Offsetting Health Care Benefits
I recently asked Worklaw® Network attorney Mike Ott to help one of our Members with regard to employers providing incentives to employees for “opting out” of health coverage. Under current law, in general it is OK to offer an incentive to employees that elect not to be covered by a health plan. However, a significant disincentive occurs with constructive receipt under IRS income tax rules. Basically, if you give cash in lieu of benefits, the IRS sees this as an option to all employees, not just the ones that elected coverage. So, suppose an employer gives a rebate of $50/month for an employee that opts out of coverage. The employee that opts out of coverage is paid 600/year. The $600 is treated as compensation and the employee has to pay income tax on the additional compensation and the employer and employee has to pay FICA tax on the additional compensation. That result is anticipated. However, the employees that elected health coverage are also required to pay tax on the benefit they could have received as cash. As such, the employer is responsible for imputing $600 of income to those employees, including deduction for taxes and the payment of the employer portion of FICA taxes on the imputed income. Failure to impute the income could result in the employer being liable for the entire tax obligation for all of the participating employees.
There is an alternative to the adverse tax consequences for current employees by using a 125/cafeteria plan and/or a flexible spending account model. In this case, the employer could provide excess flexible spending account dollars to all eligible employees (the employer can define who is eligible as long as it passes nondiscrimination testing). The employer would raise the employer provided cost of the medical premium by the amount of the anticipated incentive. For example, suppose the incentive is anticipated to be $50/month and the employer subsidizes coverage by $150/month for each employee. The employer could lower its subsidy to $100/month and provide an FSA account benefit of $600 to those electing coverage. The $600 can be used by the employee to pay toward health coverage, up to $50/month. The employees that elect coverage are effectively left in the same position. The employees that choose not elect coverage can use the $600 to pay for benefits on a tax free basis. Another option would simply be to lower the employer subsidy and raise all of the employees’ wages by the $50/month. Those that elect coverage would effectively get the $50 on a tax free basis by using it to pay for the employees share and those that don’t elect coverage get an additional $50/month in cash. In this case, the employer should treat the compensation differently and provide descriptive communication materials so that it gets recognized by the employees.
The IRS has now agreed that mandatory (i.e. opt-out) 125 plans are permissible. This makes the “perception” of providing an opt-out cash benefit much easier to communicate. Basically, under this scenario all employees can be mandated to participate in the health program and if they opt-out, they get a designated amount of cash. This can be accomplished by combining an opt-out health benefit plan with a mandatory participation in a flexible spending account plan. It’s always been permissible as an opt-in program, but the use of the mandatory FSA effectively forces the employee to recognize the benefit provided from the employer since the employee has to choose to receive the cash.
The imputed income issue generally is not a problem with the Medicare opt-outs, since in those cases, the employer generally is requiring that the participants provided the incentive or supplemental benefit also be covered by Medicare. Because all of the employees covered by Medicare get the benefit, there are no adverse tax consequences. Also, many employers provide the supplement as a reimbursement for health benefit only (e.g., payable for co-pays, deductibles or out-of-pocket costs for covered prescription drugs) and are not eligible to receive the benefit in the form of cash.
As far as Obama Care, it’s uncertain where we will end up at this time. We are awaiting a decision by the Supreme Court as to the constitutionality of the new law. At this time there is no consensus as to how the Supreme Court will rule. The last figures reviewed indicated that 55% of the practitioners surveyed though it would be repealed significantly (i.e. possibly eliminating mandatory coverage, which will effectively cause the entire statute to fail), and 45% felt that it would be substantially upheld. Personally, I’m in the minority and feel that it will be found constitutional. I have reviewed applicable case law, and although the Fed did a very poor job in presenting its case, I still believe it will be substantially upheld. However, again, we are really in a waiting mode now.