Act, reference controlled group status when determining eligibility for the exception.

  1. How Do I Identify a Controlled Group?

 Determining controlled group status requires synthesizing regulations and other guidance across multiple Internal Revenue Code (“Code”) provisions and therefore is a task for a specialized ERISA or tax practitioner.  What follows are very simplified definitions aimed at helping advisors outside that specialized area flag potential controlled group issues for further analysis.

Strictly speaking, the term “controlled group” refers to shared ownership of two or more corporations, but this article uses the term generically as it is the more familiar term.  “Ownership” in this context means possession of the voting power or value of corporate stock (or a combination thereof).  Shared ownership among other types of business entities is described as “a group of trades or businesses under ‘common control.’”  Ownership in this context refers to ownership of a capital or profits interest in a partnership or LLC taxed as a partnership.   Controlled groups can also arise in relation to tax-exempt entities, for instance if they own 80% or more of a for-profit entity, or even between two tax-exempt entities where there is substantial overlap of board membership or board control.

Complex interest exclusion rules mean that not all ownership interests are counted towards common control; exclusion may turn on the nature of the interest held (e.g., treasury or non-voting preferred stock) or on the party holding the ownership interest (e.g, the trust of a tax-qualified retirement plan).

The two main sub-types of controlled group are: parent-subsidiary, and “brother-sister,” although a combination of the two may also exist.  A parent-subsidiary controlled group exists when one business owns 80% or more of another business, or where there is a chain of such ownership relationships. As that is a fairly straightforward test, I will focus on the lesser known, but more prevalent, brother-sister type of controlled group.

A brother-sister controlled group exists when the same five or fewer individuals, trusts, or estates (the “brother-sister” group) have a “controlling interest” in, and “effective control” of, two or more businesses.

  • A controlling interest exists when the brother-sister group members own, or are deemed to own under rules of attribution, at least 80% of each of the businesses in question.
  • Effective control exists when the brother-sister group owns or is deemed to own greater than 50% of the businesses in question, looking only at each member’s “lowest common denominator” ownership interest. (So, a group member that owed 20% of one business and 40% of another business would be credited only with 20% in the effective control test.)
  • In order to pass the 80% test, you must use the interests of the same five or fewer persons (or trusts or estates) used for purposes of the greater than 50% test.  See US v. Vogel Fertilizer, 455 US 16 (1982). Put otherwise, the two tests consider only owners with a greater-than-zero interest in each of the businesses under consideration. If, under this rule, you disregard shares adding up to more than 20% of a business, the 80% test won’t be met and that business generally won’t form part of the controlled group. (Although the remaining businesses may do so.)

The controlled group attribution rules are quite complex and can only be touched on here. Very generally speaking, an ownership interest may be attributed from a business entity to the entity’s owner, from trusts to trust beneficiaries (and to grantors of “grantor” trusts as defined under Code § 671-678), and among family members. Stock options can also create attributed ownership under some circumstances.  The attribution rules can have surprising consequences. For instance, a couple, each with his or her wholly-owned corporation, will be a controlled group if they have a child under age 21 together, regardless of their marital status, because the minor child is attributed with 100% of each parent’s interests under Code §1563(e)(6)(A).  Community property rights may also give rise to controlled group status. Careful pre-marital planning may be necessary to prevent unintended controlled group status among businesses owned separately by the partners to the marriage.

This is the first part of a two-part discussion that was first published as an article in the Santa Barbara Lawyer Magazine for October 2017.  The second half will address a variation of these rules that are specific to businesses formed by doctors, dentists, accountants, and other service providers.

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Filed under 401(k) Plans, ADP and ACP Testing, Affordable Care Act, Benefit Plan Design, Cafeteria Plans, COBRA, Common Control Issues, Employer Shared Responsibility, ERISA, Health Care Reform, Nondiscrimination Rules for Insured Health Plans, Nondiscrimination Testing for Qualified Retirement Plans, Plan Reporting and Disclosure Duties

Agencies Release Exchange-Related COBRA Guidance

Recent weeks have seen the publication of several pieces of agency guidance that reflect the increasing prominence of individual coverage on the health exchanges as an alternative to continuation of group coverage under COBRA. The new guidance consists of:

  • updated model COBRA notices from the Department of Labor (both the initial or “general” notice, and the qualifying event notice) which describe exchange coverage as a COBRA alternative and mention the possible availability of exchange subsidies (both notices are available here);
  • DOL proposed regulations that streamline issuance of future model COBRA notices;
  • an announcement of, and links to, the new model COBRA notices and proposed regulations, in Affordable Care Act FAQ XIX, together with guidance on other ACA issues; and
  • announcement, in a Department of Health and Human Services bulletin, of a limited special enrollment period permitting those who elected COBRA coverage under outdated election forms to drop it, between now and July 1, 2014, and enroll in coverage on a federally facilitated exchange (FFE); and
  • an FAQ published by the Centers for Medicare and Medicaid Services (CMS) Centers clarifying the circumstances under which COBRA qualified beneficiaries may switch to exchange coverage.

Each development is discussed in turn, below.

Updated COBRA Notices

On May 2, 2014, the Department of Labor, the agency responsible for COBRA notice and disclosure duties, published online updated versions of both the “general” notice (given upon initial plan eligibility), and the “election” notice (triggered by a qualifying event). The election notice now expressly identifies the availability of exchange coverage, including access to premium tax credits for those eligible, as an alternative to COBRA coverage. The model notices currently are posted online at the DOL website in English, and Spanish language versions will soon follow.

Proposed DOL Regulations re: COBRA Notices 

Also on May 2, 2014, the Department of Labor issued an advance copy of proposed regulations (technically, a “Notice of Proposed Rulemaking”) pursuant to which future model COBRA notices may appear in written agency guidance, including through online posting, rather than as “appendices” to proposed and final regulations published in the Federal Register. One of the stated reasons for this approach is to “eliminate confusion that may result from multiple versions of the model notices being available at different locations.” And in fact, if view the online version of DOL Technical Release 2013-02, which in May of last year announced earlier exchange-related revisions to the model COBRA election notice, the link to the model notice link now clicks through to the most recent update posted last week, rather than to the version that originally was issued with the Technical Release.

 Summary of COBRA Developments in ACA FAQ Part XIX

May 2, 2014 also saw publication online of Affordable Care Act FAQs Part XIX, of which Q&A 1 summarizes the above developments and directs readers to the new model COBRA notices and the proposed regulation.

FAQ Part XIX contains additional guidance on a number of ACA issues including cost-sharing limitations, coverage of preventive services, and Summaries of Benefits and Coverage. I will cover this new guidance soon in a separate post.

Special Enrollment Period to Transfer from COBRA to FFE Coverage

Generally, an individual may enroll him or herself in exchange coverage upon first becoming eligible for COBRA, during an exchange open enrollment period, or upon exhausting COBRA coverage. However, persons currently enrolled in COBRA may have elected to do on the basis of COBRA notices that did not identify exchange coverage as a COBRA alternative in these situations. Accordingly, on May 2, 2014 the Department of Health and Human Services issued a bulletin announcing a limited special enrollment period, lasting until July 1, 2014, during which COBRA qualified beneficiaries in states that use the Federally Facilitated Exchange or Marketplace may drop COBRA coverage and enroll on the FFE. The guidance does not mandate that state-run exchanges extend the same special enrollment period.

CMS FAQ re: Transition from COBRA to Exchange Coverage

Lastly, on April 21, 2014 the Centers for Medicare and Medicaid Services (CMS) posted an online FAQ asking whether someone who voluntarily drops COBRA coverage during an exchange open enrollment period may enroll in the exchange (and, if eligible, qualify for premium tax credits). CMS made clear that this transition is possible even for someone whose COBRA has not expired, and that enrollment on the exchange is permitted any time during the year for someone whose COBRA coverage has expired. The FAQ made it clear that a qualified beneficiary whose COBRA coverage had not yet expired could not enroll in exchange coverage outside the annual exchange open enrollment period. (The next exchange open enrollment period is from November 14, 2014 to February 15, 2015.)

 Speculation as to COBRA’s Future

Against that background, some speculation as to COBRA’s future is warranted. COBRA continuation coverage, enacted in 1985, was in essence a legislative response to pricing and underwriting barriers to individual coverage that the Affordable Care Act has either eliminated (for instance, by banning pre-existing condition exclusions) or made less burdensome (for instance, through access to premium tax credits and cost sharing on the exchanges).   Without question, the health exchanges are a “disruptive technology” to the COBRA model, but COBRA continuation coverage likely will remain in some demand until such time as individual exchange coverage is comparable, in terms of provider networks and in other respects, to current group coverage.  That tipping point may not occur for some years, or even at all.      What is likely in the short term is that COBRA’s already steep adverse selection rate will continue to climb, as continuation of group coverage becomes more and more about retaining access to a broad network of healthcare providers.





Filed under Affordable Care Act, COBRA, Federally Facilitated Exchange, Health Care Reform, Health Insurance Marketplace, Plan Reporting and Disclosure Duties, PPACA, Pre-Existing Condition Exclusion, State Exchange, Summaries of Benefits and Coverage

Model “Notice of Marketplace Coverage Options” Released

Update:  On September 4, 2013, the DOL, HHS and IRS issued a Frequently Asked Question (Part XVI) stating that it is permissible for an entity other than the employer – such as a carrier, third party administrator (TPA), or multi-employer plan – to distribute the Notice of Exchange.  The FAQ cautions that, if the employer delegates Notice distribution duties, the employer must “take proper steps” to ensure that a Notice is provided to all employees regardless of plan enrollment.   Therefore if the third party provides the Notice only to a subset of employees (for instance, an insurance carrier providing the Notice only to employees enrolled in the group health plan), this must be disclosed to the employer so that the employer can timely provide the Notice to employees who are not covered under the plan.

The U.S. Department of Labor released, on May 9, 2013 Technical Release 2013-02 on the “Notice of Exchange” employer disclosure responsibility under the Affordable Care Act, together with an updated initial notice of COBRA coverage that includes information on health coverage alternatives offered through the exchanges, now formally referred to as the “Health Insurance Marketplace.” Together with the guidance, the DOL also published two model notices of coverage on the “Marketplace,” one for employers that offer group health coverage, and one for employers that do not.

Publication of the model notices in early May comes a good bit earlier than the “late summer or fall of 2013,” which the DOL announced in January when it postponed the original March 1, 2013 employer disclosure deadline.  This is the result of numerous employer requests that that the Notice be made available earlier in the year, to provide more time for them to inform employees of upcoming coverage options through the Marketplace.  Therefore employers may use the model Notices and rely on the Technical Guidance earlier than the proposed distribution date of October 1, 2013, although only employers with self-funded group health plans will be likely to do so, given that 2014 premium rates for insured plans are not yet known. The Guidance will remain in effect until regulations on the Notice requirements are published.

Technically, the notice requirement, which is set forth in Section 18B of the Fair Labor Standards Act (FLSA), applies only to employers subject to the FLSA.  However that is a very broad category, including employers involved in interstate commerce with an annual dollar volume of business of at least $500,000.  Other categories of employer, including schools, hospitals, institutions of higher learning, nursing homes, and federal, state, and local government agencies, are automatically covered under the FLSA.  The guidance provides a link to an internet compliance tool that employers can use to determine whether or not they are subject to the FLSA, and hence the disclosure requirement.

Employers must provide the Notice of Marketplace Coverage to current full-time and part-time employees – regardless of their enrollment status under existing group plans – no later than October 1, 2013, which is also the date on which open enrollment in the Health Insurance Marketplace will begin.  Thereafter employers must provide the Notice to each new employee upon hire, which the Guidance defines as within 14 days of an employee’s start date.  Employers wanting to provide the Notice to current employees and new hires in advance of the October 1, 2013 deadline may use the Model Notices and rely on the terms of the Technical Release in doing so.

There is no requirement to provide a Notice to dependents or other individuals or are or may become eligible for coverage under the plan but who are not employees.

As outlined in my earlier post, the Notice must do all of the following:

  • Inform employees of the existence of the Marketplace, describe the services they provide, and the manner in      which the employee may contact the Marketplace to request assistance (i.e., at;
  • Inform employees that they may be eligible for a premium tax credit or for cost-sharing reductions if the      employer’s plan provides less than 60% actuarial value and they purchase coverage through the Marketplace; and
  • Inform employees that, if they purchase coverage through the Marketplace, they may lose the employer      contribution (if any) to any health plan sponsored by the employer, and that unlike exchange coverage, which is purchased with after-tax dollars, all or a portion of the employer contribution towards coverage under its own plan, if received, would be excludable from the employee’s income for Federal income tax purposes.

All of these disclosures are set forth in “Part A” of the Model Notices.  The Model Notice for employers with group health coverage also requires that the employer add a name and contact information for someone with more information about employer-sponsored coverage, which may include a human resources personnel or even a broker or third party administrator contact.

“Part B” of the Model Notices contains information on the employer and on employer-sponsored coverage, if any, in sections that are numbered to correspond to line items the employees must complete when enrolling for coverage and/or financial aid on the Marketplace.  Employers are not required to complete this section of the Model Notice unless and until an employee requests the information from them as needed to enroll on the Marketplace.  Supplying the information up front in the standardized format is a good idea, however, as it will allow employees to enroll in the Marketplace without seeking individualized assistance from the employer.  The additional information sought from employers that do not provide group health coverage is as follows:

  • Employer name
  • Employer Identification Number (EIN)
  • Employer address
  • Employer phone number
  • City
  • State
  • Zip code
  • Contact information for employer representative
  • Phone number of contact person, if different from employer general number
  • Email address for contact person.

The additional information sought from employers that do provide group health coverage is identical except they must identify a contact person with information about employer sponsored coverage.  There are also entries for the employer to describe plan eligibility rules, whether or not dependent coverage is offered, and whether the plan meets minimum value (60% actuarial value) and affordability standards.  It notifies employees that, even if the employer plan provides minimum value and is affordable, they may qualify for financial aid on the Marketplace based on their household income.  (Note that this likely would happen only if certain deductions such as alimony or payment of student loan interest reduced someone’s household income to a point lower than the income the individual received from employment.  In such an instance the employer would not be subject to an IRC Section 4980H penalty tax so long as their plan met “affordability” for that individual, based on the safe harbor definition of compensation they selected and use.)

The Model Notice for employers that do provide coverage also contains a section corresponding to the “Marketplace Employer Coverage Tool” that employers voluntarily may complete and provide to employees.  The questions it covers are as follows:

  • Whether the employee currently is eligible for employer-sponsored coverage or will be eligible in the next 3 months
  • Whether the employer offers a health plan that meets the minimum value standard
  • Premium amounts (on a weekly, bi-weekly, semi-monthly, monthly, quarterly, or annual basis) for the lowest-cost plan offered by the employer that meets minimum value standards, factoring in any discount offered for tobacco cessation programs (but not any other wellness incentives).  (This is consistent with the proposed regulations on Minimum Value and other premium tax credit eligibility issues that were published on May 3, 2013).
  •  For employers whose plan year will end soon (at the time they prepare the Notice) and who know that the health plans they offer will change, a description of the changes to be made, including that the employer will not offer coverage, or will begin offering affordable, minimum value coverage, in which case premiums (on a weekly, bi-weekly, semi-monthly, monthly, quarterly, or yearly basis) must be estimated, along with the date on which the changes will occur.

Employers are free to prepare their own versions of the Notice of Marketplace Coverage provided that it covers all the required disclosures and provides the information that employees will need to enroll for coverage, and financial aid, on the Marketplace.  In addition, the Guidance states that the Notice must be provided in writing in “a manner calculated to be understood by the average employee,” a standard which presumably is met by the Model Notices.   Employers may deliver it by first-class mail, in person at the workplace, or electronically if DOL safe harbor requirements  – set forth at 29 CFR § 2520.104b-1(c) – are met.

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Filed under Affordable Care Act, COBRA, Health Care Reform, Health Insurance Marketplace, Plan Reporting and Disclosure Duties, PPACA

Special COBRA Coverage Terms for the Departing Executive: Pitfalls to Avoid

It is not uncommon for employers to provide special terms to departing executives regarding their group health coverage that they do not generally offer to rank and file employees.  Common examples include a period of remaining on active coverage status even after employment responsibilities have largely ceased (for instance during any period in which the executive receives severance compensation), or employer payment of COBRA premiums for some period of time after termination.  Generally the terms of the special coverage arrangement are set forth in a separation or severance agreement, and may vary from case to case.  Employers traditionally have exercised a significant degree of discretion in this area without a clear sense of the compliance issues that might arise.   

Special continuation coverage arrangements do, however, pose several potential problems under ERISA.  First, any self-funded group health plan is subject to nondiscrimination provisions under Section 105(h) of the Internal Revenue Code (“Code”), including the requirement that the plan’s eligibility provisions not discriminate against non-highly compensated individuals.  To the extent that extended active status coverage or subsidized COBRA coverage are extended only to departing executives, who may likely comprise “highly compensated individuals,” these practices would not meet nondiscrimination requirements and under Section 105(h)(7) the market value of the continuation coverage provided to departed executives could be includible in their taxable compensation.

The Patient Protection and Affordable Care Act (“PPACA”) extended nondiscrimination rules to insured group health plans for the first time.  Thus, providing extended active coverage under an insured plan only to terminated executives, or subsidizing only their COBRA premiums, could comprise a violation of PPACA’s nondiscrimination rules.  The rules as such do not yet exist and the IRS is not enforcing the nondiscrimination requirement against insured plans until after regulations issue.  However, extending active status coverage to a terminated executive likely is contrary to the terms of the group health policy and representations made by the employer in the application process, and could possibly provide grounds for a carrier to deny coverage of claims incurred during the extended active coverage.  Employers that subsidize COBRA premiums for departing executives should be aware that this practice, while not contrary to the carrier’s rules, likely will be disallowed under the nondiscrimination regulations, when they issue.

Yet another problem may exist for self-funded group health plans, with regard to stop loss insurance coverage.  In Bekaert Corp. v. Standard Security Life Ins. Co. of New York, 2011 U.S. Dist. Lexis 91605 (No. Dist. Ohio 2011), Standard Life Insurance Company denied stop-loss coverage for approximately $475,000 in medical claims incurred in 2009 by a former executive of employer Bekaert Corp., a Mr. Padgett, who ten years earlier had elected “extended COBRA medical health benefits” under the terms of his severance agreement with Bekaert.  This consisted of continued group health coverage at no cost for one year, followed by Medicare bridge coverage at regular monthly premium costs until such time as the retiree reached age 65 and became covered by Medicare, or qualified for other group health coverage.  Bekaert referred to this arrangement at “Option D” coverage, as contrasted with “Option C” coverage consisting of unlimited, no-cost retiree coverage up to a lifetime maximum of $100,000.  In its written description of coverage provided to Standard it did not outline Option D coverage in detail, only stating that Option D participants were not entitled to retiree coverage. 

Standard denied coverage for Mr. Padgett’s medical claims on several different grounds, the most salient being that Mr. Padgett was neither an active employee nor a COBRA recipient (for whom coverage could not exceed 36 months at maximum) and hence was not a covered person under the stop-loss policy.  Bekaert raised several arguments attempting to establish that it had sufficiently disclosed Option D coverage to Standard, and that the COBRA coverage limitations did not apply under the specific circumstances, but the district court rejected these arguments ad granted summary judgment for Standard.  The court noted that:

“While Bekaert may have had every intention of extending continuation coverage to Option D retirees beyond that which COBRA requires, the language of the Plan fails to do this.  Bekaert’s decision to pay Mr. Padgett’s claims for benefits was required by the Separation Agreement it had with Mr. Padgett, but not by the terms of the Plan.  The Separation Agreement is not part of the stop-loss agreement at issue here.  Consequently, Standard is not bound to reimburse Bekaert for the Padgett claim paid according to the Separation Agreement.”

Reading between the lines, it would appear that stop-loss coverage might have attached if Bekaert had described Option D coverage in more detail to Standard and also disclosed that it was intended to go beyond COBRA’s time limitations when necessary to “bridge” the applicable former employee to age 65 and Medicare coverage.  Bekaert’s fatal flaw appears to have been to use COBRA terminology to describe Option D coverage, without expressly flagging for Standard that it was not intended to be limited to COBRA’s 18- and 36-month coverage periods.

What is the lesson for employers?  Certainly self-funded employers should carefully examine their stop-loss coverage agreements and identify any gaps between the terms of their group health plan as disclosed to the stop-loss carrier, and the continuation coverage provisions in separation or severance agreements with former employees.  Claims that arise under any terms or arrangements that fall in the limbo land between active coverage and retiree coverage, if any, as disclosed to the stop-loss carrier, could be at risk of rejection for the reasons set forth in the Bekaert case.

Insured employers also should examine its separation and severance agreements with former executives in light of coming nondiscrimination regulations, and also to identify continuation coverage arrangements that are inconsistent either with the employer’s representations to its carrier in the application process, or with the time limitations under COBRA or state “mini-COBRA” statutes, as applicable.  Claims incurred outside COBRA’s parameters are equally at risk of being denied by a primary carrier, as in the stop-loss context.




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Summary Chart of Health Plan Excise Taxes

Below is a link to a chart in which I have attempted accurately to summarize excise tax provisions that apply to a variety of group health plan errors including COBRA and HIPAA violations, and violation of PPACA requirements including nondiscrimination rules (subject to change pending issuance of regulations).   Comparable taxes apply to failure to make “comparable employer contributions” to HSAs or Archer MSAs; more information is available in final regulations under IRC Section 4980B et seq.

Health Plan Excise Tax Chart Updated

The chart is a summary only and provided for general informational and educational purposes.  It does not comprise legal advice to anyone.

The post immediately below goes into more detail about possible excise tax consequences of COBRA violations.

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Insurers, TPAs May Bear Sizeable Excise Tax Burden for COBRA Violations

Since 1989, failures to comply with the continuation coverage requirements of COBRA have potentially triggered excise taxes under IRC § 4980B on those responsible for the error, equal to $100 per affected person, per day. However the Internal Revenue Service rarely imposed and collected the tax and there previously has been no affirmative duty on taxpayers to report or pay it.

That situation changed for plan years beginning on or after January 1, 2010. Now there is an affirmative obligation on employers and other responsible parties — including insurers and third party COBRA administrators – to report and pay the excise tax on IRS Form 8928. (A draft version is available online.) The tax is equal to $100 per affected person, per day, for each day of the noncompliance period. (A cap of $200/day applies when a failure affects more than one qualified beneficiary.) The noncompliance period begins on the day the failure first occurs and ends on the earlier of (a) the day the failure is corrected; or (b) the date which is 6 months after the last day in the maximum applicable COBRA period.

Examples of failures that would trigger excise taxes are COBRA notice failures (missing, late, or incomplete initial or qualifying event notices); COBRA premium violations (overcharging, or not complying with grace period rules); and procedural failures such as not allowing COBRA recipients to make changes at open enrollment, or on special enrollment events.

The maximum excise tax that may apply to an employer for unintentional failures – those which are due to reasonable cause and not willfull neglect — is equal to the lesser of (a) $500,000 or (b) an amount equal to 10% of the employer’s aggregate health plan expenditure during the prior tax year.  For insurers and third party administrators, however, the maximum excise tax for unintentional failures is $2,000,000.

For willful violations, the $500,000 and $2,000,000 tax caps would not apply. Additionally, minimum excise taxes apply in the event a COBRA failure is discovered on audit. The minimum tax amounts are the lesser of (a) $2,500 or (b) the excise tax calculated without application of certain exceptions noted below. This minimum amount increases to $15,000 where the failures for any year are more than de minimis.

Taxes must be paid, and Form 8928 filed, on or before the due date (without extension) of the employer or other responsible party’s federal income tax return (or that of insurer, HMO or TPA, where applicable). An automatic 6-month extension of the filing deadline only is available by filing Form 7004, however the excise tax still must be paid on the original deadline.

Interest is charged on taxes not paid by the due date even when a filing extension applies. Penalties of as much as 25% of the unpaid tax amount also separately apply for late filing of Form 8928, and for late payment of excise taxes, respectively.

Certain exceptions to the excise tax obligation do apply. First, the tax will not apply during the period where the employer or responsible party did not know, or by exercising reasonable diligence would not have known, that a COBRA violation had occurred. Second, once a COBRA violation is discovered, no excise tax will apply if the failure was due to reasonable cause and not willful neglect, and it is corrected within 30 days of discovery. “Correction” for these purposes means retroactively undoing the error, and putting the affected parties in at least the same financial position they would have been in, had the failure not occurred. When the error is failure to offer COBRA coverage, correction will include a retroactive offer of coverage back to the date it originally would have been available, in exchange for which the former employee must pay applicable premiums and the COBRA administrative charge. An employer or other responsible party generally cannot demand a lump sum payment of past-due premiums but must instead work out a payment schedule.

Although not an “exception,” there are additional prerequisites that must be met in order for the excise tax to apply to insurers or third party administrators. First, the insurer or TPA must be the cause of the COBRA error (other than as a result of employer action or inaction), and it must have assumed responsibility for the error under a legally enforceable written agreement. TPAs in particular will want to review their service agreements in this regard, and be sure to carve out responsibility for errors arising from employer action or inaction.

Church and governmental plans are exempt from the excise tax for COBRA violations. And finally, the IRS may waive all or part of the excise tax where the failure was due to reasonable cause and not willful neglect, and where the amount of tax is excessive relative to the failure involved. In such instances, a statement of reasonable cause should be filed with the Form 8928 that also addresses the need to abate excessive taxes. Generally it is necessary to pay the tax with the filed return and hope for reimbursement later, but given the potentially extremely large tax amounts at issue it is possible that the IRS could accept the return without the full tax payment. A seasoned tax advisor should be consulted in such instances.

Excise taxes apply under IRC §4980D to a number of other health plan failures, including violations of HIPAA, the Genetic Information Nondiscrimination Act (“GINA”), the Mental Health Parity and Addiction Equity Act, and prospectively will apply to violation of as yet un-issued regulations that will govern non-discrimination under insured health plans. Excise taxes under 4980E and 4980G also apply to failures to make “comparable employer contributions” under Archer MSA arrangements and HSAs, respectively.  Only employers, not TPAs, however, are subject to these other types of health plan excise taxes. Future posts will discuss these other excise taxes in more detail.

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