If an employer wishes to offer compensation in lieu of group health plan coverage (oftentimes referred to as an “opt out payment” or a “waiver payment”)—such as $50 per month if an employee waives group health plan coverage—there are two important compliance issues that must be considered. First, in order to preserve the tax-free nature of the group health plan coverage, the offer must be made through a so called “cafeteria plan” or “section 125 plan” (noting that it is Section 125 of the Internal Revenue Code that allows the tax benefit). Second, in many cases, an opt out payment must be taken into account as part of the employee cost of coverage for purposes of the affordability requirement of the Affordable Care Act (ACA) “employer mandate” (more on this below).
Prior to the ACA, another popular benefit was simply reimbursing employees for individual insurance coverage that they purchased on their own. In most cases, these types of reimbursements could be made on a non-taxable basis. However, as part of the implementation of the ACA, these types of so called “employer payment plans” became prohibited, regardless of whether the reimbursements are taxable or non-taxable. For the time being, the only way for an employer to “pay for” individual insurance coverage obtained by an employee is to provide additional taxable compensation, whether though a simple salary increase or a monthly “bonus” or “stipend.” The key is that the payment not be a “reimbursement”—i.e., not conditioned on proof that the employee indeed obtained his or her own individual insurance coverage. Rather, the increased compensation (regardless of the form) must be unconditional and taxable.
If an employer is subject to the ACA employer mandate (i.e., because the employer averages 50 or more full-time employees and full-time equivalents), then offering an opt out payment through a cafeteria plan may impact the affordability test that must be satisfied in order to avoid ACA penalties. For 2017, employer coverage is considered affordable if the employee’s required contribution for employee-only coverage does not exceed 9.69% of the employee’s household income. For example, if employee-only coverage under employer Medical Plan A will cost an employee $100 per month, then the employer will have satisfied the ACA affordability requirement so long as $100 per month does not exceed 9.69% of the employee’s household income. However, if the employee is offered an unconditional opt out payment of $50 per month if the employee waives the employer coverage, then the deemed cost of coverage will be $150 per month (i.e., the $100 out of pocket cost plus the “opportunity cost” of losing the $50 opt out payment) and the coverage will only satisfy the ACA affordability requirement if $150 per month does not exceed 9.69% of the employee’s household income.
In many cases, the difference between a monthly cost of $100 and a deemed monthly cost of $150 could be the difference between affordable coverage vs. unaffordable coverage, which can lead to ACA penalties. The only way to avoid this affordability issue is to make sure the opt out payment qualifies as a so called “eligible opt out arrangement.” Eligible opt‐out arrangements are arrangements under which opt out payments are available only to employees who provide “reasonable evidence” (which may include an employee attestation) that they and their “expected tax family” (i.e., all individuals for whom the employee reasonably expects to claim a personal exemption deduction for the taxable year) have or will have coverage other than individual insurance coverage (such as coverage under a spouse’s employer’s plan) during the period covered by the opt out arrangement. This is the only way to avoid having an opt out payment impact ACA affordability.
Compensation in lieu of benefits is still possible in the ACA era. However, in addition to the pre-ACA requirement to implement opt out payments through a cafeteria plan in order to preserve the tax-free nature of the group health plan coverage, new post-ACA requirements must also be addressed in order to prevent exposure to ACA penalties.
This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, legal or tax advice. If you have any legal or tax questions regarding this content or related issues, then you should consult with your professional legal or tax advisor.