There are many rules regarding COBRA subsidies and reimbursement. It is important to be aware of them.
Question: What are the rules around offering COBRA subsidies for former employees or employees on extended leave? What about COBRA reimbursement for new hires to cover the cost of coverage through a previous employer during the waiting period?
Compliance Team Answer:
Part I: COBRA Subsidies for Terminated Employees (e.g., as part of a severance benefit) or Employees on Non-Protected Leave (e.g., sabbaticals)
For terminated employees, there is no option to extend active coverage beyond the standard date coverage would terminate (either the date of termination of employment or the end of the month following termination of employment). For non-protected leaves, the carrier will usually allow an extension of active coverage of up to six months pursuant to the company’s leave policies (see 5/26 FAST for full details).
The issue is that the insurance policy (fully insured plan) or stop-loss carrier (self-insured plan) has agreed to cover only active eligible employees and COBRA qualified beneficiaries. They do not cover inactive employees who are not on COBRA. You want to make sure you avoid a situation where the employee stays on active coverage, but the carrier refuses to pay the claims because the employee was not eligible under the terms of the policy. In that situation, the employer would need to self-fund the claims (this is the worst-case scenario).
In many cases, the employer would like to cover all or a part of the cost of COBRA for these individuals once the period of active coverage ends. This is commonly either as part of a severance package or to encourage some form of non-protected leave (e.g., maternity leave beyond the PDL/FMLA/CFRA protected period, sabbaticals).
a) The COBRA subsidy solution for a fully insured plan: For fully insured plans, there is no issue with offering to subsidize COBRA for some or all of the maximum coverage period. This is still permitted (and fairly common) because the ACA’s fully insured nondiscrimination rules have not been issued yet and therefore are not effective. The IRS has stated the rules will not apply until plan years beginning a specified period after they are issued (e.g., they may apply the first plan year beginning on or after six months following the regulatory issue date).
To address the possibility that the fully insured nondiscrimination rules may be issued and take effect during the COBRA subsidy period, we would suggest the company consider stating in any communications that it will cease the COBRA contributions if those ACA nondiscrimination rules are issued and become effective during the COBRA term.
b) The COBRA subsidy solution for a self-insured plan: Subsidizing COBRA typically is not an option because of the §105(h) nondiscrimination rules applicable to self-insured plans. The COBRA subsidy would generally have to be available to all employees in order to meet those requirements.
If the IRS were to audit a self-insured health plan and find its arrangement to be discriminatory, all highly compensated individuals would be taxed on all or a portion of the benefits they received under the plan, referred to as the “excess reimbursement.” This could be a significant tax liability depending on the amount and cost of services actually received by the HCIs.
Instead, the company can pay the employee some amount in standard compensation that’s intended to cover the cost of COBRA (or coverage on the individual market). This will be standard taxable income subject to withholding and payroll taxes. The employer has the option to gross up the former employee for the tax liability.
Part II: COBRA Reimbursement for Coverage Under Prior Employer’s Plan
In some situations, employers will want to reimburse all or a portion of the cost of a new hire’s COBRA coverage through a prior employer. This is commonly designed to address any waiting period the employee has to enroll in coverage with the new employer.
a) Potential Issue With Establishing a Group Health Plan
There is an argument that reimbursing an employee’s COBRA coverage through a prior employer creates a new group health plan in the form of the reimbursement. That would be problematic for a number of legal reasons.
However, this has been a long-standing industry practice without becoming an issue. So I would characterize this a more of a theoretical concern than one that is likely to present itself in practice.
b) COBRA Reimbursement Not an ACA Individual Policy Issue
There are no ACA individual policy reimbursement issues with reimbursing COBRA premiums because COBRA is not an individual policy (it’s a continuation of group coverage).
c) Taxable or Non-Taxable?
The issue with the payment method is whether the company will be treating this compensation as taxable or non-taxable.
If the company is going to treat the compensation as taxable, the process does not matter. Whatever is most convenient (generally simply paying the employee the amount of the COBRA premium, plus a gross up if desired) is fine. This is the simplest approach administratively, but the downsides are a) the payments are taxable, and b) there is no guarantee the employee uses the additional amounts to pay for COBRA.
If the company wants to treat this as a non-taxable health expenditure, it will need to either:
- Pay the COBRA premiums directly to the COBRA administrator (or to the employee via check made out directly to the COBRA administrator); or
- Distribute reimbursement to the employee only upon the employee substantiating the expense (i.e., only upon the employee providing a receipt showing proof of payment).
IRS Notice 2011-1:
Because regulatory guidance is essential to the operation of the statutory provisions, the Treasury Department and the IRS, as well as the Departments of Labor and Health and Human Services (collectively, the Departments), have determined that compliance with § 2716 should not be required (and thus, any sanctions for failure to comply do not apply) until after regulations or other administrative guidance of general applicability has been issued under § 2716. In order to provide insured group health plan sponsors time to implement any changes required as a result of the regulations or other guidance, the Departments anticipate that the guidance will not apply until plan years beginning a specified period after issuance. Before the beginning of those plan years, an insured group health plan sponsor will not be required to file IRS Form 8928 with respect to excise taxes resulting from the incorporation of PHS Act § 2716 into § 9815 of the Code.
Treas. Reg. §1.105-11(c)(3)(i):
(3) Nondiscriminatory benefits.
(i) In general. In general, benefits subject to reimbursement under a plan must not discriminate in favor of highly compensated individuals. Plan benefits will not satisfy the requirements of this subparagraph unless all the benefits provided for participants who are highly compensated individuals are provided for all other participants…
IRS Publication 15-B:
COBRA premiums. The exclusion for accident and health benefits applies to amounts you pay to maintain medical coverage for a current or former employee under the Combined Omnibus Budget Reconciliation Act of 1986 (COBRA). The exclusion applies regardless of the length of employment, whether you directly pay the premiums or reimburse the former employee for premiums paid, and whether the employee’s separation is permanent or temporary.
IRS Information Letter 2006-0042:
On the other hand, if the employer makes the payments for the health insurance directly to the insurer, then the payments are not included in the employee’s gross income. See Revenue Ruling 61-146, 1961-2 C.B. 25. This holds true even if the payments are routed through the employee to the insurer, as long as the employee’s right to dispose of the funds is not unlimited. However, if the employer makes health insurance payments directly to the employee with only an understanding that the employee will purchase health insurance with them, and there is no verification of or control over the purchase, that amount is included in wages for employment tax purposes and would be subject to FICA taxes. See Revenue Ruling 75-241, 1975-1 C.B. 316.
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