The effective date for the Affordable Care Act’s “Cadillac tax” on high cost health coverage may be over two years away, but the time to start planning to avoid its application is now. While the tax’s nickname implies that it will apply only to the most luxurious of health plans, preliminary information released by the IRS shows that the tax will likely impact the employer-sponsored health coverage offered to a much more extensive group of middle class taxpayers.
The penalty itself is steep, and the types of benefits that are counted in determining whether it applies may be surprising—two factors that highlight the importance of thoughtful advanced planning to minimize this tax’s impact, especially when it comes to employer-sponsored benefits like HSAs and FSAs.
Cadillac Tax Basics
Within the next few years, employers can become subject to an excise tax if employer-sponsored health coverage costs more than $10,200 per individual employee or $27,500 for family coverage. This Cadillac Tax has many employers looking for ways to lower the cost of the health care options they currently offer employees, and the solution commonly involves switching over to plans with lower premiums and correspondingly higher deductibles (known as HDHPs).
The tax, which is 40% of every dollar spent on health insurance costs in excess of the annual limits, can have a severe impact on employers who offer health coverage to their employees. Importantly, the annual threshold limits are indexed annually for inflation based on the consumer price index plus 1%. This will generally produce inflation-indexed thresholds that grow at a relatively slow rate when compared to the increasing costs of health insurance and medical expenses generally.
This means that the Cadillac tax could soon impact a wide segment of those employers who sponsor health coverage—which, of course, means that those employers will need to reevaluate the benefits they provide and, in many cases, offer less generous coverage to employees.
What Counts as the Cost of Coverage?
Importantly, initial IRS guidance indicates that it is not only the basic cost of health insurance premiums that count in determining whether the employer-sponsored health coverage exceeds the threshold limits. While in many cases the insurance company issuing the policy itself may be liable for the tax (in the case of fully-insured coverage), the employer will become liable in the case of employer or salary reduction contributions to a health savings account (HSA) or health flexible spending account (FSA) that it administers.
Pre-tax contributions to HSAs are included in determining whether an employee’s health coverage is subject to the Cadillac tax, but an employee’s after-tax contributions are not included in the calculation. As a result, many employers will learn that the popular combination of high deductible health plans (HDHPs) and pre-tax HSA dollars may no longer be the most cost effective way to provide comprehensive coverage.
The cost of health FSAs, Archer MSAs, HRAs, retiree coverage and multi-employer plan coverage are also expected to be included when calculating whether the threshold that triggers the Cadillac tax has been crossed.
The IRS notice provides a preliminary roadmap for what implementation of the Cadillac tax will look like, giving employers time to prepare for the 2018 effective date—but it’s important to note that the notice has yet to be codified into actual rules, so the final rules could vary from the initial guidance.
Originally published on Tax Facts Online, the premier resource providing practical, actionable and affordable coverage of the taxation of insurance, employee benefits, small business and individuals.
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