IRS | Payroll Unlimited

Health Care Reform Will Affect Premium-Only Cafeteria Plans – But How?

Premium-only cafeteria (“POP”) plans have been a popular way for employers to help employees obtain favorable tax treatment for their share of premiums for health insurance and other qualified benefits. POP plans provide a “win-win” solution – employees save by paying their share of insurance premiums on a pre-tax basis, and employers save by not paying FICA and federal unemployment taxes on those amounts.

Under current law, the term “qualified benefit” is broadly defined to include many types of insurance coverage, whether offered on a group or individual basis (for example, medical, dental, vision, disability, AD&D, and group term life insurance). Beginning January 1, 2014, the Affordable Care Act (“ACA”) adds a new section 125(f)(3) to the Internal Revenue Code (“Code”). This provision significantly narrows the definition of “qualified benefit” to exclude individual insurance coverage offered through a State Exchange. Although the scope of the ACA change remains unclear, and the precise impact on POP plans remains unknown, we expect POP plans will continue as a tax-favored vehicle after ACA. This article outlines the new rules, and describes the potential impact.

Background

The ACA provides incentives for States to establish and operate two types of Exchanges – American Health Benefit Exchanges (“Individual Exchanges”) and Small Business Health Option Program Exchanges (“SHOP Exchanges”). Individual Exchanges will help people purchase individual health insurance coverage, and SHOP Exchanges will help qualified employers purchase group health insurance coverage. States also have discretion to consolidate Individual and SHOP Exchanges into a single Exchange. If a State chooses not to set up Exchanges, then the Federal Government will establish and operate Exchanges in that State.

The Exchanges will sell only qualified health plans. These are health insurance plans that cover essential health benefits, meet specific cost-sharing rules and satisfy actuarial value requirements (bronze, silver, gold, platinum and a catastrophic plan for individuals under 30). Exchanges are not exclusive – subject to State regulation, individuals and employers will also be able to purchase individual and group health insurance coverage “off” the Exchanges. But people with income between 100% and 400% of the federal poverty level have a strong incentive to purchase individual health insurance coverage on the Individual Exchange – premium tax credits are not available for coverage purchased “off” the Exchange.

There are a multitude of definitions related to Exchanges. A “qualified employer” is a small employer that makes all full-time employees eligible for small group health insurance coverage on a SHOP Exchange. A “small employer” is an employer with no more than 100 employees, although States may choose to use a narrower definition for 2014 and 2015 (an employer with no more than 50 employees). Beginning in 2017, States may also choose to allow larger employers to purchase group coverage on a SHOP Exchange.

New Restrictions on Qualified Benefits

New Code section 125(f)(3) includes a general rule and an exception. Under new Code section 125(f)(3)(A), the general rule is that the term “qualified benefit” does not include a qualified health plan offered through an Exchange. The legislative history suggests this rule is intended to prevent employers from using cafeteria plans to allow employees to make pre-tax purchases of individual health insurance coverage from an Individual Exchange. And new Code section 125(f)(3)(B) provides the exception – the general rule does not apply to “qualified employers” (as defined above) that offer employees the opportunity to enroll in a qualified health plan through an Exchange. The legislative history suggests this rule is intended to allow qualified employers to use cafeteria plans to allow employees to pay their share of premiums for group health insurance coverage from a SHOP Exchange.

Winners and Losers?

Predicting winners and losers at this point is dicey. One challenge is that the law includes ambiguities, and the IRS has not yet issued guidance. Another challenge is that several interpretations are left to the States – how to define the term “small employer” for 2014 and 2015, whether to let larger employers purchase coverage on the SHOP Exchange beginning in 2017, and whether to combine the Individual and SHOP Exchanges.

Are POP plans doomed? Not at all. But POP plans will need to change modestly to reflect the new restrictions. For example, POP plans will not be able to facilitate the pre-tax purchase of individual health insurance from an Individual Exchange. This will be true for both small and large employers. But otherwise, POP plans will remain quite viable. For example, POP plans can facilitate the pre-tax payment of an employee’s share of premiums for qualified employers that purchase group coverage on an Exchange. In addition, POP plans can facilitate the pre-tax purchase of individual health insurance “off” an Individual Exchange. And POP plans can also facilitate the pre-tax payment of an employee’s share of premiums for large employers that purchase group coverage “off” the Exchange.

Summary

Based on what we know today, we believe that POP plans will generally continue to be available as a vehicle to provide tax favorable premium conversion benefits for employers and employees. However, beginning in 2014, employers will not be able to use POP plans to help employees make pre-tax purchases of individual health insurance coverage on an Individual Exchange.

IRS Releases Guidance on Additional Medicare Tax on High-Income Earners

On June 11, 2012, the Internal Revenue Service (IRS) released new guidance, in a 20 questions and answers (Q&A) format, on the 0.9% additional Medicare tax scheduled to go into effect in 2013. The Q&As are intended to assist employers and payroll service providers in adapting systems and processes that may be affected by the new tax.

Background:

As a result of the enactment of the Affordable Care Act (ACA), effective for wages paid on or after January 1, 2013, the Medicare tax rate increases from 1.45 percent to 2.35 percent on wages earned above $200,000 for single filers and $250,000 for joint filers ($125,000 for a married individual filing separately). This increase only applies to the employee Medicare portion of the Federal Insurance Contributions Act (FICA) tax. Consequently, employers do not have to match the increased Medicare tax amount from employee’s wages. However, employers are still responsible for the withholding and reporting obligations with respect to the increased employee Medicare tax. If an employer fails to withhold and deposit the additional Medicare tax amount AND the employee pays it with his or her tax return, the employer will not be required to pay the missed amount, but the employer will be subject to penalties for the failure to withhold the tax.

NOTE: The employer is required to withhold the increased amount from all workers with wages exceeding $200,000 regardless of the marital status claimed on the employee’s Form W-4. Over and under withholding for the employee will be reconciled upon the filing of his/her tax return.

Some of the highlights of the Q&As are as follows:

All wages that are currently subject to Medicare tax are also subject to the additional Medicare tax if they are paid in excess of the applicable threshold for an individual’s filing status (see above). (Q&A 4)

The additional Medicare tax also applies to employees who are nonresident aliens and U.S. citizens living abroad if their wages exceed the applicable thresholds. (Q&A 6)

An employer must begin withholding the additional Medicare tax once an employee’s wages are over the threshold, even if the employee may not ultimately be liable for this tax. For example, consider a situation where one spouse earns $210,000 and the other spouse earns $25,000, and the couple files a joint return. Although the employer would be required to withhold on the higher earner’s wages to the extent they exceed $200,000, the couple would not be liable for the additional Medicare tax because their combined income is less than the applicable $250,000 threshold. Any excess additional Medicare tax withheld will be credited against the total tax liability shown on the employee’s personal income tax return. (Q&A 7)

An employer is not required to notify an employee when it begins withholding the additional Medicare tax. (Q&A 8)

Although an employee can’t request additional withholding specifically for the additional Medicare tax, an employee who anticipates being liable for it may request that his employer withhold an additional amount of income tax withholding on Form W-4, which will be applied against all taxes (including any additional Medicare tax liability) shown on the employee’s income tax return. (Q&A 10)

An employer begins withholding the additional Medicare tax in the pay period in which it pays wages to the employee exceeding the $200,000 threshold and not earlier, even if the employee’s annual wages are expected to exceed the threshold. (Q&A 11)

If an employee receives wages from an employer in excess of $200,000 and the wages include noncash fringe benefits, the employer calculates wages for purposes of withholding the additional Medicare tax in the same way that it calculates wages for withholding the existing Medicare tax. The employer is required to withhold additional Medicare tax on total wages, including noncash fringe benefits, in excess of $200,000. The value of noncash fringe benefits must be included in wages and the employer must withhold the applicable additional Medicare tax and deposit the tax under the rules for employment tax withholding and deposits that apply to noncash fringe benefits. (Q&A 13)

To the extent that tips and wages exceed $200,000, an employer applies the same withholding rules for additional Medicare tax as it does currently for the existing Medicare tax. An employer withholds additional Medicare tax on the employee’s reported tips from wages it pays to the employee. If the employee does not receive enough wages for the employer to withhold all the taxes that the employee owes, including additional Medicare tax, the employee may give the employer money to pay the rest of the taxes or the employee may need to make estimated tax payments to cover any shortage. (Q&A 14)

If an employee receives third-party sick pay, wages paid by the employer and by the third party need to be aggregated to determine whether the $200,000 withholding threshold has been met. (Q&A 16)

If an employee has amounts deferred under a nonqualified deferred compensation (NQDC) plan, the employer calculates wages for purposes of withholding additional Medicare tax on the NQDC in the same way that it calculates wages for withholding the existing Medicare tax. (Q&A 17)

For a copy of the IRS FAQ’s, please click on the link provided below:
http://www.irs.gov/businesses/small/article/0,,id=258201,00.html