A popular feature in comprehensive benefits packages, long-term disability insurance provides replacement salaries for employees who suffer from an extended illness or injury. While many employers carry an inexpensive group LTD plan as a matter of course, only some take advantage of an IRS ruling that would allow disabled employees to receive their disability income tax free. This failure can prove costly for employees and represents a lost opportunity for savings by employers as well.

Maximizing Benefits

The IRS ruling in question (Revenue Ruling 2004-55) clarifies the distinction between before-tax and after-tax benefits as it applies to disability income, and it provides a mechanism for distinguishing between them. Simply stated, if an employer pays 100 percent of an employee’s premium, the salary replacement benefits to the employee are taxable. Conversely, if the employer increases an employee’s pay to cover the cost of LTD and then deducts the premium from the employee’s check, the benefits are tax free.

Of course, this change means that the employer and employee incur some extra expenses—an increased salary will mean increased FICA, SDI, and so forth—but these are relatively small expenses. Consider the difference in benefits. An employee who is earning $60,000 a year and is covered by an employer-paid LTD plan offering a two-thirds salary replacement, will receive $3,350 a month if disabled. Assuming he or she has a 16 percent effective tax rate, that net replacement salary is reduced to $2,814. That’s a cost of more than $500 a month as opposed to the few dollars a month that employer and employee would have paid in compensation-based taxes.

Moreover, employers who are looking for savings should note that a less expensive after-tax LTD plan—providing only 60 percent salary replacement rather than the two-thirds given in the example above—would net the employee $3,000 per month, an improvement of almost $200 a month. In other words, by offering the LTD as an after-tax benefit, employers can provide employees with larger benefits with less coverage and pay smaller premiums (as much as 20 percent with some carriers). The cliché of a win-win situation has rarely been so applicable.

Avoiding the Three-Year Look-Back Rule

If your firm is paying LTD premiums in pre-tax dollars and is ready to change, be sure to take advantage of a mechanism provided in IRS Ruling 2004-55 that allows benefits to be tax free from day one.

Ordinarily, the IRS applies a three-year look-back rule that considers benefits taxable in the proportion that they were paid for by before-tax premiums over the last three years. However, the IRS has provided a method that allows employees to qualify for tax-free benefits immediately after the change is made to paying with after-tax dollars. The workaround requires specific amendments to the plan description and a modified enrollment form that allows employees to elect for after-tax payment of the LTD insurance. (See below for information on obtaining sample forms.)

Employees can decide on an individual basis whether they want to have their LTD paid for in pre- or after-tax dollars, so firms can implement the program for employees who want to take advantage of this opportunity without forcing others to make any change in the way they have traditionally received benefits.

Doug Hessel is Program Director, CalCPA ProtectPlus Ancillary Products at Hover Insurance Services. For further information and sample forms email dhessel@hoverinsurance.com

Health Care Reform Cadillac Tax

What You Need to Know Now About: The Cadillac Tax

Another component of the Patient Protection and Affordable Care Act (PPACA) commonly referred to as the Health Care Reform Act is a tax on benefit-rich or “gold-plated” insurance plans. This tax is often referred to as “The Cadillac Tax” and, although it is not scheduled to go into effect until 2018 and may see several revisions in design before then, some plan sponsors are beginning to develop strategies to address it.

1.  I sponsor a grandfathered health plan. Am I subject to The Cadillac Tax?

Yes. The Cadillac Tax is applicable to both grandfathered and non-grandfathered health plans. 

2.  Are there any exceptions for certain groups of employees such as collectively bargained union groups?

During initial debate about implementing The Cadillac Tax for 2013, there was debate about excluding federal employees and union groups from the provision; however that was abandoned when the implementation of the tax was delayed to 2018. At this time, union groups will also be subject to the tax in 2018.

There are some adjustments to the current 2018 Annual Value Amounts for certain groups. For example, insurance plans that have an above average population of older workers or female workers may have higher 2018 Annual Value Amounts based on a still to be determined formula. The reasoning is that the higher cost to insure these groups is due to risk factors and not to benefit-rich plan designs.

This line of reasoning is also responsible for higher 2018 Annual Value Amounts for retirees and workers in high-risk professions (firefighters, coal miners, etc.). The amounts for these professions are set at $11,850 for an individual and $30,950 for a family plan. 

3.  How many plan sponsors might be subject to The Cadillac Tax?

Initially, when the tax was scheduled to go into effect in 2013 the CBO estimated that by 2016 19% of all workers would be subject to The Cadillac Tax.

With the delayed implementation date of 2018, several studies and estimates have been performed and assuming just an average annual trend of 8%, the projection is in the range of 40%-60% of all plan sponsors will trigger The Cadillac Tax. Of course, all these projections assume the plan sponsor does not make any significant plan design changes like increased deductibles and other employee out-of-pocket costs and that the details of The Cadillac Tax as currently constituted for 2018 remain unchanged.

4.  Who will determine whether the insurance plan is subject to The Cadillac Tax and how will they do it?
The expectation is that the IRS will be responsible for determining who is subject to the tax and that they will use the amount reported on the employees’ annual W-2 form.

As noted in a previously released Health Care Reform Update on W-2 Reporting (10/14/2010), employers will need to disclose the cost of employer provided health insurance on the employee’s 2012 W-2 form. One of the reasons for including the cost of employer provided health insurance was simply to communicate the cost of the coverage to the employee. It is assumed that another reason for this W-2 requirement is to provide the IRS with the information needed in order to determine what plan sponsors are subject to The Cadillac Tax.

Once again, more guidance is needed on the matter. For the W-2 reporting, in addition to reporting the costs for the medical coverage and drug coverage, the employer must also report the cost for other employer-sponsored health care services such as executive physicals, employee assistance programs, Medicare supplemental policies, etc. If these additional health care services are reported in a lump sum format with the medical and drug coverage than the annual value amount may be overstated for purposes of calculating The Cadillac Tax. 

5.  What are the chances that The Cadillac Tax will be repealed or revised before 2018?

Repeal is unlikely.  

Revision is a possibility. The initial proposed implementation of the tax was for 2013 but then delayed to 2018. Union groups wanted to be exempt from the tax when it was proposed for 2013. Those same groups will, most likely, want to be exempt from the tax in 2018. There are also so many other variables between now and 2018 that could dramatically change the design of the tax. It is not unrealistic to expect that the current amounts of $10,200 and $27,500 or the amount of the excise tax could be changed several times before 2018.

6.  What do I need to do now?

• First, determine if The Cadillac Tax in 2018, as currently designed, will affect you. Start by taking your 2010 annual fully-insured or self-funded rates and assume an annual average trend at 9%. At that percentage, your 2010 annual rates will be double the amount by 2018. Are you above the 2018 Annual Value Amounts of $10,200 for an individual and $27,500 for a family plan?
• If it appears that your plan will be subject to the tax in 2018 and you wish to avoid paying the tax, develop a strategy. Many plan sponsors are already implementing new strategies to address the 2018 tax either by encouraging healthier behaviors now in an attempt to reduce annual average trend rates, or, by increasing employee cost sharing on a more gradual basis leading up to 2018.
• As always, our recommendation is to always do what is in the best interest of the plan. For some plan sponsors, the best course of action may be to continue offering a benefit-rich plan design and pay The Cadillac Tax. The important thing is to know the options available to you.

 If you have any questions on this or any new health care reform regulation, please contact a member of your Banyan Consulting team.

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The federal health care reform law will have a substantial impact on employers. Here are the main issues  that employers will want to be aware of:  

 1. Keeping the same coverage  

Employers will be able to avoid some of the law’s requirements by keeping their coverage the same after the law’s effective date (March 23, 2010). Unfortunately, it is very unclear at this time what kinds of minor changes will alter coverage, or keep it the same; this will be clarified in later regulation.  

 Changes that must be made to all plans include:  

• waiting periods for coverage must be less than 90 days; 
• no lifetime benefit maximum limits;
• dependent coverage for adult children up to age 26; and
• no annual limits on certain types of benefits (unless permitted by later-issued regulation).

2. New benefit and other plan changes If an employer does not keep its coverage the same, employers will need to make additional changes such as:  

• extending 100 percent coverage for preventive care;
• removing any prior authorization requirement or increased cost-sharing for emergency
• services (regardless of whether the services are provided in or out of network);
• no pre-existing limitation for children under age 19; and
• coverage of routine patient costs in clinical trials for life-threatening diseases.

3. FSA/HRA/HSA changes The law also will require changes to these types of accounts. In 2011, employees will no longer be able to receive pre-tax reimbursements from their FSA, HRA or HSA for non-prescribed over-the-counter medications, and the excise tax for nonqualified HSA withdrawals will increase from 10 percent to 20 percent. In 2013, employee contributions to FSAs will be capped at $2,500 annually, with the cap adjusted annually to the Consumer Price Index.  

4. Employee notification of value of coverage and exchange information Effective in 2011, employers will need to start reporting the value of the employer-sponsored coverage to employees on their W-2s. And in March 2013, employers will need to begin notifying employees about state exchanges and the availability of premium subsidies and free choice vouchers, all of which will be available beginning in 2014.  

5. Fees and penalties imposed on employer plans   

Under the law, employers will be subject to a number of fees and exposed to penalties for certain behaviors. Among them are the following:    

• Effective in 2013, a fee will be assessed on employers with self-funded health plans to fund a comparative effectiveness research agency. (For employers with fully insured health plans, the health insurer will be assessed the fee.) In 2013, this fee will be $1 times the average number of lives covered under the plan; for 2014 to 2019, the fee will be $2 times the average number of covered lives. The fee will end on September 30, 2019.
• Effective in 2014, if an employer has 50 or more full-time employees, then the employer may be subject to penalties under the law if it provides either no health coverage to full-time employees, or provides coverage to full-time employees that is not affordable. Penalties vary from $2,000 to $3,000 per employee.
• Effective in 2018, a 40 percent excise tax on high-cost plans will be applied to plans costing more than $10,200 for individual coverage, or $27,500 for family coverage.

6. Employer administrative reporting duties    

The law will require employers to annually report to the IRS a number of pieces of data, including:  

• Whether the employer offers minimum essential coverage to full-time employees;
• Any waiting period for health coverage;
• The monthly premium for the lowest cost option in each enrollment category under the plan;
• The employer’s share of the total allowed cost of benefits provided under the plan;
• The number of full-time employees during each month;
• The name, address and taxpayer identification number (or Social Security number) of each full-time employee, and the months each employee was covered under the employer’s plan, and
• “Such other information as the [Health and Human Services (HHS)] Secretary may require.” This requirement will likely be further refined in later regulations.

7. Changes to employee wellness programs  

• Effective in 2010, wellness programs may not require disclosure or collection of any information relating to the presence of firearms, and may not base premiums, discounts, rebates or rewards on the basis of firearm or ammunition ownership.
• Effective in 2014, the law codifies the HIPAA nondiscrimination rules on wellness programs and increases the incentive cap of 20 percent of premium to 30 percent. The HHS Secretary has the discretion to increase the incentives cap to 50 percent.

 This document is issued for informational purposes and is not intended to constitute legal advice. Please consult your attorneys in connection with any fact-specific situation under federal, state or local laws that may impose additional obligations. The information is current as of the date on the first page of the document. 

Anthem Blue Cross is the trade name of Blue Cross of California. Independent licensee of the Blue Cross Association. ® ANTHEM is a registered trademark of Anthem Insurance Companies, Inc. The Blue Cross name and symbol are registered marks of the Blue Cross Association.   

Learn more about CPA ProtectPlus healthcare plans

This is Part 3, of a three part article.  For Part 2, see Employers, What You Need to Know About the Federal Stimulus Package: Part 2.

This article was written by Connie Chuang and Gage C. Dungy, attorneys with the labor and employment law firm of Liebert Cassidy Whitmore.