By Katrina Veldkamp, Best Best & Krieger.
The future of the Cadillac tax, a key cost-control mechanism and federal revenue source enacted as part of the Patient Protection and Affordable Care Act (ACA), is unclear.
Though initially set to take effect in 2018, Congressional lawmakers delayed the controversial tax on high-cost health plans in December 2015, postponing the levy’s implementation by two years until 2020.
In fact, it is possible that the Cadillac tax could be repealed before it goes into effect. Both Democratic presidential hopefuls have embraced repealing the Cadillac tax, while Republican candidates are calling on a full repeal of the ACA.
Despite its uncertain future, the prospect of the tax could have an impact on health benefit decisions by encouraging employers to reduce costs to avoid triggering the tax. However, in order to determine how to avoid the tax, it is important for employers to understand the fundamentals of the tax.
What follows is an overview of the tax, including insights into what you need to know about the guidance the Internal Revenue Service (IRS) has issued so far.
What is the Cadillac tax?
The purpose of the Cadillac tax is to rein in high-cost employer-provided health coverage by placing a 40 percent tax on the cost of benefits exceeding statutory thresholds. It is intended to encourage employers to offer more cost-effective group health plans.
The Cadillac tax thresholds are initially set at $10,200 for individuals and $27,500 for families. Those thresholds will rise annually with inflation and cost-of-living increases. A 40 percent excise tax will then be imposed on an employee’s excess benefits – the difference between the cost of an employee’s “applicable coverage” for a given year and that year’s fixed threshold.
What is applicable coverage?
Applicable coverage includes any employer-sponsored group health coverage that is excludable from an employee’s gross income. The broad definition of applicable coverage includes major medical coverage, health care flexible spending accounts, health savings accounts, health reimbursement arrangements, coverage for on-site medical clinics that provide more than de minimis care, executive physical programs, multiemployer plans, and retiree health coverage. It does not matter whether the plan is insured or self-funded, or whether it is paid for using employer or employee pre-tax contributions. Note, however, that coverage paid for with employee after-tax contributions is not counted as applicable coverage.
The benefits included in “applicable coverage” are determined on an employee-by-employee basis. Applicable coverage only consists of the particular coverage for which the individual employee is enrolled, not all the coverage offered to the employee.
What does not count as applicable coverage?
HIPAA excepted benefits are generally excluded from applicable coverage. This includes insurance for general liability, auto liability, workers’ compensation, or other incidental or secondary insurance. Stand-alone dental and vision plans, as well as long-term care coverage, are also excluded. However, unless the IRS chooses to treat self-funded, limited-scope dental and vision plans and employee assistance programs as excepted benefits, those plans may be counted as applicable coverage.
How is the cost of applicable coverage determined?
The IRS has not yet finalized the rules for determining the cost of applicable coverage. However, it expects to use rules similar to those for calculating COBRA premium costs. If the Cadillac tax survives, the IRS will issue further guidance regarding how to calculate the cost of applicable coverage under both the Cadillac tax and COBRA.
What purpose does the excise tax serve?
The tax is meant to discourage employers from offering overly generous, high-priced health plans. It also acts as a source of revenue to fund costs associated with health care coverage under the ACA.
Tax law currently excludes employer-sponsored health benefits from taxable income, so that employers are encouraged to spend on tax-free benefits rather than taxable wages. By constraining health coverage spending, the tax aims to encourage employers and employees to spend less on health coverage and use health plan services more efficiently.
Why did the Cadillac tax come under fire?
The Cadillac tax, proponents argue, is critical to making the health care system more efficient – curbing high health care spending while limiting costly plans. Over time, supporters have held, an employee’s take-home pay could increase.
Opponents, however, say the tax would only end up hurting businesses and middle-class workers, especially those living in areas experiencing higher health care costs or with an older population. With the tax in effect, challengers argue, employers would likely lessen their health coverage spending to get below the Cadillac tax cap, to the detriment of employees.
Who would be impacted by the Cadillac tax?
The Kaiser Family Foundation estimated that a quarter of small employers – employers with fewer than 200 employees – would have at least one plan that would trigger the Cadillac tax if it took effect in 2018. Similarly, the analysis found that 46% of employers with 200 or more employees would have at least one plan that exceeds the threshold in 2018 unless changes are made. Projections showed impacted employer numbers rising each year thereafter, up to as many as 41% of small employers and 68% of large employers by 2028.
Even though the tax is now delayed until 2020, some employers are already taking measures to reduce covered benefits or increase deductibles to avoid paying the 40 percent tax.
Who pays the tax?
The coverage provider pays the tax. Generally, the coverage provider is the person who administers the health plan benefits. For insured coverage, the coverage provider is the insurance carrier. However, identifying the coverage provider gets murky with self-funded plans. It could be the employer or the person or company that does the day-to-day administrative work for the plan; one potential approach is to use the administrator named in the health plan. The IRS has not yet finalized its approach to determining who the administrator is.
The employer is responsible for calculating the taxes owed and for notifying the IRS and each liable coverage provider of any tax due.
How is the Cadillac tax calculated?
Say an employee has self-only coverage under an employer-sponsored health plan. That plan has a total monthly cost of $1,000. The projected monthly limit under the initial statutory threshold is $850 ($10,200 divided by 12 months). Since the employee’s total monthly cost of $1,000 exceeds the $850 limit, the excess of $150 is subject to the 40 percent excise tax. Thus, the excise tax for that employee would be $60 per month.
While it is an election year and the Cadillac tax’s future is in limbo, employers can still take a proactive approach and look at their health plans to see if they will exceed the projected limits. Since the tax could be substantial, it would be prudent to prepare for the law’s future application in the event it is not repealed.
Katrina Veldkamp is an associate in Best, Best & Krieger’s Employee Benefits practice group in Ontario. Her practice is focused on various employee benefits issues, including pensions, health and welfare plans, and post-employment benefits. She advises both private and public sector clients. She can be reached at firstname.lastname@example.org.