New IRS Excise Tax on High Cost Health Plans – the “Cadillac Tax”

Beginning in 2018, certain employers will be liable for a new 40% federal excise tax on the value of excessive benefits provided through their health plans.  Health plans providing high cost benefits are referred to as “Cadillac” plans, and the new federal excise tax on high cost plans has come to be known as the “Cadillac tax”.

  1. Background.

The Cadillac tax (found in Section 4980I of the Internal Revenue Code – the “Code”) was adopted as part of the 2010 Patient Protection and Affordable Care Act.  The Cadillac tax is intended to provide employers with an incentive to restrain the growth of health care costs through the imposition of a tax on employers who provide higher cost health benefits.

Code § 4980I(g) directs the IRS to write regulations to implement the Cadillac tax.  While the IRS has yet to issue these regulations (as of October 1, 2015), the IRS has released Notice 2015-16 (February 23, 2015) and Notice 2015-52 (July 30, 2015) which identify certain issues regarding the Cadillac tax.

Given the absence of regulations and the delayed implementation date (the new tax is imposed beginning in 2018), employers may be tempted to ignore the Cadillac tax.  However, a number of insurers and health organizations have reported that the Cadillac tax may apply to over 25% of health plans.  Employers need to have at least a general understanding of the Cadillac tax.

Under the Cadillac tax, if the aggregate cost of “applicable employer-sponsored coverage” provided to an employee exceeds a statutory dollar limit (revised annually), the excess is subject to a 40% excise tax.  See Notice 2015-16.  For these purposes, “employee” includes any former employee, surviving spouse, or any other primary insured individual (i.e., certain retirees or COBRA beneficiaries).

The calculation of the Cadillac tax utilizes numerous defined terms (e.g., applicable employer-sponsored coverage, excess benefit, annual limitation, coverage provider, applicable share, etc.).  A review of these definitions is beyond the scope of this post (and will be addressed in subsequent posts).  Instead, the remainder of this post deals with two threshold issues: (1) who is liable for the Cadillac tax;  and (2) who must calculate the Cadillac tax?

  1. Who is liable for the Cadillac Tax?
  1. Coverage Providers.

The Cadillac tax is imposed on “coverage providers” (Code § 4980(I)(c)).  Coverage providers are determined by reference to the nature of the employee’s health care coverage.

For health insurance coverage, the coverage provider is the health insurance company.  For health savings accounts (“HSAs”) and “Archer” medical savings accounts (“MSAs”), the coverage provider is the employer.

For other employer sponsored coverage (including self-insured health plans, health flexible spending accounts (“FSAs”) and health reimbursement arrangements (HRAs)), the coverage provider is the “person that administers the plan benefits.”

In many cases, the “person that administers the plan benefits” is the employer, but often an employer will contract with a third party administrator (“TPA”) to administer plan benefits.  The “person that administers the plan benefits” is not defined and guidance on identifying this person will be addressed in the upcoming Cadillac tax regulations.  See Notice 2015-52.

Significantly, a single employee may have multiple coverage providers. For example, Employee Adam may have health insurance coverage and coverage through a health FSA administered by his employer.  In that case, the coverage providers of Adam’s “employer-sponsored coverage” include the insurance company that issued the insurance policy, Adam’s employer who administers the health FSA.

It is expected that insurance companies and TPAs will modify their contracts to provide for the employer to reimburse them for their Cadillac tax liability.  See Notice 2015-52.  Even though the Cadillac tax is imposed on the “coverage provider”, employers should recognize that they will ultimately be responsible for paying the Cadillac tax.

  1. Applicable Share.

If the “excess benefit” is provided by multiple coverage providers, the Cadillac tax is allocated between the coverage providers in accordance with their “applicable share”.  Generally, the “applicable share” is the ratio of the cost of the health coverage allocable to the coverage provider to the total cost of the health coverage for the employee.

For example, assume Employee Betty has total “employer-sponsored coverage” at a cost of $16,000 which is made up of $2,000 under her employer administered FSA plus her health insurance with a cost of $14,000 and the Cadillac tax equals $1,000.  The “applicable share” (between her employer and her insurance company) of the $1,000 Cadillac tax would be as follows:

Cadillac Tax Provider’s

Coverage Cost

Total

Coverage Cost

 

Applicable Share of Cadillac Tax

       
$1,000 x (2,000 ÷ 16,000) = $125.00 Employer Share
$1,000 x (14,000 ÷ 16,000) = $875.00 Insurance Company Share

In contrast, assume Employee Charles  (with the same employer) has a total coverage of $15,000 which is made up of $1,000 under a similar FSA and the same health insurance valued at $14,000 and a Cadillac tax of $600 (the $400 Cadillac tax reduction is based on the $1000 reduction in total benefits between Charles ($15,000) and Betty ($16,000) [$1000 x 40%]).  The “applicable share” (between the employer and the insurance company) of the $600 Cadillac tax would be as follows:

Cadillac

Tax

Provider’s

Coverage Cost

Total

Coverage Cost

 

Applicable Share of Cadillac Tax

       
$600 x (1,000 ÷ 15,000) = $40.00 Employer Share
$600 x (14,000 ÷ 15,000) = $560.00 Insurance Company Share

It should be noted that the “applicable share” is actually used to allocate the “excess benefit” (from which the Cadillac tax is calculated) rather than the amount of the Cadillac tax (as illustrated in these examples).  In any event, these examples illustrate that the Cadillac tax will have to be computed for each employee (including certain former employees) and that the amount of the Cadillac tax can vary for each employee.

III.       Who is responsible for calculating the Cadillac Tax?

Generally, Code § 4980I(c)(4) states that each employer shall (1) calculate the “excess benefit” subject to the Cadillac tax and the “applicable share” (discussed above) of such “excess benefit” for each coverage provider; and (2) notify the IRS and each coverage provider of the amount of the excess benefit allocable to the coverage provider.  Under a special rule, in the case of a multiemployer plan, the plan sponsor is responsible for these calculations and reports.

In the case of multiple entities that are treated as a single employer for Cadillac tax purposes, a method for determining which entity is responsible for calculating and reporting will need to be addressed in the upcoming Cadillac tax regulations.  See Notice 2015-52.

Significantly, the employer has to compute the “excess amount” and the “applicable share” with respect to each employee (and certain former employees and other persons).  This may be a substantial burden for employers with multiple health plans which permit participants to elect among multiple coverage options.

In summary, beginning in 2018, employers will be required to determine whether any of their employees receive “excess benefits” through their health plans (i.e., “applicable employer-sponsored coverage”).  If “excess benefits” exist, the employer is required to allocate “excess benefits” between “coverage providers” and report this information to the coverage providers and the IRS.  Even though the Cadillac tax is imposed on coverage providers, employers should recognize that they will ultimately be responsible for paying it.

About the Author

Jonathan H. Nason
Jon is a tax lawyer who advises employers on the design, implementation and administration of employee benefit plans, including ERISA and HIPAA compliance.