Is the fully-insured health plan you offer employees “discriminatory” under the Internal Revenue Code? In other words, are you creating two classes of people in your organization—on the one hand, the highly compensated who receive very generous benefits, and on the other, the rank and file who receive benefits that are good, but just not as good?
Most employers with fully-insured health plans probably think the answer to this question is “no,” but then again, they have probably never put their health plan to the test, and therefore, don’t know the real answer to the question. The reason for that is that they haven’t had a need to.
However, that may be about to change. The Affordable Care Act, when it was signed into law, expressly required that non-grandfathered fully-insured health plans comply with nondiscrimination testing requirements. Subsequently, the federal government explained that employers do not need to comply with these requirements until it issues rules or guidance clarifying what was intended. Today, more than five years after the ACA was signed into law, the federal government still has not issued that guidance.
However, the guidance could be coming very soon. While some HR executives have said they’ve completely given up on the IRS ever issuing new rules, Treasury officials have informally commented that they expect guidance or proposed rules to be released before the end of 2016, and potentially as early as late 2015. So, it’s possible this will become a real issue in just a few months.
Nondiscrimination testing, explained
The concept of nondiscrimination testing revolves around Section 105(h) of the Code. Currently, this Section of the Code only applies to self-insured health plans, but it will apply to all employer-sponsored health plans when the new guidance or regulations are issued.
The test is designed to make sure that highly compensated individuals and non-highly compensated individuals are treated relatively equally. In other words, to make sure the benefits received under the plan, and the eligibility terms for those benefits, are relatively equal.
Highly compensated individuals are defined as one of the five highest-paid officers in the organization, a shareholder who owns more than 10% of the value of the stock, or as one of the highest-paid 25% of all employees.
Yes, it really is possible that your plan is discriminatory
Most employers know in their heart of hearts that they did not create two classes of health plans, one for the C-suite and one for all other employees; they just don’t think that way. However, under the current rules for self-insured plans, even small changes to a plan’s design, like changes pertaining to the duration of eligibility, or what may seem like small extra perks, can result in a discriminatory plan under the Code.
Further, even though the current rules do not take the factor of “utilization of benefits” into account, it’s quite possible the new rules will take this factor into account. This would make it much more likely that plans will be found to be discriminatory where the employer never intended it.
Consider this example:
An employer sponsors two health plan options for its employees: (1) a low-cost HMO, or a POS plan that has low co-pays, and (2) a high-cost, high-deductible health plan with fewer options. Now, suppose that the employer subsidizes the cost of the employees’ plans in both options by offering to pay 30% of each employee’s monthly cost, leaving the employee to pay the remaining 70% regardless of which plan they choose. That seems pretty fair, right? Every employee has access to either plan, and the employer is paying 30% of the premium in each instance. However, it is possible most of the highly compensated individuals will choose the first option because they can afford it, and most of the rank and file employees will choose the second option. Because the first option could be much more expensive, the employees’ utilization of the plan’s benefit options could result in the employer paying more to subsidize the cost of that first option, resulting in the employer paying more for the benefits of the highly compensated employees. Under the new rules, this could be considered a discriminatory plan.
What can employers do now?
Again, we’re still waiting for the guidance, so it’s difficult to predict where the IRS finally comes down on the new rules. But we do know the new penalties under the ACA will be higher, making this issue vitally important to pay attention to. Currently, when a self-insured plan discriminates, the amounts paid to highly compensated individuals that are considered to be discriminatory (called “excess reimbursements”) are taxed. Under the ACA, a fully-insured plan that fails to comply with the nondiscrimination rules is subject to a civil action to compel it to provide nondiscriminatory benefits. Additionally, for each day the plan fails to comply, the employer is subject to excise taxes or civil penalties of $100 per day per individual discriminated against.
For now, the prudent course of action is to avoid creating the potential for a scenario like the one above. To a certain extent, this requires a crystal ball. It’s difficult to structure health plans until you get the rules, but employers should try to avoid creating the potential for stark differences between groups of employees.
Employers that already provide potentially discriminatory benefits need to clearly reserve the right to stop providing these benefits on a tax-favored basis. This may require amending plan documents and other benefits-related policies, and should be considered sooner rather than later.
For the last several years, employers have been scrambling to keep up with the provisions of the ACA. With some smart planning now, employers can minimize the scramble when the new nondiscrimination testing rules are released.
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