The post below has been updated to account for the 2-year delay passed by Congress in December 2015.

Implementation of the ACA has taken quite a long time, and there are two final pieces left. One of them is the 40% excise tax on so-called high cost employer-sponsored health coverage, better known as the "Cadillac tax." (The final shoe to drop will be fully insured nondiscrimination, if you're wondering.) In this post we'll collect and analyze the available guidance, and we'll keep updating it as we get clarity from IRS.

Background on the Cadillac Tax

Beginning with calendar year 2020, the ACA imposes a 40% tax, determined monthly, on the excess of the aggregate cost of so-called “applicable coverage” for each employee, former employee, surviving spouse or other primary insured individual over a certain dollar limit. (The statute pegs the limit in 2020 at $10,200 for employee-only coverage and $27,500 for all other coverage tiers, but for a number of reasons it is very likely the actual limit an employer will use in 2020 will be something different.) The tax is a below-the-line expense, meaning it is not a deductible business expense for income tax purposes. Complicating matters considerably is the fact that the statute severs responsibility for paying the tax—insurers, TPAs and employers—from responsibility for calculating the tax—which falls exclusively on employers. If the tax itself was not enough to discourage employers from offering coverage in excess of the limit, the administrative burden it imposes may be.

The Particulars

Employers to Which the Cadillac Tax Applies

This is probably the easiest of all the parts of the Cadillac tax to grasp. The excise tax on excess "applicable coverage" applies to all employment-related health plans, period. No exceptions. It applies to all employer-sponsored plans regardless of the size of the employer. It applies to multi-employer plans, church plans, governmental plans, MEWAs, everything.

What Counts as "Applicable Coverage" and What Doesn't

First, understand what the Cadillac tax is designed to measure: the overall value of the health benefits offered by the employer to an employee. Who pays for what is irrelevant. The value of the plan is what it is, regardless of the extent to which the cost is shared between employee and employer. (That's why employee salary reduction contributions to FSAs are included, for instance.)

With that in mind, here's what is included in "applicable coverage:"

• Insured major medical – likely the composite rates used for COBRA (without the 2% administrative charge), but hopefully with some added flexibility for permissive disaggregation to account for differences in employer locations and business units
• Self-insured major medical – IRS still mulling this over; could be the COBRA rate or could be a cost factor determined after the calendar year closes and claims are paid (let's hope it's the former)
• FSA entirely funded with employe salary reductions (no employer contributions) – amount of employee salary reduction, prorated across the calendar year; carryover amount ignored
• FSA with employer contributions – greater of total reimbursements or employee salary reduction, prorated across the calendar year; carryover amount ignored
• HSA – both employer and employee contributions prorated across the calendar year, but employee after-tax contributions are not because there's nothing employer-sponsored if contributions do not pass through an employer's cafeteria plan
• HRA (both active and retiree-only) – IRS hasn't opined yet, but the amount will likely be the annual allocation made available to the employee for reimbursement, ignoring carryover amounts, prorated across the calendar year
• Hospital indemnity and specified disease/illness policies if premiums are paid on a pre-tax basis – entire premium amount, even if entirely employee-paid
• On-site medical clinics if more than basic first aid – IRS has not issued guidance on how to allocate the value of these clinics
• Executive physical programs – likely just the cost of the program allocated across all participating executives

Here's what is not included:

• Dental coverage
• Vision coverage
• Employee assistance programs (EAP) – not finalized, but IRS likely to exclude EAPs
• Short-term disability
• Long-term disability
• Accidental death & dismemberment
• Workers' compensation
• Long-term care insurance
• Hospital indemnity and specified disease/illness policies if premiums are paid on an after-tax basis
  
• On-site medical clinics for first aid – IRS to issue further guidance, but it seems like the IRS is indicating that if the clinic is really work-comp driven it would be excluded, but if it was more employee wellness driven, it would be included
• VA benefits and other coverage provided to members of the military and their families by states or the federal government
  

How the Annual Limits Are Determined

Determining the annual limit for any particular year is actually rather complex because it is adjusted for several things. The statute pegs the limit in 2020 at $10,200 for employee-only coverage and $27,500 for all other coverage tiers (and for any coverage provided under a multi-employer plan, even employee-only coverage), but there's a one-time adjustment in 2020 for medical inflation that exceeds 55%, measured from 2010, when the ACA was enacted. Thereafter, the limit is adjusted starting in 2021 for changes in cost of living.

The statutory base limit could be increased in a particular year or for a particular employee/former employee by $1,650 to $11,850 for self-only coverage and by $3,450 to $30,950 for other-than-self-only coverage under one of two possible circumstances:

1. On an individual basis, the limit is increased for pre-65 retirees.
2. On a plan-wide basis, the limit is increased if a majority of plan participants work or retired from high-risk professions (law enforcement, firefighters, paramedics, EMTs, longshoreman, construction workers, miners, workers installing or repairing electrical and telecommunications lines and workers in the forestry, agricultural and fishing industries).

The cost-of-living adjustment is made after these increases are applied, as applicable. We expect the IRS to annually publish four limits: inflation-adjusted base limits for self-only and other-than-self-only coverage, and inflation-adjusted higher limits for self-only and other-than-self-only coverage for retirees and high-risk professions.
 
We also expect the IRS to annually publish age-and-gender adjustment tables because the Cadillac tax, after the inflation adjustment, is further increased for employers whose workforces are older or employ more females than the national average. The IRS' current thinking is that employers would determine their age and gender makeup as of January 1 and compare the distribution of ages and genders to tables the IRS will publish. Employers with higher proportions of older and/or (presumably) female workers will get to add a certain dollar amount to the self-only and other-than-self-only limits (as adjusted for inflation, retirees and high-risk professions).

Confused yet?

Who's Liable for the Cadillac Tax

Before getting too far into the weeds of who pays the tax, first recognize that the issue of who pays is largely administrative. The employer has the responsibility for calculating the tax and informing its vendors of the amount of their respective contribution, and those vendors are going to expect compensation to cover the tax, so in reality the vendors are little more than paying agents, analogous to the three-way relationship for payroll taxes among a company, its payroll vendor and the IRS. The details are scant, but here's the guidance we do have.

• Insured major medical coverage – The insurer pays the tax on excess benefits attributable to insured coverage.
• Self-insured major medical coverage – Unknown; two possibilities, discussed below.
• HSAs – The employer pays the tax on excess benefits attributable to a health savings account (HSA) or Archer medical savings account.
• HRA – Unknown; two possibilities, discussed below.
• FSA – Unknown; two possibilities, discussed below.
• Separate Rx administration (PBM) – Unknown; two possibilities, discussed below.

The IRS is debating whether the employer or third-party administrator will pay the tax on excess benefits attributable to health reimbursement arrangements (HRA), healthcare flexible spending accounts (FSA), self-insured major medical coverage and self-insured pharmacy benefit management (PBM). While there's some precedent for self-insured medical TPAs and PBMs to pay a fee or tax on an employer's behalf (i.e., the transitional reinsurance fee), there's no such precedent for administrators of HRAs or FSAs. Also, FSA and HRA administrators tend to be smaller outfits than their major medical and Rx counterparts. If the IRS imposes the duty of payment on the TPA, it would mark a big change in those niche industry. That's why we think it more likely that the IRS will impose the payment obligation for self-insured coverages on the employer rather than the TPA. 

Calculation Mechanics and Payment Timing

If any excise tax is owed, it is calculated and paid on a calendar year basis, regardless of what the employer's plan year is. It is also calculated month-by-month, employee-by-employee and former-employee-by-former-employee based on the benefits in which each employee or former employee is enrolled. An employee electing family coverage and $2,550 in FSA salary reductions will have a different applicable coverage value than an employee electing a different medical coverage tier, and the value will be different, still, for an employee electing a different FSA salary reduction amount.

As we've indicated above in discussing what is "applicable coverage," the IRS is considering deviating from the timing of determining COBRA rates (required to be calculated in advance), potentially instead opting to determine coverage value after the end of the year for self-insured coverage and insured coverage with experience rebates or level-funding formulas. Ultimately, we don't believe the IRS will go this route and will instead opt to use the COBRA rate determination mechanics. If it does, the IRS likely will clamp down on employers' ability to change methodology for COBRA rate calculation, requiring a methodology to be used for a period of two to five years.

Another calculation mechanics issue arises with respect to employees who are enrolled in several types of coverage, some of which are employee-only and some of which are not. For example, an employee could be enrolled in employee-only major medical and a healthcare FSA that reimburses expenses incurred by the employee's entire family. The IRS is likely going to permit employers to use the higher other-than-self-only limit in such cases.

Other than what's discussed here, not much else is known about the mechanics of the Cadillac tax. The IRS still has yet to issue guidance or give any sort of indication as to when the notice from employers to their vendors might be due, when the tax payment is due, etc. We expect most of these issues will be addressed when IRS issues proposed regulations.