Page 21 of 23

Notice 2011-28: Transition Relief and More on W-2 Reporting of Health Care Costs

On March 29, 2011 the IRS released Notice 2011-28 which contains guidance, in question-and-answer format, on W-2 reporting of the cost of health care coverage, a requirement of PPACA. This reporting requirement – often mistaken for a tax on health care costs – was originally required for Form W-2s for 2011 issued to employees and SSA in early 2012. In an earlier Notice the IRS postponed the reporting requirement until 2012 W-2s issued in early 2013. Now, Notice 2011-28 postpones the reporting duty yet another year – and until further guidance issues – for employers that in 2011 issue fewer than 250 Forms W-2 (this is also the threshold for mandatory electronic reporting).

Again – if your company issues fewer than 250 Forms W-2 for 2011 – i.e., the forms that you send to employees and SSA in early 2012 – then in 2012 your company is relieved from tracking and reporting the value of group health care coverage on Forms W-2.

For employers that will have to report the value of health coverage for 2012 Forms W-2 the Notice contains helpful information on a number of points:

1) With regard to reporting the cost of health coverage in a year in which an employee terminates employment, the employer can either report the cost of COBRA coverage for the balance of the months of the year, or report only on months in which the employee actively was employed. The employer must use one or the other reporting method for all terminating employees.

2) If terminated employee requests a copy of his or her Form W-2 before the end of the year, the employer is not required to report any amount in box 12, designated for the cost of coverage.

3) When an employee transitions employment in the course of a year, either the predecessor or successor employer may each report the cost of coverage for the period the employee worked for them, or the successor employer can report the cost for the whole year pursuant to a procedure set forth in Revenue Procedure 2004-53. Employers that undergo a change in control transaction should flag this issue for negotiation along with COBRA duties and related payroll issues.

4) The amount that must be tracked and reported is the “aggregate cost of applicable employer-sponsored coverage.” “Applicable employer-sponsored coverage” means coverage under any group health plan that is excludible from an employee’s gross income under IRC Section 106, with the exception of: (a) coverage for long-term care; (b) coverage for on-site medical clinics; (c) coverage under separate dental or vision insurance (unbundled from group health); or (c) individual hospital indemnity or disease-specific coverage.

5) The aggregate cost of coverage includes the employer and the employee portion, whether or not the employee paid for the coverage on pre-tax basis under a cafeteria plan. The aggregate cost also includes the cost of coverage provided to over-age dependents (older than age 26 – some states mandate coverage past this age) – even when the cost of this coverage is added to employees’ taxable wages.

6) Amounts excluded from the aggregate cost of coverage include (a) contributions to an Archer MSA, (b) contributions to HSAs, and (c) salary reduction elections under a health flexible spending arrangement (“FSA”). When a health FSA is offered under a Section 125 cafeteria plan, the amount the employer must include in the aggregate reportable cost of coverage on Form W-2 is the amount of the employee’s salary reduction for all qualified benefits – not just the health FSA, plus the amount of any employer flex credits or contributions that the employee elects to apply to the health FSA. If the employee’s total salary reduction for all flex benefits equals or exceeds that amount of the health FSA for a given year, the employer does not include the amount of the health FSA for that employee for that year. Examples in the Notice under Q&A 19 spell this out in more detail.

7) An employer may choose from among several methods of calculating the reportable cost under a plan: (a) using the COBRA premium cost to the employee; (b) using the premiums charged for the employee’s coverage; (c) using a modified COBRA premium (where the employer subsidizes COBRA premiums or bases them on premiums calculated in a prior year. In addition, employers using one or more composite rates can use those rates to calculate the cost of coverage for reporting purposes.

8 ) Employers must track changes to the cost of coverage occuring during the year, for reporting purposes. This will occur when an insured health plan is on a fiscal year renewal cycle or when a self-funded plan uses the COBRA premium method and the 12-month period used to determine the COBRA applicable premium is not the calendar year.

9) Employers must track changes to the cost of coverage occuring when an employee commences, changes, or terminates coverage, for instance when an employee who switches from individual to individual plus spouse coverage in the middle of the year.

10) The reportable cost of coverage must always be determined on a calendar year basis; this will be an issue for employers whose health plans use a fiscal year.

The IRS requests public comments on a number of points including on challenges employers may face in implementing reporting of coverage costs on the 2012 Forms W-2, as well as issues raised by applying the reporting requirement to employers filing fewer than 250 Forms W-2 in a year. This may suggest that the IRS is evaluating a permanent reporting waiver for this group; hopefully this will be addressed in future guidance.

California Senate Passes AB 36 With Unanimous Vote

Updated April 5, 2011
The California Senate voted unanimously on March 24, 2011 to approve California Assembly Bill 36, which would bring California income and employment tax laws into conformity with federal tax law regarding group health coverage provided to dependents up to age 26. This vote was the last step in the legislative process before the bill goes to Governor Brown for signature.

Because AB 36 offers retroactive relief from having to track imputed state income for employees with overage dependents, employers will need to look to the Employment Development Department for guidance on amending information reported for 2010 on Forms DE 6 and DE 7, the quarterly wage and withholding report, and annual reconciliation report, respectively. Adjustments to either form filed in 2010 are made on form DE 678.

For 2011, however, DE 6 and DE 7 are replaced with form DE 9 (Quarterly Contribution Return and Report of Wages) and DE 9C (Quarterly Contribution Return and Report of Wages (Continuation)). Those new forms are amended by filing new EDD form DE 9ADI (Quarterly Contribution and Wage Adjustment Form). Per a contact at the EDD, after final passage of AB 36 they will study the measure and advise on corrective reporting steps; so the above instructions may change. To correct employee wage statements, employees will need to file Form 540X with the Franchise Tax Board.

DOMA Repeal Bill Introduced by House Democrats

Only a few weeks after the Justice Department announced withdrawal of its support for the federal Defense of Marriage Act, legislation to repeal it was introduced in the House of Representatives. Specifically, on March 16, 2011 Rep. Jerrold Nadler (D. N.Y.) re-introduced the Respect for Marriage Act, which he first sponsored in 2009. The legislation has the support of over 100 co-sponsors in the House, including four openly gay members of Congress. A version of the bill shortly is expected to be introduced in the Senate by Sen. Dianne Feinstein (D. California). This will be the first time that the Senate has entertained a bill to repeal DOMA, which since 1996 has limited the rights and protections of federal laws to legally married, opposite sex spouses.

Prior to DOMA, marital status was decided at the state level, and if the Respect for Marriage Act becomes law this again will be the case. If a same-sex couple legally was married in a state that permits such unions, such as Massachusetts, the couple would have equal treatment under federal law as an opposite-sex married couple. Couples who are registered domestic partners or in civil unions would not have spousal status for federal purposes unless they also legally were married under state law. Lamda Legal prepared a concise summary of the likely impact of the Respect for Marriage Act; you can read that summary here.

Physician Congresspersons Generally an Anti-PPACA Crowd

The Republican co-sponsor of H.R. 1004, the Medical FSA Improvement Act, is Representative Charles Boustany (R. La.), a retired heart surgeon. He is one of 19 Representatives who are doctors or nurses by profession. Four Senators have medical training, including Rand Paul of Kentucky. This blog post summarizes the backgrounds of some of the Republican medical professionals in Congress in 2011, and states their respective positions on PPACA. Whether through party affiliation, as a result of lessons learned in the healthcare trenches, or both, none of those surveyed support PPACA outright. Common themes are opposition to more government involvement in healthcare, support for laws permitting the purchase of insurance across state lines, expanded access to and use of Health Savings Accounts, tort reform, and support of small business pooling to increase insurance purchasing power. Former medical professionals on Capitol Hill who do support PPACA include former nurse Rep. Lois Capps, representing California’s 23rd District (including Santa Barbara) and Rep. Jim McDermott (D. Wa.), a psychiatrist.

Cashout Feature Would Replace “Use it or Lose It” Rule for Medical FSAs

U.S. Representatives Charles Boustany (R. Louisiana) and John Larson (D. Conn.) have proposed a bill, the Medical Flexible Spending Account Improvement Act (H.R. 1004), that would repeal the “use it or lose it rule” applicable to medical flexible spending accounts or “FSAs” effective January 1, 2013. A prior version of this bill was introduced in 2009, also with bipartisan support, but appears to have died in committee.

The use it or lose it rule is the most often-cited reason that employees choose not to enroll in medical FSAs, which often form part of a cafeteria or “flex” plan under Section 125 of the Internal Revenue Code. The rule exists because Section 125 plans are barred from operating as a means of deferring income from one year to the next. Employees who overestimate their reimbursable expenses must leave unused, deferred cash compensation in their employers flex accounts unless they can come up with last-minute reimbursable expenses, such as new eyeglasses.

The Act would allow employees to take their unused health FSA balance as a taxable distribution after the close of the plan year to which the balance relates, and no later than the end of the 7th month following the plan year end. Thus, an employee who participates in a medical FSA with a calendar plan year would be able to receive distribution of their unused 2013 account balance on or after January 1, 2014, but no later than July 31, 2014. The distributed amount would be included in the employee’s taxable income for 2014.

The bill contains a transition rule applicable for plan years that begin before the date the bill is enacted, allowing individuals to make a new medical FSA election or revise an existing one so long as the new election is made within 90 days after the date of enactment of the bill.

Medical FSAs are subject to other changes under PPACA; this year the ability to receive reimbursement of over-the-counter medicines ended, unless a doctor’s note for the OTC item is provided. And in 2013 the maximum reimbursement amount – currently without a ceiling – is capped at $2,500.

Eliminating forfeitures under health FSAs will expose employers to more out of pocket expenses in operating these arrangements. Employers must act as insurers under these plans, making 100% of the reimbursement budget available to each employee on day 1 of the plan year, and can get burned by employees who cash out and quit early in the calendar year. Forfeiture accounts will no longer be available to make up for such losses. However employers’ exposure also will be capped by the $2,500 dollar limit, and if elimination of the use it or lose it rule increases medical FSA participation, they will enjoy a reduced employment tax burden.

Proposed Regs Describe State Innovation Waiver Process

The Treasury Department and Department of Health and Human Services (HHS) today released guidance, in the form of proposed regulations, on how states may obtain “Waivers for State Innovation” in lieu of complying with central features of PPACA, including the individual mandate. Originally such waivers were to become available in 2017 but the Obama Administration recently accelerated that deadline to 2014, which is when the key PPACA features first go into effect.

According to the regulations, waiver applications are to be submitted to the Secretary of HHS, which will complete a preliminary review within 45 days. The regulations do not set a minimum time between submission of an application and the effective date of the waiver, but request public comments on whether or not it should require submissions be filed no less than 12 months before the waiver is to take effect.

Completion of the preliminary review triggers the federal public notice and comment period, and the 180-day federal decision-making period. Additional public notice and comment periods occur at the state level, as well.

In order to receive a waiver, a state must demonstrate that its alternative system will provide coverage that is at least as comprehensive (in terms of benefits) as coverage would be under the PPACA, and as least as affordable, in terms of cost-sharing protections against excessive out-of-pocket spending. States must also demonstrate that a comparable number of citizens would be covered under the alternative plan, and that the plan is federal deficit neutral.

The regulations describe heavy documentation requirements on each of those points, including a detailed 10-year budget plan showing federal deficit neutrality.

The regulations also describe post-award monitoring and quarterly and annual reporting procedures states must follow in order to maintain their waiver. This includes a requirement to hold a public forum at the state level, six months after a waiver is implemented, at which members of the public may comment on the progress of the waiver. The state must provide a summary of this forum to the Secretary of HHS.

The preamble to the regulations also notes that the Treasury and HHS Departments are soliciting public comment on whether or not there should be annual limits on the number of waivers that may be submitted.

California Tax Conformity for Overage Dependent Coverage Moves Closer

California Assembly Bill 36 has progressed from the Assembly to the Senate, where with any luck it will be approved and sent to Governor Brown by the end of this month. The bill will bring state income and employment tax laws into conformity with PPACA and subsequent IRS guidance on the provision of group health coverage to overage dependents, retroactive to March 30, 2010. I will continue to post updates on the progress of this much needed legislation.

PPACA Unconstitutionality Ruling Stayed, Pending Fast Track Appeal

On March 3, 2011 U.S. District Judge Roger Vinson stayed his January 31 ruling that the entirety of PPACA was unconstitutional as a result of the individual mandate provision. In that earlier ruling the Judge held the individual mandate provision to violate the Commerce Clause of the U.S. Constitution, and also to be so intertwined with the rest of PPACA that the law as a whole could not stand. The stay will be in effect while an appeal is pending, however Judge Vinson gave the Justice Department only until March 10 to file its appeal and also required that it seek expedited review on appeal, either to the 11th Circuit or the Supreme Court. It is likely the Justice Department will appeal to the lower court given its apparent strategy to let the court challenges to PPACA proceed in their normal course (thereby possibly avoiding a Supreme Court decision in 2012 that could impact the presidential election).

What this means for the time being is that states and the federal government can continue to implement PPACA, which at this stage has nothing to do with the individual mandate but instead takes the form of popular measures such as extensions of coverage to overage dependents. This should help resolve confusion that could exist in states, such as Alaska, that vowed to stop implementing PPACA as a result of the January 31 ruling. Other than in Alaska this was largely a symbolic stance; a number of anti-PPACA states sought federal funding for implementation of the state exchanges that Alaska declined. (Alaska’s governor announced that the state will treat PPACA as being in place as a result of the ruling.) Clearly, also, the government agencies charged with implementing PPACA continued their activities notwithstanding the unconstitutionality ruling.

The question of whether or not that ruling acted as a true injunction against implementation of PPACA, or simply an official statement of disapproval, is addressed in the new ruling at some length. Judge Vinson expressed surprise that the Justice Department waited several weeks to file a request for “clarification” of the earlier ruling rather than immediately seeking a stay of its enforcement, given that his ruling made quite clear that it was meant to serve as the “‘functional equivalent of an injunction'” against enforcing a law the Judge had decreed to be “‘void.'”

Amidst this lecture of sorts, Judge Vinson acknowledged that “[i]t would be extremely disruptive and cause significant uncertainty” to enjoin enforcement of PPACA pending appeal. It is fortunate that Judge Vinson saw fit to recognize that and rule as he did, given his wholesale rejection of PPACA just five weeks ago. Which raises the possibility that the delayed timing of the Justice Department’s request for “clarification” of the order was in part strategic. From the balance of the Judge’s opinion, it would seem that a direct request to stay his order made in the immediate aftermath of the January 31 ruling would have had little likelihood of success.

Obama Supports Bipartisan Bill Acellerating State Waivers under PPACA

President Obama for the first time today backed a truly substantive change to PPACA by endorsing a bipartisan bill that allows states to obtain waivers from PPACA requirements – including the individual mandate – starting January 1, 2014. This is as soon as the requirements were to go into effect, and three years earlier than originally was possible under PPACA.

In a speech to the National Governor’s Association at the White House, President Obama endorsed Senate Bill 248, the “Empowering States to Innovate Act.” The bill, now sponsored by Senators Ron Wyden (D-Ore.), Mary Landrieu (D-La.) and Scott Brown (R-Mass.), initially was proposed by Senators Wyden and Brown in November 2010, and amends PPACA Section 1332. That provision, titled “Waiver for State Innovation,” allows states to seek waivers starting January 1, 2017 from certain aspects of PPACA compliance including: 1) state exchanges and the prerequisites for “qualified health plans” that may be offered through an exchange; 2) employer “pay-or-play” provisions; 3) cost-sharing reductions and tax credits for exchange participants; and 4) the individual mandate.

A waiver, if granted, may last for up to 5 years, subject to extension by the Secretary of HHS. In order to qualify for a waiver, a state must design an alternative health care reform program and demonstrate that it will do all of the following: 1) provide coverage that is at least as comprehensive as that which would be offered under the PPACA exchanges and is at least as affordable; 2) cover a comparable number of residents as would qualify under the PPACA exchanges, and 3) not add to the Federal deficit.

The President called the bill a “reasonable proposal” that provides flexibility while still guaranteeing reform (in the form of the “equivalency” demonstrations that states must make in order to obtain a waiver), and openly invited states to pursue self-help methods of reform.

Punting significant reform components to the states in this fashion is an interesting strategic development as it could defuse, for instance, the federal court challenges to the individual mandate, as well as some aspects of general Republican opposition to federal reform. As one commentor notes, however, many states are more concerned about subsidizing the costs of Medicaid expansion under the PPACA than they are about implementing the exchanges. The same commentator notes that other states, such as Vermont, could use the waiver as an opportunity to put single-payer systems in place. Ultimately, if SB 248 is enacted as an amendment to PPACA, health care reform in 2014 and beyond may be less a federal phenomenon than a state-by-state experiment.

DOJ Deems DOMA Unconstitutional

The Deparment of Justice officially has taken the position that the federal Defense of Marriage Act (DOMA) violates equal protection guarantees under the Fifth Amendment. As set forth in a letter to Congress from Attorney General Eric Holder, which reportedly reflects the President’s own thinking on the subject, the Administration no longer supports the reasoning and arguments formerly used to uphold DOMA. The DOMA was enacted under President Clinton in 1996 (before “L’Affaire Lewinsky,” for those who are counting.) The DOMA defines a legal spouse, for federal law purposes, only as a lawfully married member of the opposite sex.

As a result of DOMA, registered domestic partners do not have the same status and rights as opposite sex spouses under ERISA retirement and health plans, under federal estate tax laws, and in a variety of other legal settings. As a simple example, a surviving registered domestic partner does not have the same ability as an opposite sex surviving spouse to treat an IRA inherited from a decedent spouse as the surviving partner’s own account, which greatly increases the stretch-out distribution capability of the account. This “spousal election” right remains limited to opposite sex spouses. Although the tax laws recently changed to allow non-spouse beneficiaries (including domestic partners) the ability to roll over amounts from an inherited IRA, the rollover right simply does not permit the same stretchout options as does the spousal election.

In California, registered domestic partners (as defined by Section 297 et seq. of the California Family Code) do have the same legal status and rights as opposite sex spouses for all purposes under California law. This means that benefits such as group health insurance that an employee provides to his or her registered domestic partner are treated at the state tax level just as are any other benefits provided to a dependent, and do not result in imputed California income to the employee. However unless the domestic partner meets the federal definition of a dependent (as set forth in IRC Section 152), provision of benefits to him or her will cause the employee to experience imputed income at the federal level. It is rare for a domestic partner to meet the dependency test under Section 152 as it requires they receive more than half of their financial support from the employee partner, and with regard to non-health benefit plans also imposes a cap on compensation that is extremely low.

Employers in states like California have long been burdened with the process of tracking and assigning a value to benefits provided to domestic partners, for federal tax compliance. Now, in a whipsaw effect, they are required to do just the opposite (track imputed state income) with regard to group health benefits provided to dependent children up to age 26, as a result of expanded coverage to this group under PPACA. Fortunately California likely will bring its tax laws into conformity with PPACA in the near future, as AB 36 wends its way through Sacramento.

The path to repeal of DOMA likely will be longer and more fraught with controversy because of the “hot button” nature of the issue at the national level. However, there have been less direct attempts to address the problem nationally in the past. The “Tax Equity for Domestic Partners and Health Plan Beneficiaries Act” was introduced in Congress by Republican Senator Gordon Smith of Oregon, but never moved past the committee level. It is possible that as DOMA is reexamined in coming months, even factions that disagree on the moral/religious issues can reach agreement that parity in tax treatment between spouses and domestic partners is warranted at the federal level. I will continue to track this issue as it develops.