IRS Guidance On Cadillac Tax Provides An Opportunity For Plan Sponsors To Submit Views On Open Questions

The Internal Revenue Service ("IRS") recently issued Notice 2015-16 (available at to begin implementation of the Cadillac tax in 2018.(1) Notably, proposed or final regulations have not yet been issued on the Cadillac tax provision. Notice 2015-16 describes and invites comments on possible approaches for implementing the Cadillac tax with respect to (i) what constitutes applicable coverage, (ii) how the cost of applicable coverage is determined and (iii) how the annual dollar limits are applied. Public comments may be submitted until May 15, 2015. The IRS (2) indicates future notices will be issued addressing other aspects of the Cadillac tax provisions. 

Action Item: Employers should familiarize themselves with the Cadillac tax provisions including the likely direction to be taken by the IRS in implementing the tax so they can determine which of their employer-provided medical benefits are likely to be subject to the tax and begin taking mitigating actions. To the extent any of the employer's benefits are impacted by the issues raised in the notice, the employer may wish to provide comments to the IRS.

Applicable Coverage:

Generally, applicable coverage includes employer provided group medical coverage that is excludible from the employee's gross income, or would be excludible if it were employer provided coverage, which includes coverage paid for by the employee on an after-tax basis. The statute identifies the following types of coverage as applicable coverage: health flexible spending accounts, health spending accounts, Archer medical savings accounts, retiree coverage, on-site medical clinics, and specified disease coverage and fixed indemnity insurance if the coverage is excludible from gross income. Excluded from the definition are accident or disability income insurance, supplemental insurance, liability insurance, workers compensation, automobile medical payment insurance, long-term care coverage, and limited scope dental and vision insurance and fixed indemnity insurance that is not excludible from gross income. 

The Notice indicates that future guidance on the definition of applicable coverage is expected to: 

     Clarify that coverage provided to members of the military and their families by state or federal governments is excluded from the definition of applicable coverage.

     Include executive physical programs and health reimbursement arrangements ("HRAs") as applicable coverage.

     Exclude as applicable coverage on-site medical clinics that only offer de minimis medical care. The IRS invites comments on the proper treatment of on-site medical clinics that provide certain services in addition to or in lieu of first aid, such as immunizations.

In addition, the IRS is considering using its rulemaking authority to exclude from the definition of applicable coverage self-insured limited scope dental and vision benefits and employee assistance plans that qualify as excepted benefits. Comments are requested as to any reasons why the IRS should not adopt such approach. 

Cost of Coverage

The cost of applicable coverage is determined under rules similar to those used for determining COBRA premiums. The IRS has asked for input regarding application of the COBRA rules and the adoption of possible alternative rules. 

     Analogizing to the COBRA rules, the cost of any specific coverage will be determined based on the average cost of that type of coverage for all similarly situated individuals. The Notice proposes treating individuals as similarly situated based on the benefit package (e.g., a PPO and HDHP) in which they are enrolled and applying certain mandatory disaggregation and permissive disaggregation rules. Mandatory disaggregation would be required for self-only and other-than-self-only coverage, but employers would be permitted to treat all types of other-than-self-only coverage (e.g., employee plus spouse coverage or family coverage) as a single type of coverage and would not be required to determine the cost based on the number of persons covered, In addition, the IRS is considering allowing employers to further subdivide similarly situated employees based on other objective criteria such as geographic location, specified job categories, etc. (3)

     As an alternative approach, the Notice asks for employer's views on determining the cost of coverage under other methods, such as by reference to the cost of similar coverage available elsewhere, such as through the market place exchanges.

     The Notice recognizes the challenges in calculating the cost of coverage HRAs given the limited guidance for determining the COBRA applicable premium for an HRA and proposes, as one possible approach, determining the cost of coverage based on the amounts made newly available to a participant each year (excluding carryover amounts and amounts made newly available before 2018). As a supplement or alternative to that approach, the Notice proposes determining the cost of coverage under an HRA based on the claims and administrative expenses attributable to HRAs for a particular period (determined separately for each level of employer HRA coverage, such as self-only or family, if different employer contribution amounts are provided) and dividing that sum by the number of employees covered for that period at each level of coverage. The Notice also seeks comments regarding the types of HRAs maintained by employers (e.g., HRAs that only permit reimbursements of employee contributions or that cover a range of benefits some of which are not applicable coverage) and how the cost of coverage should be determined for those arrangements.

Annual Dollar Limits

As noted above, the statute contains different dollar limits depending on the type of coverage an employee has - self-only or other-than-self-only. The Notice identifies two possible approaches for applying the annual dollar limit for employees with both self-only and other-than-self-only applicable coverage, such as self-only group medical coverage with an HRA that covers the family. One approach bases the annual dollar limit on the employee's major coverage and the other applies a composite annual dollar limit determined by pro rating the dollar limits based on the cost of each type of coverage. The IRS invites comments these approaches including any potential administrative difficulties.

Because employers are permitted to deduct their health plan costs, the government in essence subsidizes the cost of these plans. The Cadillac tax allows the government to recoup some of this subsidy with respect to high dollar health plans. The net effect of the tax will be to encourage employers to provide less costly plans. This can be done by either cutting benefits or increasing cost sharing; however, in taking either of these approaches employers will need to be mindful of the ACA coverage mandates and cost sharing limits. 

1 - The Cadillac tax imposes a 40% nondeductible excise tax on the cost of "applicable coverage" that exceeds the annual statutory dollar limitations (i.e., $10,200 per employee for self-only coverage and $27,500 per employee for other than self-only coverage for 2018). The tax is calculated and paid by the insurer in the case of an insured plan and the employer in the case of a self-funded plan. 
2 - References to the IRS in this Client Alert also include the Department of Treasury.
3 - Notably, the IRS states that it would want to harmonize any changes adopted for purposes of the Cadillac tax provisions in future guidance regarding COBRA premiums. Accordingly, employers should be mindful of this when commenting on the proposed guidance.  
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The information provided is for educational purposes only. This information is from sources we believe to be reliable, but we cannot guarantee or represent that it is accurate or complete. The opinions are those of the writer, and the opinions and information presented are subject to change without notice.

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