You are on page 1of 3

Prompt Action Required Because New Health Care Non-

Discrimination Rules Covering Executives May Affect


Insured Health Coverages
Thomas M. White
ARNSTEIN & LEHR LLP
120 S OUT H RI VERS I D E PLAZ A | SUI T E 120 0
C HI C AG O, I L 6060 6
P 312 .8 76. 718 4 | F 312. 876 .0 288
tmwhite@arnstein.com

Most employers recognize that their self-insured health plans must not discriminate in favor
of highly compensated employees if those benefits are to be provided on a tax free basis.
However, these non-discrimination rules have not previously been applied to insured health
care programs. Consequently, many employers have purchased health care policies only for
key executives and some employers provide “preferential” insured health care benefits to
former employees after their COBRA continuation period expires. Under new health care
legislation, the Patient Protection and Affordable Care Act and the Health Care and Education
Reconciliation Act of 2010, significant tax penalties may be imposed on many employers that
provide “discriminatory” insured health benefits. These rules will apply, for example, to
individual health care policies, certain COBRA continuation arrangements and to some
longterm care contracts. The tax rules regarding discriminatory non-insured programs
continue in effect.

Except as explained below, effective for plan years beginning after September 23, 2010,
nondiscrimination rules apply to many insured group health plans. In general, employers with
fewer than 50 employees are not subject to the new standards. For example, it would be
discriminatory for an insured plan to provide benefits only to the president of the plan’s
sponsor, to provide better (or less expensive) benefits to executives or other highly
compensated employees, or to extend cost-free COBRA continuation coverage only to a
handful of the most highly compensated employees.

1
Consistent with prior law, there are no adverse tax consequences to the highly compensated
employee who benefits under a discriminatory insured health plan. Instead, the new law
provides for a $100 per day per participant penalty on employers that establish discriminatory
insured health plans. This penalty is draconian and in almost all cases will exceed the cost of
the insurance premium.

For purposes of compliance, the group that may not receive discriminatory (i.e., preferential)
benefits are (i) the employer’s five highest paid officers; (ii) individuals who are 10% or more
shareholders of the employer; and (iii) the highest paid 25% of all employees.\

There are different effective dates for complying with the new law.
• Employers that have provided benefits under insurance policies in effect on March 23,
2010 may continue to provide discriminatory benefits if these programs do not lose
their “grandfathered” status. However, under recently issued guidance, grandfather
status ends, for example, when the benefit is provided under a new insurance policy.
Because many employers adopt new insurance contracts each year, the grandfather
exemption might be of limited utility.

• Policies that are purchased after March 23, 2010 and before September 23, 2010 will be
subject to the non-discrimination requirements beginning with the first “plan year”
(typically, the contract year) commencing after September 23, 2010. Policies purchased
on or after September 23, 2010 will be immediately subject to the new rules.

• Employers should proceed now to determine whether they will be covered by the new
nondiscrimination standards. Any new insurance and employment related contracts
should comply with the new rules. In the case of existing arrangements, if the new rules
will apply, employers should identify the affected employment agreements and then
notify those individuals who receive discriminatory benefits of the consequences of the
new tax regime.

2
Because in many cases, these agreements are still legally binding between the employer and
employee, they may not be amended or terminated without the consent of each party. This
means that negotiations will be necessary and employees may request an increase in the
payments due them because the new bargained for consideration will be subject to income
tax and, therefore, less valuable to the individual, while the old benefit was non-taxable to the
employee.

There are aspects of the new health care tax rules which have yet to be clarified by
appropriate regulations. Of course, in a very complex and technical area such as this, legal
counsel and the employer’s insurance broker should be contacted as soon as possible in
order to identify the scope of any problems and possible solutions.

********

Click here to read about recent changes the IRS made to the deadline for complying with the
new non-discrimination rules.

You might also like