November 4, 2015
Mark W. Wolfgram, CPA, MST
Bel Brands USA, Inc.
Key Highlight: New 40% Non-Deductible Tax Debuts in 2018; Planning Needed Now to Avoid/Minimize this New Tax Burden
Despite Supreme Court challenges in 2012 and 2015, the Affordable Care Act (also known as “Obamacare”) remains the law of the land as we enter 2016. The final, and perhaps most unnerving, aspect of the law to be implemented is now squarely on the horizon - the so-called “Cadillac Tax” on high value insurance provided by employers. This article will provide background information on the Cadillac tax, inform the reader how the tax will be computed, and offer planning strategies for CPAs to use with their clients or their businesses.
The Cadillac tax is a new excise tax imposed on high-cost health care coverage plans under Internal Revenue Code Section 4980I. This tax is effective January 1, 2018. The tax is paid by the provider of the insurance coverage. For self-insured companies, they will remit the tax directly to Treasury. For companies with insurance providers, the insurance providers will remit the tax directly but, presumably, would pass the tax down to the company providing the benefits.
There are three aspects of the tax which, on the surface, are troubling for employers. First, the tax rate is 40 percent on the value of health care coverage over the established thresholds (more on those later). Second, there is a 100 percent penalty on any underpayment of the tax, plus interest expense on the underpayment amount. Third, the tax is not deductible for Federal income tax purposes. The tax rate, underpayment penalty rate, and non-deductibility of this tax is unique in the tax code and definitely causes some concern.
The Cadillac tax was included in the Affordable Care Act as a revenue raiser to help pay for the broader availability of insurance. The tax is also supposed to act as a deterrent for companies to skirt compensation rules by offering employees tax-free benefits. Some economists will also argue that the tax should drive down the cost of health care spending. The argument is insurance companies now are paying too much for health care and that by limiting the value of health care coverage the underlying health care costs will subsequently be driven down as well.
The Cadillac tax is applied against the excess value of health coverage over the established threshold amounts. Initially, the thresholds are set at $10,200 for single coverage and $27,500 for all other coverage. These thresholds are subject to change, however, based on health care cost fluctuation measured between the Affordable Care Act’s passing in 2010 and the effective date of the Cadillac tax on January 1, 2018. Note the thresholds may go above the initial $10,200/$27,500 thresholds but will not be lower than those values. The thresholds will be adjusted annually for inflation.
The thresholds can also be adjusted for certain companies meeting unique profiles. Companies with employee bases which have an age or gender imbalance are eligible for an additional $1,650/$3,450 in threshold cap. Companies where more than 50 percent of their employees are engaged in high-risk professions such as police and fire departments or construction, mining, and agriculture are also eligible for a threshold increase.
But what is the value of the health coverage employers’ offer? The specifics are not 100 percent final but here are a list of items which are included at this point:
Health Insurance Made Available to Employees Which is Excluded from Income
Employee Salary Reductions
Prescription Drug Coverage
Employer Contributions to Health Savings Accounts
Dental/Vision/Supplemental Health Insurance Which Are Not Separate Policies
The following items are specifically excluded at this point:
Separate Dental/Vision/Supplemental Health Insurance Policies
Coverage Purchased by Employees with After-Tax Dollars
Disability/Long-Term Care Benefits
Workers’ Compensation Insurance
Automobile Medical Payment Insurance
Other Similar Insurance Cover Under Which Benefits for Medical Care are Secondary or Incidental to Other Insurance Benefits
The IRS issued Notice 2015-16 earlier this year to gather comments on the Cadillac tax and help clarify open issues relating the this provision in the Affordable Care Act. The comment period ending in May and tax practitioners await the findings of those comments. The IRS is schedule to issue a future notice on actually calculating and assessing the excise tax so tax practitioners should be on the lookout for more information. Regulations related to the Cadillac tax are expected in 2017.
Of course, every aspect of the Affordable Care Act receives tremendous scrutiny in Washington and on the political campaign trail. Efforts to repeal the Cadillac tax are in various stages. On September 22, 2015 the Republican-controlled House of Representatives passed a bill to repeal the Cadillac tax along with other Affordable Care Act provisions. This bill was passed using the “reconciliation” technique which should allow for it to be moved through the Senate at some point. The bill would then get to President Obama’s desk where it would be vetoed without hope of being overturned by a divided Congress. Republican presidential candidates have been vocal and unified in their opposition to many aspects of the Affordable Care Act, including the Cadillac tax. Even presidential candidates on the Democrat side have begun to fight the Cadillac tax. Sen. Bernie Sanders introduced a bill to repeal the Cadillac tax on September 24, 2015 and Hillary Clinton vowed to repeal the tax on September 29, 2015.
This information might cause the reader to infer that planning for the Cadillac tax is not worthwhile given the opponents it has in Washington and on the campaign trail. The problem with repealing the Cadillac tax, however, is the cost. The estimated budget hit for repealing the Cadillac tax is $87 billion. Items which costs much less than this are difficult to push through so a controversial provision such as the Cadillac tax would be extremely difficult to add to the deficit and/or replace with a similar revenue raiser. While it would obviously be easier to hope for a repeal, that would not be a wise strategy at this point.
Depending on where a CPA practices, the approach to planning for the Cadillac tax will be different. Client-facing CPAs in public practice should be getting information about the Cadillac tax in front of clients now. Year-end planning meetings are the perfect opportunity to show clients that you are thinking of them and helping them make sure they are on top of this situation.
Internally-facing CPAs will most likely be involved in the planning process for their companies. The starting point should be determining who will be leading the efforts for the Cadillac tax. Typically this would be the HR team or the team which handles employee benefits.
The next step would be to determine possible Cadillac tax exposure based on current and trending rates for your insurance offerings. The company’s benefits provider will be crucial in gathering the data for this step and helping the company analyze the findings. The benefits provider can then review plan offerings to determine whether the right benefits mix is being offered.
There are many reasons to consider doing this analysis now but two particularly stand out.
One, if a company determines the Cadillac tax will have a material impact on their benefit offerings, a decision has to be made on how to approach the next steps. The company could decide to just pay the Cadillac tax and keep the current offerings. This impacts future budgeting and should be considered a cost of doing business. But if the company decides to reduce costs in various ways (reduce offerings, increase deductibles, etc.), it may be best for that company to reduce the cost over time rather than going off a cliff between 2017 and 2018. Conversations surrounding employee benefits are never easy so it’s important to consider the impact on employee morale and retention when changes to benefits are proposed.
Two, companies with union employees need to plan future negotiations carefully. Companies may now be negotiating contracts with the employee union which will spill into 2018 and making any health offerings subject to the Cadillac tax. If planning is not done now, companies may be unknowingly committing themselves to paying the Cadillac tax should the benefits being offered exceed the thresholds outlined above.
All CPAs should continue to monitor the legislation related to the Cadillac tax and respond to IRS requests for comments, where appropriate. CPAs should also be sure to keep the lines of communications open between the involved parties so everyone is progressing in a unified fashion.
The Cadillac tax is certainly something to be concerned about at this point but proactive planning and education are the keys to minimize the burden this new tax may have on companies.
For more information on the Cadillac tax, please review Internal Revenue Code Section 4980I, Notice 2015-16, and/or reach out to your benefits provider.
Disclaimer: This article is designed to provide information in regard to the subject matter and has been prepared with the understanding that neither the Illinois CPA Society nor the author of this article is providing accounting, tax or legal advice or is performing any legal, accounting or other professional service. If accounting, tax or legal advice or other expert assistance is required, the services of a competent professional person should be sought.